What is and how does it work?
A 1035 exchange refers to the IRS tax code that allows for a tax-free transfer of an insurance product like life insurance or an annuity contract for another without a tax consequence. The advantage to you is this – you don’t have to be stuck with an old, poorly designed policy. You can exchange an outdated or underperforming product for a new one with better guarantees, more attractive features, and less restrictive requirements. When we work with clients to determine if this makes sense for them – we always order an in-force illustration of the current policy and carefully review all the details to ensure we can improve their position before making any recommendations.
There are a few key things to understand to make sure you get the maximum benefit:
- You cannot take ownership of the funds and then use them. You must transfer the funds from policy to policy or company to company.
- The policy owner must remain the same
- Both full and partial exchanges are allowed for annuities, but companies can set their own rules.
- Usually, a 1035 requires the same products – for example, life insurance to life insurance. However, you can use a life insurance policy to purchase an annuity.
- If you have an outstanding loan on the policy – it is advisable to pay the loan back before the exchange. Many carriers are unwilling to issue a new policy with an outstanding loan.
- You can combine multiple policies into one more efficient policy.
Here are a few examples of when a 1035 can be a perfect solution:
We had a client who was no longer working and didn’t want to keep paying her life insurance premium, but she had a significant amount of money in her cash value. She has the right to 1035 to a single premium whole life plan. A single premium plan means the policy is paid up, and no additional premiums are due. She could access her cash value, keep a tax-free death benefit for her children, keep her living benefits, and all the other contractual features that come with a whole life policy.
Another client had two universal life policies and a variable universal policy. After reviewing the in-force illustrations, we could see that with the increasing cost of insurance and expenses, she could do better. We did a 1035 exchange for all three policies into one Infinite Banking-designed policy. Now he has an efficient place to store his cash and a guaranteed death benefit.
Another impressive feature of a 1035 exchange is that the cost basis from your old plan is credited to the new plan. Cost basis is the original amount of money you put into the contract. For example, let’s say you have an underperforming variable annuity with high fees that you put in $200,00, but it is now worth only $160,000. You can move it to a much more efficient Fixed Indexed Annuity that provides lifetime income. Because you were credited the original cost basis, you will pay fewer taxes when you turn on income.
A tax-free 1035 exchange can be valuable if you want to improve an existing product, but your advisor must understand the benefits and downfalls.
Do you have an old whole life, universal life, indexed universal life, or annuity policy that needs to be reviewed? Do you know the death benefit amount, the current cash value, if you have living benefits, or what income you can expect? If you can’t answer these questions – please let us help put an end to the mystery! Give us a call at 574-234-1980 or send us a message at hello@neeserinsurance.com.
