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.
* A rider is an optional feature that provides for enhanced policy benefits.
You can exchange an old life policy for a new life policy without paying an taxes using Section 1035.
A life policy can be exchanged for a new annuity policy, without any taxes due.
You can exchange an old life policy for a new long term care insurance policy, or for a new life policy with benefits for long term care.
New life policies have improved benefits and new optional features that may improve your situation by using Section 1035.
You can exchange a whole life policy for an indexed universal life policy, or you can exchange an old universal life policy for a new whole life plan.
By using Section 1035 you can preserve your cash values by legally avoiding taxation. You can also preserve your cost basis, which may be useful in the future.
If you need income now, an exchange of your old annuity into an new annuity may pay you a higher guaranteed income.
A newer annuity can pay a higher income in the future than most older annuities by using a modern income rider design.
If your old annuity isn't paying high enough interest, then a tax free exchange for a new annuity can improve your yield.
Some new annuities pay higher benefits than older annuities for people that need long term care.
A fixed annuity or variable annuity can be exchanged for a new indexed annuity with better benefits and higher income guarantees.
By using Section 1035, an old non-qualified annuity can be exchanged for a new non-qualified annuity, tax free.
Brent began his career in insurance in 1991 as a Career Agent with a large midwestern mutual life insurance company. In 1997, Brent started an independent life insurance brokerage agency, taking over a family-built book of business that dates back to 1922, including servicing policies issued in the 1890s. He's been helping his clients use Section 1035 for more than thirty years.
Using Section 1035 can help you and your family enjoy more benefits from the life insurance policies and annuities you have paid premiums for.
A Section 1035 Exchange can enable you to get more coverage, more benefits, or reduce your premiums, all while avoiding the tax trap from premature policy surrenders.