THERE IS A HUGE CHANCE YOU CAN DO THIS TAX-FREE!

1035 Life Insurance Exchange Guidelines and  Exchange Procedures

A Section 1035 exchange permits a policy-owner to transfer the cash value from one life insurance or annuity contract to another without income tax consequences, provided proper procedures are followed and the policy-owner does not receive any money (property) in the exchange.

Even if there is no gain in the policy to be exchanged, a 1035 exchange permits the adjusted cost basis of the old policy to be carried over to the new policy. To qualify, however, it is very important to remember that the insured and owner must be the same on both policies.

You can transact a Section 1035 IRS policy exchange as follows:

• A life insurance contract for another life insurance contract or for an annuity contract if you no longer desire the death benefit element.

Note: The exchange of two single life policies for a policy insuring two lives (survivorship policy) does not qualify as a non-taxable exchange.

However: The IRS has permitted an exchange of a survivorship policy where the first insured has died for a single life policy insuring the life of the surviving insured.

• An endowment contract for an annuity contract. 

Note: Endowment to endowment is not allowed by IRS 1035 rules.

• An annuity for an annuity.

Note: An exchange of an annuity for a life insurance policy is not a 1035 exchange and may result in income tax consequences.

Important 1035 Exchange Procedures:

1. Non Citizen Rule: Theses rules do not apply to any exchange having the effect of transferring property to any non-United States person.

2. New Product Requirements: In order to accommodate the transfer of values, the life insurance product must be able to accept unscheduled deposits.

3.  Loans: The product for an exchange of a policy "with no outstanding loan" would be best suited into a new Universal Life plan. There may also be a carrier who will also allow you to transfer a policy loan into their product, but this type of 1035 exchange may be questioned by the IRS.

4.  Underwriting: Full evidence of insurability based on age and amount still applies in most exchange products now available.

5.  Replacement Compliance: Full compliance with appropriate state replacement regulations always applies and is adhered to by our firm or by associates of our firm.

6.  Agent Procedures: In order to process an exchange, an FSI representative or associated representative will obtain:

a. The completed state-specific application with wording in the "Special Instructions" section to indicate "This is a 1035 exchange."

b. Evidence of insurability based on the insured’s age and amount applied for.

c. The applicable new carrier 1035 Exchange Form should be signed (original signature (s) only) by the owner (s), collateral assignee, etc. This agreement contains a number of conditions and should be read carefully by the owner (s) before signing.  It serves as a legal "assignment with limited power of attorney rights" for direct cash value transfer purposes.

d. If the owner is a corporation or other business entity, provide the full name of the entity followed by the signature and title of the authorized party. If the owner is a trust, provide the full name of trust and trust date, followed by the signature(s) of the trustee(s). Insert the title "Trustee(s)" following the signature(s).  A copy of the trust agreement may also be required.

e. The old policy or policies should be returned with the applicable Exchange Form.

f.  All state-specific replacement paperwork is always required.

g. Money down on application depending on product and circumstances.  If so, a Conditional Insurance Receipt or Temporary Insurance Receipt (issued on a state specific basis) will be issued for any money taken with the application.  (not always required or necessary in paid up policy situations)

h.  A copy of any sales proposal, study used to make a decision to re-issue any policy or terminate any policy as as well as a copy of any sales illustration used to predict future values on new plans implemented.

Upon receipt of the above requirements, the following will generally occur:

1. If the Company approves the new policy for insurance in a standard or better rating class, or in a rated class that had previously been requested and accepted in writing, the Company will automatically request a surrender of the old policy or policies.

2. If the new policy is approved with a rated premium, the Company will await the confirmation of acceptance by the owner prior to beginning the surrender process.

3. The Company will issue the new policy for delivery upon receipt of the 1035 proceeds.

4. If surrender cannot be effected, the old policy will be reassigned to the policy-owner and the Company’s obligations under the exchange agreement will terminate.

Special Notes On 1035 Exchanges

1. Approximate processing time for exchanges is 30 days from receipt of paperwork in good order at the company that issued the contract to be exchanged. Clearly, conservation will be attempted, and you should be prepared for a significant delay before the surrender proceeds are received and applied to the new policy.

Tip: You can shorten this "hold" time by giving your agent written instructions that his delay could cause legal liability upon him if the firm were to go into receivership during the delay period.

2. An exchange of a life policy issued prior to June 21, 1988, that would be a modified endowment contract if issued after the effective date of IRC Section 7702A (i.e., fails the 7-pay test), will lose its grandfathered status. It is unlikely that such an exchange will be in the client’s best interest.

3. The new insurer will not pay premiums if any become due on the old policy (s). If the client wishes assurance that there is no break in coverage before issue of the new policy, the client should be instructed to pay the premiums on the in-force policy, although it might be prudent to pay the minimum modal amount permitted.

4. Some insurance carriers will not transfer the outstanding loan balance on life insurance products. Such carriers will surrender the loan first, with the balance of the funds transferred to the new policy. This treatment may create an adverse tax consequence. A pre-request to any carrier you have with a policy loan is a smart step prior to requesting a re-issue via 1035 provisions.

5. While 1035 exchanges allow for tax-free treatment, some situations can result in immediate taxation. For example, the receipt of any cash or "boot" not poured into the new contract will result in income tax to the extent of any gain in the contract.

A Word of Caution:  We encourage the parties involved to seek the independent advice of a competent tax advisor before proceeding with any 1035 life insurance exchange.  However, our handling of the exchange will be with ultimate care and caution to have the highest chance of success.

Good News!  To date, our firm has transferred hundreds of thousands of dollars via 1035 exchanges for our clients over a period of many decades -- and not one has failed!!!