Are you pondering over what is a 1035 exchange?
If yes, then you have come to the right place. There are many individuals all over the world who own life insurance policies. According to the most recent information and sources, the individual life insurance of Americans amounts to $11.8 trillion of the face value. This shows that many people own life insurance policies.
But at times, there are certain situations due to which these individuals may want to exchange their policy with any other annuity contract or another specific life insurance policy; that is why so many people are found asking what a 1035 exchange is. Mostly, people pondering about what a 1035 exchange is exchange their life insurance policy because they do not find the policy in hand to be appropriate and suitable to their needs.
This is the time when Section 1035 by the Internal Revenue Service (IRS) comes in. Providing a means for exchanging life insurance policy or an annuity contract, all those asking “What is a 1035 exchange?” must keep in mind that it can be used only when it involves the policyholder or contract of the same type of product.
If you are pondering over what a 1035 exchange is, then you may also be interested in exchanging your current life insurance policy or annuity contract for a new policy and a 1035 exchange would definitely be a great option for you to consider if you want to secure yourself from paying extra taxes.
If you want to know what a 1035 exchange is, keep reading this blog. If you need help with a 1035 exchange please call us at 407-502-2400, or email us at [email protected].
Types of Life Insurance Policies
Before we go onto explaining what a 1035 exchange is, you should first understand the types of life insurance policies. There are various types of life insurance policies. The benefits and features do vary but you can understand them with the help of the following description;
· Whole Life Insurance Policy
This form of insurance policy is also called an ordinary life insurance policy. Basically, it is a permanent life insurance policy which means that an individual will be compensated for their whole life. It gradually builds cash value and saves money of an individual though the premium payment, which remains the same for the life of the individual.
· Term Life Insurance
This form of insurance policy actually provides compensation and coverage for a limited and specific time period. After the policy ends, there is, as such, no benefit for the insured person but the premium does increase with age at the end of every period.
· Variable Life Insurance
This form of life insurance policy has variations offering a fixed premium and death benefits. However, it is not like the traditional life insurance policies. In this type of policy, the policy holder has discretion in choosing the investments for the policy offers. Also, the cash value is invested in portfolios of securities in a separate account by the insurance company. The company does not guarantee any returns on investments and this is why your cash value is likely to fluctuate.
· Universal Life Insurance
Providing coverage for the life of the insured as well as providing flexibility in the premium payments, in universal life insurance, the costs are deducted from the cash and account value.
· Variable Universal Life Insurance
This type of insurance is a hybrid. It combines some features of variable life insurance and features of universal life insurance.
All these life insurance policies are registered with the Securities and Exchange Commission (SEC). The insurance companies also provide remedies to investors in case of problems with the insurance policies.
What is a 1035 Exchange?
If you want to learn the core of what is a 1035 exchange, then read this section very carefully. The section 1035 exchange is basically a tax free exchange of life insurance policy or an annuity contract for a new one. If you are concerned about what a 1035 exchange is, then you should also keep in mind that you can only qualify for the section 1035 exchange for a new contract when the policy holder exchanges the existing contract in return for the new contract. In this case, the annuitant and the policy holder should be the same.
Furthermore, section 1035 exchange is actually a provision of the United States tax code which gives the ability to transfer funds from an annuity, endowment or life insurance policy to a policy of a similar type. When the funds are transferred from the old to the new policy, the exchange can occur under section 1035 without any taxes.
Now that you have understood what a 1035 exchange is, you should also know that with this life insurance policy, you will be able to transfer your funds for putting off any gains. For example, if you transfer all the proceeds from an old policy to the new one, no taxes will be levied on the gain of the original policy at the time of transfer if there are no outstanding loans on the original policy. On the contrary, if the gains from the policy are transferred without using the 1035 exchange, they will be taxed at the ordinary income tax rates of the policy holder.
All those asking what a 1035 exchange is, they should remember that even if a policy does not have any gains, they will be advantageous no matter what. With 1035 exchange insurance, policy holders can avoid paying more taxes than required by the federal laws, like in a modified endowment contract. Also, when policy holders like paying future premiums for a new policy, the 1035 exchange can be helpful at that time as well. This lets individuals enjoy purchasing a new policy without having to pay more money.
Moreover, even when there are no gains to be deferred, section 1035 exchange still permits a policy holder to preserve their basis. For instance, if the cash value of the original policy is higher than the gross value, this means that an individual is suffering losses. But, a 1035 exchange helps policy owners enjoy the higher basis of the new contract. The original contract’s tax basis becomes the new contract basis in this scenario.
What are the Requirements for a 1035 Exchange?
If you are interested to know what a 1035 exchange is, then you may be also be interested in knowing the requirement of the 1035 exchange. The internal Revenue Service (IRS) has three requirements for the policy holders to enjoy the benefits of the 1035 exchange to be tax free. All those asking what a 1035 exchange is should go through the requirements below;
- The policy holder of both the polices must be the same.
- The face amount of the new policy is either greater or equal to the face amount of a policy holder’s existing policy.
- Policy holders cannot take direct possession of the money being transferred. It must go from one insurer to another insurer.
Do You Really Need a 1035 Exchange?
If you are concerned with what a 1035 exchange is, then it is likely that you want to own one. To understand and determine whether you want to take advantage of the 1035 exchange life insurance policy, you should first look into the following circumstances and question about them at the first place;
- You should consider your health. Also, see if you have felt some changes in your health from the time you first filed the life insurance policy. If you notice changes, you are required to either pay the additional premium under the new policy or deny the coverage.
