1035 Exchange – Life Insurance to Annuity
What is a 1035 Exchange?
A 1035 Exchange is a section of the Internal Revenue Service (IRS) code. It allows for a tax-free transfer of an existing annuity, life insurance or long term care (LTC) policy for another one of like kind.1 This is now a popular way to fund Hybrid Long-Term Care Insurance.
To qualify, the contract or policy owner must meet certain criteria. Both full and partial Exchanges are allowed, but some rules will vary by company. Generally, 1035s between products within the same company are not reportable for tax purposes as long as the IRS criteria is met.2
Here are some highlights of performing 1035 Exchanges:
- The tax code says the existing insurance policy must be Exchanged for a new policy. You cannot receive a check and then use the proceeds to buy a new insurance policy.
- Eligible policy types include:
- 1035 Exchange Life Insurance to Life Insurance
- 1035 Exchange Life Insurance to Annuity
- 1035 Exchange Annuity to Annuity
- You cannot 1035 Exchange an Annuity to a Life Insurance policy
1035 Exchanges for Life Insurance, Annuities & LTC
A 1035 must generally occur between products of like kind. Examples are Life Insurance to Life Insurance or Non-qualified Annuity to Non-qualified Annuity. You can Exchange Life insurance for a Non-qualified Annuity. But, you cannot Exchange a Non-qualified Annuity for a Life Insurance policy.
In 2006, the Pension Protection Act (PPA) modified the 1035 Exchange code.3 The change allowed for life insurance and non-qualified annuity Exchanges into long term care products. This includes both traditional and hybrid long-term care policies.
With a 1035, the contract or policy owner must not take constructive receipt of the funds to buy a new policy. So funds must be transferred straight from one company to the other.
Plus, the annuitant or policyholder must remain the same. For instance, an Exchange from an annuity owned by Tom Smith cannot be Exchanged into an annuity owned by Janet Smith. Nor could it be a joint annuity owned by Tom and Janet Smith.
An Exchange defers the internal build up of gains associated with your life insurance policy. Because of the tax-free nature of long term care insurance, an Exchange ensures the taxable gain disappears if used to pay for long term care expenses.
With annuities, a 1035 may allow you to convert an existing annuity into a long term care annuity. This can defer the gains associated with your annuity.
Acceptable 1035 Exchanges for Life Insurance, Annuities and LTC
Hybrid Long-Term Care Insurance
A Hybrid Long-Term Care Insurance policy combines the benefits of Life Insurance, or an Annuity, with long term care benefits. You can buy a Hybrid Long-Term Care Insurance policy by paying a one-time lump sum premium, or over a set period of time.
The policy works like traditional Life Insurance if you don’t need long term care. It would then pay a death benefit to your beneficiary when you die. And the death benefit is often similar to the amount paid for the policy. But if you need long-term care, the amount of money available can exceed the death benefit or Long-Term Care Annuity value, often several times over, offering tremendous leverage of premium dollars.
Click below for more articles from this section:
1 Internal Revenue Service (irs.gov), site accessed 11/10/2022.
2 Not all long term care insurance policies and companies accept 1035 Exchanges.
3 Pension Protection Act of 2006 (investopedia.com), site accessed 11/10/2022.
We do not provide tax or legal advice and suggest you consult with your accountant or tax professional. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal or accounting advice.