Understanding The 1035 Tax Free Annuity and Life Insurance Exchange
Get a Quote »You may wish to exchange your old annuity or life insurance policy for a new one for any number of reasons. Section 1035 of the I.R.S tax code allows you to do so without incurring any taxable gains.
The gains from your old policy can be transferred to a new insurance policy on a tax free basis. You can continue to defer taxes in your new policy for a desired number of years or for your lifetime.
What is a 1035 Exchange?
A 1035 tax free exchange is the I.R.S. tax code that allows for the transfer of a non-qualified annuity or life insurance policy to a new policy of equal or greater value. Capital gains and/or income taxes resulting from the growth of the old policy will be avoided and deferred when the transfer is completed properly.
There are three examples of a 1035 exchange:
Tax Free Annuity to Annuity Exchange
Transferring funds from one annuity investment to another is the most common example of a 1035 transfer. Oftentimes this is done simply to establish a new investment.
Perhaps your old annuity is yielding below average interest or you would rather exchange an aggressive and unpredictable variable annuity for one with a more conservative fixed investment account. (View current annuity rates here)
Technically, the exchange only qualifies if you are transferring from a non-qualified annuity to another; otherwise it would be a rollover of qualified funds like an IRA or 403(b). Non qualified accounts are simply those you have already paid taxes on the invested principal, but not the gains.
In order to avoid income taxes on the accumulated gains, you can exchange your old annuity for a new one with the assistance of a licensed agent. It is important to note that there are protocols to this procedure that must be met in order to avoid a taxable event. Both of the insurance companies involved will have paperwork that must be filled out correctly. It is a good idea to contact a knowledgeable agency or agent (presumably us) in order to assure that you are in compliance.
Cash Value Life Insurance 1035 Exchange
This involves the transfer of the accumulated cash value in your old life insurance policy to a new one. You are allowed to withdrawal all (or some of) the cash value in your variable, universal or whole life insurance policy and deposit the funds on a tax free basis into a new life insurance policy.
There are several policy types that allow for the transfer of your cash value, but term life insurance is not one of them. Term life insurance has no cash value for the insured. Additionally, you cannot avoid income taxes by purchasing a term policy using the cash value from an existing whole, variable, universal, or indexed life contract.
You might consider this exchange if you wanted to establish a new single premium paid up life insurance policy. Perhaps your life insurance needs have changed and you no longer wish to pay ongoing premiums. In other cases, you might simply want to establish a new policy that is more in line with your present needs and continue to pay premiums into the new account.
Life Insurance to Annuity 1035 Transfer
If you wish, you can withdrawal the cash value from your life insurance policy and transfer it tax free to an annuity investment account. This is the least common of the three allowable strategies. Conversely, you may not transfer any gains from an annuity account to a life insurance policy without creating a taxable event.
Life insurance policies offer several tax advantage over annuities. At passing, all proceeds from a life policy can be withdrawn tax free by your beneficiaries – including the gains. And life insurance can also avoid federal estate taxes and state inheritance taxes when setup properly.
Thus, if you are unhappy with your life insurance policy for some reason, it may be wise to transfer the accumulated cash value to a single premium paid up policy rather than into an annuity account. If you desire safety and predictability, a single premium whole or indexed life insurance contract can be a good alternative. Both indexed and whole life will earn fixed interest and increase in value year over year based on the declared rate.
In summary, there are several reasons why you might exchange an old life insurance or annuity policy for a new one. You might be seeking a higher rate of return than what your existing annuity policy offers or you may wish to establish a more conservative investment. In the case of life insurance, you may simply wish to transfer the existing cash value to a paid up policy so you can avoid ongoing premium payments.
At Hyers and Associates, we work with several highly rated insurance companies that provide very competitive life and annuity policies for our clients. Contact us today and we will make a suitable recommendation based on your needs.