Avoid the Tax Trap! Uncle Sam wants to tax your life insurance cash values, or your annuity cash values. A 1035 Tax Free Exchange can avoid, or at least defer, taxes.
The most common reason why an old life insurance policy or old annuity policy is exchange for a new life insurance policy or new annuity policy is because newer policies often perform much better than old insurance policies, due to improvements in mortality (lower insurance cost), reductions in policy administration expense (lower costs), improvements in underwriting (lower costs), improvements in the insureds health (lower cost), improved interest crediting (higher rates of interest, and interest linked to an index), and in some cases, worsening health (higher annuity payments).
For example, starting in January of 2009, all new life insurance policies must use the 2001 CSO Mortality Table was adopted by the National Association of Insurance Commissioners back in December 2002.
In simple terms, people are living longer, so the cost of life insurance is lower now than at any time in the past.
The tax trap lies in surrendering an old policy when a new policy is purchased. If there is any taxable gain built up inside the policy, then the surrender is a taxable event. By effecting a “ten thirty-five exchange” the old policy’s cash values (and cost basis) are transferred to the new life insurance policy - tax free!
Another good reason to exchange an old life insurance policy to a new life insurance policy, or to exchange an old annuity policy to a new annuity policy, is the interest rate the company credits on the policy values, as well as how the interest is calculated. All things being equal, the more interest credited to a policy, the more cash value the policy owner will have available for policy loans, withdrawals, cash surrender, and retirement income.
Many old annuity policies would benefit from being exchanged for new annuity policies in order to earn more interest, just like with life insurance. For example, if your annuity policy is crediting 3% interest, and there is a new policy that is crediting 5%, then a 1035 tax free exchange may be be the right thing to do.
But there’s more...
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* A rider is an optional feature that provides for enhanced policy benefits.