What is a 1035 exchange? How do they work? 1035 exchanges can get complicated. In this guide we will answer common questions about the 1035 exchange and how you can utilize it to have guaranteed income for life and how the 1035 exchange relates to annuities and life insurance.
Table Of Contents
- What Is A 1035 Exchange?
- How Does A 1035 Exchange work?
- When Is A 1035 Exchange Good For A Life Insurance Policy?
What Is A 1035 Exchange?
A 1035 exchange is part of the tax code that allows that tax-free transfer of a life insurance policy, annuity, long term care product, or other endowment to another “like kind” product.
How Does A 1035 Exchange Work?
Generally, the exchange between “like kind” products must be the same type of product. This means you can exchange an annuity for another annuity, but not another product like life insurance or long term care.
However, you can exchange a life insurance policy for a non-qualified annuity, endowment, or long term care. You cannot exchange a non-qualified annuity or other product for a life insurance policy though.
When Is A 1035 Exchange Good For A Life Insurance Policy?
There are only certain times when a 1035 exchange makes sense.
Since the whole point of the 1035 exchange is to get tax savings, if you do not have any gain on your life insurance policy there is no point to doing a 1035 exchange as there is no tax to begin with.
A gain on your life insurance policy is the difference between the total cash value (minus any loans on the policy) and the premium tax basis, which is generally the total amount of premiums you have put into the policy.
Most people do not have any gain on their life insurance policy for many years as it takes quite a while for a life insurance policy cash value to grow.
The gain on the life insurance policy, if you have any, will be taxed as ordinary income in your tax bracket if you surrender the policy while still living and take out the surrender value. It is important to note that payout due to death will always be tax free.
A 1035 exchange is only a good idea if you have a gain on the insurance policy, want to surrender the policy, and want to convert that policy into real income, like an annuity or other financial product.
We help Seniors 1035 exchange their large cash value life insurance policies to annuities to guarantee income for life, but they are not necessary for everyone. The fact is, most people do not enough cash value in their life insurance contract to trigger any tax and warrant a 1035 exchange.
If you are unsure, contact an advisor to discuss your options.
Note: This is not tax or investment advice.