It is possible to transfer the essence of one life insurance policy from one company to another.
The process involves the transfer of cash values from one policy contract to another so that the transaction qualifies under law.
This is accomplished by a process that falls under Code 1035 of the Internal Revenue Code allowing a tax-free transfer of assets under the thinking that an exchange is made under the rules of Section 1035.
It is important that the proper procedures be followed, so there are no problems. Otherwise, taxable gains and other issues could develop.`
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A Like Property Exchange
To qualify for a 1035 exchange, the transfer of assets from one policy to another must be a “like-kind of exchange” or the transaction will not qualify and might amount to a taxable event.
The exchange takes place without the recognition of any gain in the process.
Once the exchange is made the new contract takes by the old contract, make it a non-taxable event.
Insurance Contracts That Qualify For a Section 1035 Exchange
The following examples are Section 1035 transactions that qualify for tax-free exchanges:
- A life insurance contract that is exchanged for a life insurance contract
- A life insurance contract that is exchanged for an endowment policy
- A life insurance contract that is exchanged for an annuity contract
- A life insurance contract that is exchanged for a long-term care qualified contract
Reasons why You would Make an Exchange Under Section 1035 Rules
There are certain reasons why an individual would want to transfer a life insurance to another company. They all would make sense in the following circumstances:
The newer policy is showing a higher return on the cash values to the point where it is an advantage own the newer policy in favor over the old policy.
A company may have introduced a new form of policy that is designed to pay higher returns due to an innovative design or better investments.
Life insurance does have the capability of providing attractive investment features, and it is the choice of policyholders as to what companies they should use to accomplish their personal objectives.
There may be real concern that the condition of the current life insurance company is not good, and transferring to a new company would provide better protection and value
Life insurance companies are businesses, and they don’t always operate at maximum efficiency.
While it is true that life insurance is a more secure business than most, every company does not operate all of the time at maximum profit capabilities.
Poor management can infect life insurance just as it can any business.
A newer policy may be using more up-to-date mortality calculations that result in lower premiums, better benefits and more efficient use of the premium dollars paid for the policy
As medical research and care has developed over the last 50 years or so, the advances in the science of longevity and medical care have advanced significantly.
People are living longer than ever before, so the mortality statistics have become more favorable as far as rating life insurance policies are concerned.
Older life insurance policies with higher premiums, due to out of date mortality costs would be prime candidates for a 1035 exchange to a new policy where the cost was less due to new mortality calculations.
When would it be inadvisable not to do a 1035 exchange of life insurance policies?
There are some circumstances when it would not be the best idea to attempt to make a Section 1035 exchange with life insurance policies:
- Change in Health– If the insured has had a change in health since purchasing the older policy, he might be rated or declined with the newer policy. The reason for the transfer might be overridden by health problems if the rating is too severe.
- Suicide and incontestable provisions– in the newer policy would have to be taken into account because if a death occurred, the policy claim could be denied on those grounds.
- Newer Policy– If the newer policy is issued at an older age, the higher premiums may negate any advantages offered by any concept in a new policy issue.
- Contractual language– could be a detriment to any perceived advantages to getting a new policy. It is always a good idea to thoroughly review the language in the contract to be sure it is to your advantage.
- New Contract-A person should look at a new contract with the current company. There may be factors that are just as favorable, or even more favorable by staying with the original company instead.
- Outstanding loan-If a loan is outstanding on the original contract, there may be no advantage at all in making the exchange.
Other Points Worth Noting With A Section 1035 Exchange
If the rules of a Section 1035 exchange are not followed, the result can be a taxable event that was not intended or foreseen.
In order to qualify the following must be in place:
- The contracts being exchanged must be of “like-kind.” Examples are life to life, annuity to annuity, life or annuity to long-term care, but not annuity to life.
- The funds involved in the transfer must travel from company to company and must not go from company to individual to company.
- The owner-insured, or owner-annuitant must be the same under the old insurance contract and the new insurance contract.
- The contracts involved must be life insurance, annuities, or endowment contracts that are issued by a life insurance company.
Obtaining Assistance In Implementing a Section 1035 Exchange
When contemplation of the institution of a Section 1035 exchange of life insurance policies, annuities, and long-term care policies, individuals should seek the help of competent people.
An attorney, competent life underwriter or home office personnel should be involved in the process.
The process is not terribly complicated, but there are ramifications if mistakes are made.
Following proper procedures by having knowledgeable people helping the process is a recommended procedure.
Obtaining help can avoid tax traps that could have been avoided if competent advice would have been available and followed.
The application of a Section 1035 exchange allows the owner of an insurance policy or an annuity the opportunity to take advantage of a more favorable price, rate of return, or contractual language in a newer product.
Outmoded mortality calculations, better contractual language, and the ability to change to long-term care are some of the reasons that apply to this process.
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