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This website is for those seeking annuity information that could be helpful in deciding if an annuity should be an important part of a retirement portfolio. We hope to provide answers to your questions here. Let us know if you cannot find the information you need.           Your call is always welcome  (800) 601-5433
 

1035 Exchanges

You may have heard good things about section 1035 exchanges and life insurance but are unsure about exactly what is a 1035 exchange.

Simply put, a 1035 exchange is a tax free transfer of funds from one permanent life insurance policy to another permanent life insurance policy.  Likewise, endowments can be transferred tax-free to other endowments (as long as the maturity date is equal to or before the existing policy) and annuity funds can be transferred to another annuity or to an endowment.

How To Qualify 

The Internal Revenue Service sets the policy for these exchanges in section 1035 of the IRS code.

The IRS has only a few requirements to allow for 1035 exchanges:

  • The new policy must be of equal or greater value than the existing policy.
  • You can’t sell one policy and buy another yourself. The policies must be directly exchanged in a business-to-business transaction. If you take direct control of the funds, you will be taxed.
  • The owner and the insured in the original policy must be the owner and insured in the new policy.  

How You Can Benefit From A 1035 Exchange 

In trying to understand what is a 1035 exchange, the obvious question is: How can such an exchange help me?

There are numerous compelling reasons to switch policies using a 1035 exchange, including:

  • If your health status has changed for the better (e.g., you quit smoking), you could qualify for a lower premium or higher death benefit with a new policy. 
  • You may find an insurance carrier who simply provides a more competitive rate and/or death benefit (relative to your premium) than the company who has your existing policy. 
  • If your existing policy has accumulated cash value and you don't need the cash, you can use the existing policy to “pay down” the new policy, thereby setting yourself up with a higher face-value death benefit (for the same premium) or lower premiums (with the same death benefit) for the rest of your life. You may even be able to get more face value for less of a premium! 
  • You may be able to move money in an annuity to a better-performing annuity.
  • You can exchange two or more existing policies for one new contract, as long as the other requirements are met. (However, the 1035 rule of thumb—that the new policy must be of like kind—prohibits changing the type of policy. So, for example, you can’t switch from two regular single-life policies to one survivorship policy.)
  • You can opt for a lower death benefit on the new policy, thereby lowering premiums. 
  • You may be worried about your existing carrier’s financial strength and want a more secure policy. 

The Bottom Line  

Understanding what is a 1035 exchange only gets you started. The process of dealing with your existing and new insurance company on a 1035 exchange can be challenging without professional help. An independent life insurance agent familiar with the market and 1035 exchanges can work with you to:

  • determine if a 1035 exchange makes sense for you, including obtaining a “current illustration” (cash/surrender amount) of the existing policy value
  • guide you through the process 
  • make sure you understand the tax issues as well as the benefits and consequences of your new policy.  

You stand to benefit significantly from a 1035 exchange, so don’t hesitate to seek out an independent agent who can help you get the most value from the hard-earned money you spend on life insurance.

1035 Exchange - Transfers  -  Roll-Overs
 

1035 refers to a provision in the tax code which allows for the direct transfer of accumulated funds in a life insurance policy, endowment policy, annuity policy to another life insurance policy, endowment policy or annuity contract without creating a taxable event.

Title 26, Subtitle A, Chapter 1, Sub chapter O, Part III, Section 1035 states that “no gain or no loss shall be recognized on the exchange” of life insurance policy for another life insurance policy or endowment or annuity policy.

An IRA or 401k is easily rolled over to an annuity without paying taxes. When you apply for an insurance company annuity with pre-tax money, the insurer creates an "IRA Annuity" account into which your money is transferred directly.

Non Taxable Transfers
Robert purchased a life insurance policy 20 years ago with a death benefit of $100,000, the premium was $1,000 a year and has a cash surrender value of $75,000. Robert is now retiring and has adequate life insurance provided by another life insurance policy.

Robert doesn’t need any income at this time but has decided to purchase an annuity paying a guaranteed rate of interest at 6.0%. Robert doesn’t want to “cash in” in his life insurance since there would be a “gain” which would be taxed.

The value of the policy is $75,000. The premiums paid total $20,000 and if Robert “cashes in” his policy the gain of $45,000 would be subject to taxation.

The solution is to “cash in” his life insurance policy by executing a “1035 transfer”. Robert would fill out a 1035 transfer form which would direct the life insurance company to “cash in” his policy and send the $45,000 directly to the company which is issuing his annuity policy.

In this way there would be no taxes due, further the “cost basis” of $20,000 would become the “cost basis” of his annuity contract.

1035 transfers used with annuity or variable annuity contracts in the same way to transfer the funds of one annuity to that of an annuity paying a higher rate of interest. It is suggested that before you do this, check an see if there would be any penalties or surrender charges imposed before you “cash in” an annuity contract.

Congratulations you have a new job! You’ve just retired! In either case you have to decide what you want to do with the assets you have accumulated in your retirement plan.

Leaving it where it is?
Sometimes your former employer may allow you to leave the assets you have accumulated within your current plan. However you may have greater investment options and greater flexibility in withdrawing your funds by rolling over your assets into your own IRA.

Transferring it to your new employer?
Your new employer allows you to rollover your assets from you former employer to your new employer’s retirement plan. A good choice? Again your investment options are limited to the choices that are available within your new employers plan.

Some plans may also impose a “waiting period” before you can rollover your money from your former employer.

Taking your money in cash?
Most often this is least desirable option. If your former employer sends you a check they are required to withhold 20% for federal taxes. In addition if you do not deposit balance in another retirement plan or IRA within 60 days, the entire amount becomes taxable. If your under age 59 1/2 you may be subject to an additional penalty of 10%.

Separate IRA for Rollovers
Most often opening an IRA just for money that will be rolled over from one or more retirement plans is usually the best solution. The advantages of opening an IRA just for rollovers; You can transfer these funds back into an employer sponsored retirement plan if you decide to.

You have the option of placing these funds in a wide variety of investment options including, mutual funds, variable annuities, annuities and self directed IRA’s.

The ease of calculating the minimum required distributions amount based on one account verses several accounts. Many times the institution with whom you opened your IRA will assist you in calculating the minimum distribution amount.

Reference Tax Code Section 1035

If you have questions concerning a 1035 transfer, please call us at (800) 601-5433.

 

Hammond insurance does not give tax or legal advice. The comments regarding tax treatment on this website simply reflect our understanding of current interpretations of tax laws as they apply to annuities. Since tax laws are always subject to interpretation and possible changes in the future. we recommend that you seek counsel of your attorney, accountant or other qualified tax advisor regarding annuity taxation as it applies to your particular situation

 

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