1035 exchange life insurance to annuity

Is a Life Insurance Exchange Right for Me?

(Because sometimes your current policy just doesn’t cut it)

Calculator and pen on a blue background-transfer 1035 exchange life insurance

You’ve been together for years, but lately, you’ve had this sinking feeling that your current life insurance policy just isn’t the right one for you. Perhaps you’ve been eyeing more attractive policies with better benefits, lower fees, or different investment options. 

The only question is, if you trade in your outdated life insurance policy for a newer model, will you be punished from a tax standpoint?

Fortunately, the Internal Revenue Service (IRS) allows for something known as a 1035 Exchange which allows you to exchange your current life insurance policy for one that’s a better fit for you — without tax penalties. 

Our independent insurance agents are standing by to help you get set up with the right kind of life insurance coverage for you. But first, let’s talk about why you might want to exchange your life insurance policy.

What Is a Life Insurance Exchange?

Basically, a life insurance exchange is pretty much just the way it sounds — exchanging your existing life insurance for another life insurance policy. After a number of years of making payments towards your current life insurance, the policy has taken on a cash value. 

The accumulated value is what gets transferred over into a new life insurance policy, should you make an exchange. Policyholders may choose to exchange life insurance policies for a number of reasons. But of course, as with every exchange or transfer of money, policyholders are reasonably concerned about whether they’ll be taxed when switching out life insurance policies. 

Luckily, the IRS allows for tax-free life insurance exchanges as we’ll explore further in just a moment.

Are Life Insurance Exchanges Taxed?

Annuities 1035 exchange form

Short answer? No. A 1035 Exchange through the IRS allows you to exchange your life insurance policy without tax penalties for a couple of reasons:

  • If you die, the death benefit under your life insurance policy is not taxed.
  • Beneficiaries of life insurance proceeds don’t have to pay taxes when receiving their payouts.

Now, there are a couple of important stipulations from the IRS in order for you to complete a successful tax-free exchange:

  • Your old life insurance policy must be exchanged directly for a new policy.
  • You can’t cash out your current policy for a check and then use that towards a new policy.
  • You may exchange a life insurance policy for an annuity, but not vice-versa.

If you were to cash out your existing life insurance policy for its current cash value, you would be taxed on the payout. Directly exchanging an old policy for a new one may be an easy way to save money and end up with new life insurance that works much better for you.

Why Would I Want to Exchange My Life Insurance?

Well, for several different reasons. Life insurance policyholders may decide to upgrade their policies for monetary purposes because they’re unhappy with their current insurance company, or something completely different. We’ll go ahead and explore a few common reasons for exchanging life insurance policies to start off.

You may choose to exchange your life insurance policy if:

  • You find another policy with similar benefits for a lower premium.
  • You find a policy with better benefits that may be worth the increased premium cost.
  • You find a policy with a better guaranteed return.
  • You make a lifestyle change, such as quitting smoking, that qualifies you to purchase a new policy with a lower premium.
  • You have issues or concerns with your current insurance company.
  • Your current policy is no longer serving you for any reason.

No matter the reason you choose to exchange your life insurance, the most important thing is to end up with the policy that works best for your unique needs. An independent insurance agent can be a great asset during this process, including helping you to decide if you’d benefit from an exchange at all.

When Would I Not Want to Exchange My Life Insurance?

Now for the flip side of the coin. Just like there are plenty of reasons someone would want to exchange their life insurance policy, there are just as many reasons why they wouldn’t. We’ll check out just a handful.

You may choose not to exchange your life insurance policy if:

  • Your policy comes with an early surrender charge which could reduce the value your current policy could transfer to a new policy.
  • The new policy comes with a contestability period, or a two-year time frame in which the new insurance company can challenge your death benefit claim due to an error on your application. With your existing policy, you’d likely have already exceeded this period.
  • The new policy’s lower premium is not worth sacrificing your existing policy’s benefits.
  • The new policy comes with a lower guaranteed return.
  • The new policy has a higher premium and the benefits don’t outweigh the increased costs.

As you age, the cost of a new life insurance policy goes up. When exchanging life insurance, you may be unable to find a new policy with a comparable premium to the one you’re already locked into. Of course, an agent can help you hunt for a policy at the best possible price, but increased fees are one of the main reasons life insurance policyholders decide not to switch.

How Do I Exchange My Life Insurance Policy?

Unfortunately, it’s kind of a complicated process which can be another reason people choose to hold onto their existing policy. You’ll need to start by reaching out to your independent insurance agent to help you begin the process. There’s a lot of paperwork and time involved in exchanging life insurance policies, and some may find the effort just isn’t worth it.

The process of exchanging life insurance often involves the following steps:

  • You reach out to your agent and let them know you’re interested in exchanging your life insurance.
  • Your agent reaches out to your current insurance company to gather information and projections regarding your existing policy.
  • Your agent waits several weeks to obtain this information from the insurance company and prepares information about other policy options for you during this time.
  • Your agent receives the information about your current policy and is then able to walk you through an in-depth comparison of your existing insurance alongside other policy options.

Of course, if you decide to actually make the exchange, your agent would then go through the process of making that happen for you. Your new policy may come with its own waiting period for coverage to kick in, from a few days up to two years, since a contestability period can technically be thought of as its own kind of waiting period. 

As the policyholder, it’s up to you to decide if this potentially lengthy waiting period is worth exchanging your policy or not.

Are There Controversial Opinions About Life Insurance Exchanges?

Indeed there are. However, there have been controversial opinions about life insurance coverage as a whole as well as the way it’s packaged and sold practically ever since the product became available in the first place. Life insurance exchanges are just another piece of the puzzle. And for some, more fuel to throw on the controversy fire.

Some people see exchanging life insurance policies as an easy way to dodge taxes. You’re exchanging a current policy for a potentially much better policy that might come with a better-guaranteed return or better benefits, and you’re not being taxed on the transfer. 

However, the death benefit paid out by your life insurance policy isn’t subject to taxes anyway, which is where the other side’s argument comes in. If you were to cash out your existing life insurance policy to receive a check for its current value, you WOULD be taxed on the payout. 

Some people feel that directly exchanging insurance policies shouldn’t be an option because of this, while others argue an exchange is an entirely fair and reasonable way to upgrade your coverage without being penalized for it. Regardless of the existing controversy, however, life insurance exchanges remain a legal and available option.

How to Find the Best Life Insurance

In order to get the protection you need and deserve, you’ll want to work with a trusted expert. Independent insurance agents will not only know where to find the best coverage and price but also help to make sense of the fine print.

Consider your unique needs, then connect with an agent to help you take it from there. Have a list of your specific concerns and desires handy before you reach out to help the process run even more smoothly.

Compare Life Insurance Quotes with an Independent Insurance Agent

We all know how valuable your time is, so why spend it doing all the hard work yourself? From buying new policies to making life insurance exchanges, our expert independent insurance agents will help you determine which route makes the most sense for you. 

Our independent insurance agents stay on top of the insurance industry and all the latest discounts so you don’t have to. That means they’ll help find the right coverage at the right price for you.

They’re not just there at the beginning either. If disaster strikes, your agent will be there to help walk your loved ones through the claims process and make sure they’re getting the benefits they’re entitled to. Now that’s thinking ahead.

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