What Is A 1035 Exchange?

This article will help you understand how to fund a hybrid long-term care insurance policy using a 1035 exchange. For example, an old life insurance policy or annuity could help you cover the cost of long-term care. This IRS code allows for a tax-free transfer of an existing insurance policy for another one of like kind.1 Examples are:

➤  1035 Exchange Life Insurance to Life Insurance
➤  1035 Exchange Life Insurance to Annuity
➤  1035 Exchange Annuity to Annuity

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What is a 1035 exchange on a long-term care policy?

A 1035 exchange is a provision from Section 1035 in the tax code that allows for the tax-free transfer of one type of insurance policy to another of “like kind.” 2

This tax code allows you to 1035 exchange life insurance to long-term care insurance. Or, a non-qualified annuity can 1035 exchange into a long-term care insurance policy. Both traditional and hybrid long-term care products are included. To qualify, the contract or policy owner must meet certain criteria as follows:

  • Full and partial 1035 exchanges are allowed.
  • Generally, 1035 exchanges between products within the same company are not reportable for tax purposes as long as the IRS criteria is met. Some rules will vary by company.3
  • The annuitant or policyholder must remain the same. For instance, a 1035 annuity exchange of a policy 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.
  • 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.

1035 exchange life to long-term care insurance.

Considerations

1035 Exchange Life to Long-Term Care Insurance

Consider using your old life insurance policy to help you cover the cost of long-term care. As you age, you may find that your life insurance needs have changed and a higher priority is to protect against potential long-term care needs.

A first step will be to consult with a Long-Term Care Advisor to determine that you will be able to qualify for any new coverage.

1035 Exchange Benefits

A 1035 exchange defers the internal build up of gains associated with your life insurance policy.

With 1035 annuity exchanges, you may be allowed to convert an existing annuity into a long-term care annuity. This can defer the gains associated with your existing annuity.

Because of the tax-free nature of long-term care insurance, a 1035 exchange ensures the taxable gain disappears if it’s used to pay for long-term care expenses.

1 Internal Revenue Service (irs.gov), site accessed 11/10/2022.
2 Pension Protection Act of 2006 (investopedia.com), site accessed 11/10/2022.
3 Not all long term care insurance policies and companies accept 1035 Exchanges.
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