Protect more with less
If you own a traditional life insurance policy or annuity, you can now exchange it tax free for an asset-based long-term care plan
► Click here for our just-released, complimentary special report: The Consumer’s Guide To Asset-Based Long-Term Care Insurance
One of the most popular ways to finance an asset-based long-term care insurance plan is with money from an existing life insurance policy or annuity contract. The federal tax code allows you to exchange a life insurance policy or annuity contract you currently own for a new asset-based plan on a tax-free basis. This is generally referred to as a tax-free 1035 exchange.
If you already own a life insurance policy with cash value and/or an annuity, you need to read this section. It explains an extremely attractive means of financing a new asset-based policy – one that affords you added tax breaks and extra benefits without sacrificing a thing. If you don’t own a life insurance policy or annuity, you can skip this section. However, we still encourage you to seriously consider an asset-based plan. You’ll just have to finance it with other safe-money funds.
A New Tax Law Makes A Good Thing Better
Section 1035 exchanges have been around for years, but thanks to a new federal tax law called The Pension Protection Act (PPA), this strategy is even more consumer-friendly.
PPA, which went into effect in 2010, did two things. First, it provided tax clarification of asset-based, or combination long-term care insurance policies. Second, it created the ability to pay long-term care insurance premiums in a tax-favored manner using a portion of life insurance or annuity cash values.
Prior to PPA, you could exchange an existing life insurance policy or annuity to a new life insurance policy or annuity, but not one that included a long-term care insurance rider. Now you can. Think about that; you can now replace a plain vanilla life insurance or annuity contract for a new and improved contract – one that offers all the benefits you had previously plus the added benefit of long-term care coverage.
How Does A Tax-Free Exchange Work?
It’s really easy. In general, Section 1035 of the Internal Revenue Code allows both the investment and gain in a non-qualified life insurance policy, endowment policy, or annuity contract to be transferred to another policy or contract without having to pay tax on the gain at the time of the exchange. Instead, the gain carries over to the new policy or contract.
In this case, non-qualified means the existing policy or annuity is not part of a qualified retirement plan. A qualified retirement plan is an employer-sponsored plan such as a pension, profit-sharing plan, SEP-IRA, SIMPLE IRA, or 401(k) to name a few examples.
The Most Popular Tax-Free Exchanges
Following is a list of the most popular types of 1035 tax-free exchanges that are generally permitted. Of course, it’s not a complete list, but these are without question the most common.
Before we get to the list, here are two caveats: First, unless otherwise noted, the insured person(s), the contract owner(s), and/or the annuitant(s) all have to be the same on the new plan as they were on the old plan. Second, unless otherwise indicated, “annuity” means either a deferred or immediate annuity contract.
You can do a tax-free 1035 exchange from:
» A life insurance policy1 you currently own to a new:
- Life insurance policy with a long-term care insurance rider
- Annuity contract with a long-term care insurance rider.
- Traditional, stand-alone tax-qualified2 long-term care insurance policy3
» Part of the cash value in a life insurance policy4 you currently own to a new:
- Traditional, stand-alone tax-qualified long-term care insurance policy.
» Tax-deferred annuity contract you currently own to a new:
- Annuity contract with a long-term care insurance rider5.
- Traditional, stand-alone tax-qualified long-term care insurance6 policy.
» Part of the funds in a tax-deferred annuity contract to a new:
- Traditional, stand-alone tax-qualified long-term care insurance policy with the same owner(s).
» Immediate annuity7 to a new:
- Tax-qualified long-term care insurance policy.
» Traditional, stand-alone, tax-qualified LTC insurance policy to a new:
- Tax-qualified LTC insurance policy8.
Important note: Not all policy or contract exchanges are tax-free. For example, an annuity contract cannot be 1035 exchanged for a life insurance policy. Additionally, there are rules pertaining to the ownership, insured and/or annuitants before and after the exchange.
Again, this is only a partial list. There are numerous other tax-free 1035 exchange strategies. If you have a question about a policy exchange, please call one of our licensed, knowledgeable representatives at 800-341-0297.
Reasons To Exchange An Old Plan For A New One
Here are some reasons why you might want to take advantage of a 1035 tax-free exchange:
- Newer policies may have new features that were not available when you purchased your original policy – like a rider that advances the death benefit to cover long-term care expenses.
