From IRS Bulletin 2003-51 :

The legislative history of Section 1035 states that exchange treatment is appropriate for “individuals who have merely exchanged one insurance policy for another better suited to their needs and who have not actually realized gain.” H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).
In Conway v. Commissioner, 111 T.C. 350 (1998), acq., 1999-2 C.B. xvi, the Tax Court held that the direct exchange by an insurance company of a portion of an existing annuity contract to an unrelated insurance company for a new annuity contract was a tax-free exchange under Section 1035. In that case, the transfer was made directly from the first insurance company to the unrelated insurance company, and none of the assets transferred in the transaction were received by the taxpayer.

What does all of this mean? Quite simply:

An owner of certain insurance contracts can exchange their cash into a new insurance contract without incurring current tax liability if the exchange follows certain rules.
This means that cash in an old life insurance policy can be transferred into a new cash value insurance policy, or into a new annuity. Money from an old annuity can be exchanged into a new annuity but not into a life insurance policy.
How could this benefit you?

You may have built up significant cash in an old policy (which is good) but that policy lacks some of the newer features and benefits that new annuities or life insurance offer. Some examples of improvements could be:

  • Your current annuity company’s payout ratio for conversion to an immediate annuity income stream is not as generous as another company. Solution: 1035 exchange to the new company and establish an immediate annuity
  • Your current fixed annuity earns a simple interest rate but you like the idea of a newer policy with a guaranteed* income rider and the ability to invest in stocks. Solution: exchange that fixed for a variable annuity with these benefits.
  • You have a $25,000 life insurance policy with $25,000 of cash value. Your goals have changed and you want to invest the money more aggressively. Solution: exchange the life insurance for a variable annuity
  • You have significant cash in a life insurance policy, but there it does not have a no-lapse guarantee. After proper analysis and comparison, you find another company that will offer a no-lapse guarantee and the transfer economics work. Solution: exchange the cash value to a new life insurance policy

There are many options to consider here of course. However, the important thing is not to look at your life insurance or annuity in a tunnel. A comprehensive analysis of your insurance products is required and then you can determine the best course of action to provide retirement security and develop your own plan for a secure income stream in retirement. It is also important that you make sure you don’t make any of the mistakes often involved with poorly executed exchanges that cause an unintended taxable event.

Working with a financial advisor teamed with an insurance expert and tax expert can help you pull all of this together. If you are in this situation, it may make sense to analyze your assets and financial situation to see if updates to your financial plan make sense.

Don’t Know What to Do?

If you are facing a situation like this with your annuity or life insurance  and

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don’t know what to do, give me a call. We have helped people in many situations like this. If you would first like some questions answered give us a call - 781.393.0021 or send us a quick contact and we can go from there. Thanks for stopping by!

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Notes:

*Certain protocols must be followed when enacting a 1035 exchange and the IRS can be very strict about this. Example IRS Bulletin – consult an advisor before attempting a 1035 exchange

Guarantees offered by insurance companies are based on the claims-paying ability of the insurers and are not government or FDIC guaranteed in any way

See our disclaimer HERE