Tax Free Policy Exchanges

Tax-Free Policy Exchanges

(Sec. 1035)

As life insurance policies evolve, improvements in policy design have enhanced flexibility, rate of return, and price. As a result, some consumers find it attractive to exchange old policies for newer models.

Section 1035 of the Internal Revenue Code lets consumers defer taxation of the gain in older policies when they are exchanged for new ones, provided certain requirements are met.

When the requirements of Section 1035 are met, the transferor recognizes no gain for federal income tax purposes on the exchange of any of the following:

	A life insurance policy for another life insurance policy, or for an annuity or endowment contract
	An annuity contract for another annuity contract
	An endowment contract for an annuity contract, or for another endowment contract that provides for regular payments beginning no later than the payments prescribed under the old contract

The requirements of Section 1035 specify that…

	The new life insurance policy must insure the same life as the old policy. A policy on one life may not be exchanged for a policy on two lives.
	A new annuity contract must have the same annuitant (payee) as the old contract.
	If cash or other "boot" is part of the exchange, the transferor recognizes gain up to the amount of cash or other boot received. This gain is taxable as ordinary income.
	The income tax basis of the old policy carries over to the new policy.

A 1035 exchange isn't for everyone. Consider the "red flags" that should be examined before a 1035 exchange is carried out:

	Is the insured still insurable? Does the insured qualify for the new coverage at standard rates? Don't terminate an old policy before insurability is determined.
	Does the old policy enjoy any tax advantages that are unavailable in the new policy?
	Does the old policy have an outstanding policy loan? Loans can complicate policy exchanges and may cause the policy owner to recognize taxable gain on the transaction.

(Source-Transamerica)

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