What if there was a way to increase the death benefit and reduce the premiums on an in-force life insurance policy?
How do you upgrade to a better life insurance policy without losing your investment? If you cash out your old policy, you may owe taxes on those funds, even if you take out a new policy that same day. Fortunately, a Section 1035 Exchange lets you transfer funds from one policy to another tax free.
What Is a 1035 Exchange?
“Section 1035” refers to a provision in the Internal Revenue Code allowing direct transfer of accumulated funds from one life insurance or annuity policy to another with no tax liability. The option of making a 1035 Exchange gives you more power as a consumer by letting you change insurers for free (note: the original policy still may have surrender charges if within the surrender period).
IRS Guidelines
The IRS has strict guidelines covering 1035 Exchanges:
- The owner, insured, and annuitant must not change (unless one of the original insureds has died–Survivorship policy).
- The contract must be directly exchanged between insurance companies. You cannot cash out and then reinvest.
- Multiple contracts can be merged into one during the exchange, but one contract cannot typically be broken up into many.
- There are multiple forms required when completing a 1035 Exchange including assignment, surrender, owner and beneficiary forms.
- The Contestability Period (2-years) starts over on a new policy
Conclusion
Reviewing an existing life insurance policy every year is a good idea. It’s important to consult with a reputable licensed insurance group that represents many top-rated carriers. They can help determine if a 1035 Exchange is prudent. And it’s always best to include the council of CPA’s and attorneys when dealing with advanced tax planning topics.