- The cost of life insurance, called the “mortality cost,” has gone down because people are living longer, healthier lives. So an exchange may actually be able to save you some premium dollars, even though you’re older.
- You may have concerns about the financial stability of the company that issued the original life insurance or annuity plan.
- Your existing policy may not be performing up to your standards.
Three Important Considerations
- Before exchanging an existing life insurance policy or annuity, check to see if there are any applicable surrender charges. Surrender charges are similar to penalties for early withdrawals on bank CDs. If you are beyond those charges, you can do a 1035 exchange both tax free and cost free. If charges still apply, we generally do not recommend you make the switch. However, there are still times it makes sense. For help determining if an exchange is in your best interest, request a Free Policy Review (see form on this page) or call 800-341-0297.
- When considering a 1035 exchange, do not – under any circumstances – take possession of the funds yourself. It is paramount that the insurance companies you’re working with (both the existing carrier and the new one) handle the entire transaction. Otherwise, you could be faced with a taxable event.
- You have to health qualify for a new life insurance plan and/or a long-term care annuity – and your new premium is based on your current age. Of course, if you’re not approved for an exchange, you can simply keep your existing plan. There's no risk of losing your existing coverage.
If you’re not sure if you can qualify from a health standpoint, please call us in complete confidence at 800-341-0297 to discuss your personal situation.
At RetirementGuardian, we can help you make an informed choice about this important decision. We take this responsibility seriously and will do everything possible to ensure you do it right. Your personal situation will be handled with the utmost care.
Pay No Taxes On Gains
Again, section 1035 of the tax code is very advantageous to taxpayers. It allows an owner of a life insurance policy or an annuity to exchange that contract for a new one without having to pay any income tax on any gains that may have accumulated in the old policy.
You can exchange virtually any existing annuity for a new one – and your cost basis in the older policy is carried over to your new policy. Keep in mind, though, that if you ever surrender, or cash in, a life or annuity plan, you’re required to report any gain as taxable income at that time, and the insurance company will send you and the IRS a 1099 form, stating the gain.
For a free, no-obligation quote or complimentary existing policy review, please call 800-341-0297 or complete and submit the appropriate form at the top this page.
RetirementGuardian and their representatives and employees do not provide tax or legal advice. We did not write this material for use by any taxpayer to avoid any Internal Revenue Service penalty. You should ask your independent tax and legal advisers for advice based on our particular situation.
1 Note: A life insurance policy with a long term care insurance rider (also known as an asset-based, linked-benefit or hybrid life insurance policy) is treated as a life insurance policy, not a long term care insurance policy for section 1035 exchange purposes.
2 Tax-qualified long term care insurance is provided by a policy that meets the requirements of IRC Sec.7702B(b). It must provide only for the payment of qualified long term care services, may not reimburse for expenses ordinarily reimbursable by Medicare or Medicaid, must be guaranteed renewable, cannot have any loan or surrender value, require premium refunds or dividends to reduce future premiums or increase benefits, and must meet certain disclosure and non-forfeiture requirements. Also, “LTCI” is used herein to mean a traditional long term care insurance policy. A 1035 exchange from a life insurance policy to either a life insurance policy or annuity contract with a linked benefit long term care insurance rider is also permitted.
3 Section 1035(a) as amended by the Pension Protection Act of 2006 provides that, beginning in 2010, no gain or loss shall be recognized on the exchange of a life insurance policy for a qualified long term care insurance policy, or on the exchange of an annuity for a qualified long term care insurance policy.
4 Since most LTCI policies are paid on an annual premium basis, annual partial 1035 exchanges may be the most practical funding approach.
5 Note: An annuity contract with a long term care insurance rider (also known as a linked benefit or hybrid life insurance policy) is treated as an annuity contract, not a long term care insurance policy for section 1035 exchange purposes.
6 “LTCI” is used herein to mean a traditional long term care insurance policy. A 1035 exchange from a deferred annuity to an annuity contract with a linked benefit long term care insurance rider is also permitted. An annuity cannot be exchanged for a life insurance policy of any kind, even if the life policy has a long term care insurance rider.
7 A 1035 exchange from an immediate annuity would be an assignment of rights in the contract equal to the LTCI premium payments.
8 IRC Sec.1035(a)(4) provides that no gain or loss shall be recognized on the exchange of a qualified long term care insurance policy for another qualified long term care insurance policy.
With No Obligation
Of An Existing Policy