Tax Free Exchanges using section 1035

Uncle Sam wants to tax your life insurance cash values and your annuity cash values. A 1035 Tax Free Exchange can help you legally avoid taxes on gain inside a policy.

The most common reason why an old life insurance policy or old annuity policy is exchanged 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 costs, reductions in policy administration expense, improvements in underwriting, improvements in the insureds health, improved interest crediting, higher potential dividends, and increased interest linked to an index. In some cases, worsening health can result in higher annuity income payments by making an exchange.

For example, starting in January of 2020, all new life insurance policies must use the 2017 Commissioner's Standard Ordinary (CSO) Mortality Table was adopted by the National Association of Insurance Commissioners. Beginning in January of 2022, all new life insurance policies must use updated guaranteed interest rates to comply with amendments to IRS Section 7702.

In some cases, premiums are lower, and in others the accumulation of cash values will be higher. Plus, we have many improvements in policy design. To take advantage of pricing and design improvements, one may want to cash out of an old policy and purchase a new one.

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 policy for a 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 values, living benefits, and retirement income.

For example, if your old 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.

Some new policies have special riders* which enhance their performance and values. A common example are new Living Benefit riders and Income Benefit riders.

Buyer Beware: Section 1035 Exchanges are not "Do It Yourself" deals. The average accountant or attorney will not know much, if anything, about this code section. Insurance company home offices cannot give you legal or accounting advice, and the average "financial planner" has never completed a 1035 Exchange in their life. The majority of insurance agents haven't completed one, either.

Fortunately, you've found the right place for help.

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* A rider is an optional feature that provides for enhanced policy benefits.