- You also need to consider the implications of new suicide provisions and contestable issues.
- You should give a thought to how the interest improves the new policy.
- Consider all the benefits and advantages that you may receive with the new policy as compared to the ones you already have got with the current policy.
- Consider thinking about the amount of premium you will have to pay by switching the insurance policies. The premium may be higher for the new coverage because of the issuance of the policy at a higher attained age.
- You should also consider the differences in guarantees and policy provisions.
- You should look over the differences in the way the interest is credited to the new policy.
- You should also look over the alternatives for replacement, such as additional coverage with existing insurer, change of plan with existing insurer and repaying policy loans.
- You should also see the impact of surrender charges that may occur from the surrendering of existing policies.
If you need help with a 1035 exchange please call us at 407-502-2400, or email us at [email protected].
How to Apply for 1035 Exchange?
Now that you know what a 1035 exchange is, you should also understand the procedure to apply for it. When you apply for an annuity contract and a life insurance policy, you should keep the following steps in mind;
· Step # 1: Application Process
The first and foremost step to apply for the 1035 exchange is the application process. In this step, you have to sign the documents which authorize the insurance company. These documents will make you the true holder of the non-tax qualified funds. By signing the 1035 exchange form, you become the custodian of your funds.
· Step # 2: Underwriting Procedure
When the exchange involves a life insurance policy, they will likely go through the health underwriting procedure before transferring the funds. The procedure actually varies from company to company. Also, it is likely that you may not get approved by the insurance company which will completely stop the process. So, before you get into the process of obtaining a 1035 exchange, first see whether you qualify for it or not. Typically, annuity products do not require underwriting for health.
· Step # 3: Request for Funds
After the first two steps are completed and the paperwork is done, the new insurance company will ask for the funds from the other insurance company. To ensure that you really want to switch the life insurance policies, the insurance company will show the signed 1035 form to them along with the request to transfer funds.
· Step # 4: Conservancy
Most of the insurance companies try to save their business before transferring funds they are holding. To verify the intention of your funds before they are released, policy holders must keep in mind that the company is permitted to take a minimum of 6 months to transfer the funds. The procedure is time consuming but beneficial in the long run.
· Step # 5: Transferring Funds
The new insurance company will receive a certified check for the 1035 exchange form by the ceding insurance company. The ceding insurance company will forward the cost basis of your funds. Generally, this is the amount of original dollars that are deposited to the annuity contract and insurance. Any growth found will be taxable.
· Step # 6: Review and Evaluation
In this step, the new insurance company will evaluate and review the entire policy for fulfillment. They do this to check whether or not the policy holder is doing this with their choice. Also, they see if the policy owner is the actually the owner of the new policy or not. Also, the policy holder can change the time upon discretion, as long as it has been deemed irrevocable.
· Step # 7: Issuance of Policy
Once the underwriting requirements, documentation, paperwork, legalities and funds are received by the new insurance company, the company issues the new annuity policy or new life insurance policy.
· Step # 8: Free Trial Period
Insurance policies have a free look period that is also called as trial period. According to the laws of your residence, the provision permits policy holders to receive the funds and cancel the issued policy. However, if you receive your 1035 exchange funds ahead of time but are unable to deposit the funds into an annuity policy or a new insurance policy, then you will be subject to strict penalties by the IRS.
If you are interested to know what a 1035 exchange is and are willing to change your insurance policy or annuity contract, then you will likely go through these steps. Also, it is wise to hire an attorney for ensuring a smooth process.
Benefits of a 1035 Exchange
Now that you have clearly understood what a 1035 exchange is, you should understand the benefits of it as well. It is a form that gives an opportunity to an investor to exchange an outdated and old contract with a newer contract which offers more beneficial features the investor wishes to include in the new policy. For instance, a policy holder might want to choose a contract with a higher death benefit for lower costs. Let’s explore some benefits of a 1035 exchange below;
· Tax Advantages
The 1035 exchange provides tax advantages. The surrender of the insurance policy is taxable. This is because the amount gained on the older contract is termed as income. A 1035 exchange permits the non-taxable transfer of an old agreement to an entirely new one. This is the direct exchange that is carried out between the current and new insurance companies providing stipulations that are met by the Internal Revenue Services.
· Adjusted Basis of Contract
When you file a 1035 exchange form, it makes sure that the amount of the original contract remains preserved. This means that the premiums are secured. Reserving the premiums or the adjusted basis is beneficial to an investor when the contract has faced losses in the contract.
· Switch to a Better and Stronger Carrier
Since a 1035 exchange is tax free, that is why it is not a problem to switch from one carrier to another. When a policy holder realizes that one of their carriers is not strong, they switch to a stronger and better carrier and hence, opt for the one which financially solid. This is a step to prevent the potential loss of value and hassle that you could have experienced due to your existing carrier financial instability.
· Better Health Rating
When your health improves for the qualified existing policy, a 1035 exchange would help you in switching to the new policy. Also, you will lower your cost as you will be qualified for a less expensive health rating. By using a 1035 exchange, you will be able to switch to a new policy without including any tax cost.
The elimination of taxes in a 1035 exchange opens up several opportunities for you to save money. On the basis of your current insurability, there are several ways 1035 exchanges can minimize life insurance cost.
Now that you know all about a 1035 exchange, we hope you have got the answer to, “What is a 1035 exchange?” If you also require switching your contract, opt for a 1035 exchange form and enjoy the benefits. Good luck!
If you need help with a 1035 exchange please call us at 407-502-2400, or email us at [email protected].