What Is It?
From time to time, you may consider replacing or exchanging your life insurance policy for another life insurance contract or annuity contract. Exchanging your life insurance policy means that you replace it with another policy issued by the same company or a different one. You may want to exchange your life insurance policy if, for instance, your present life insurance company becomes insolvent or if you can get a better rate of return or lower premium with another policy. The rules governing taxation of life insurance contract exchanges are spelled out in Internal Revenue Code Section 1035. In general, under Section 1035, you can exchange one life insurance contract for another without having to immediately pay income taxes; no gain or loss is immediately recognized. But, you must be careful to follow the rules to qualify for favorable tax treatment under Section 1035.
What Types of Contracts Qualify Under Section 1035?
The following are a few of the transactions that qualify under Section 1035:
- A life insurance contract exchanged for a life insurance contract (both contracts must be on the life of the same insured)
- A life insurance contract exchanged for an endowment contract
- A life insurance contract exchanged for an annuity contract
- A life insurance contract exchanged for a qualified long-term care contract
The following transactions are among those that do not qualify under Section 1035:
- An annuity contract exchanged for a life insurance contract
- An endowment contract exchanged for a life insurance contract
- An annuity contract exchanged for an endowment contract
What If You Have a Loan Outstanding on the Policy You're Exchanging?
Generally, if your loan will be cancelled (discharged) in the course of the exchange transaction, then the amount of the loan is treated as ordinary income to the extent the loan proceeds exceed your basis in the contract and is taxable as such. However, if you exchange a policy that is subject to an outstanding loan for another policy that is also subject to an outstanding loan for the same amount, then the transaction should be tax free, if all other elements of Section 1035 are met.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.
The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.