When preparing for retirement, you need to re-evaluate your insurance needs. Perhaps, you may have a cash value life insurance policy that doesn't offer what you need now. You may decide to cash it in or sell it so you can buy another insurance product. But you'd have to pay taxes on any gain you make on your policy. But with a 1035 exchange, you can bypass any immediate taxes while converting your policy to something better suited to you.
You may now find coverage with lower premiums and/or a larger death benefit if it's been a while since you purchased your life insurance policy. People living longer or underwriting guidelines that acknowledge medical advances and other factors can account for this. Or, maybe you no longer need life insurance protection, but would be better served by an income-generating product like an annuity.
If you sell or surrender a life insurance policy, it may trigger taxes since investment earnings in insurance policies grow tax-deferred. If so, you'll have to pay tax on any gains you receive above what you've contributed. This reduces their effective value to you.
You can get around this taxation by doing a Section 1035 (IRS) exchange. It allows for the direct, tax-free transfer of accumulated funds in a life insurance policy (or annuity policy) to a different life insurance contract or even to an annuity contract.
Under a 1035 exchange, you convert 'tax free' either to a more appropriate life insurance policy or turn its cash value into an income generating annuity to bolster your retirement income.
*Cost basis and gains :
The cost basis of your life insurance policy is the total gross premiums you paid less any dividends or partial surrenders (loans) you've received. You can have the cash value of this policy transferred directly into your new insurance policy or contract by the insurance company so you never have possession of the money. Note too, that if the cash surrender value of the old policy is high and you do the tax free exchange the preserves and transfers your tax basis in your old policy into the new one, you'll minimize eventual taxation of the new policy if and when you decide to surrender it down the road.
As a hypothetical example, assume you've paid $1,000 per year for 20 years for your old policy and received $4,000 in dividends. Your cost basis in the policy is $16,000 (20 years multiplied by $1,000, less $4,000) compared to the policy's cash surrender value of $10,000. If you surrender the old policy and purchase a new one with the $10,000 surrender value, the cost basis of your new policy would be the $10,000.
But if you "exchange" the old policy for the new under a tax free 1035 exchange, you can retain the $17,000 cost basis of the old policy. Preserving your cost basis will shelter a lot of future gains you may earn.
You can exchange several policies for one new one too. But, realize that all the policies must have the same insured party and owner.
Also, recognize that the purchase and exchange of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant. Not all applicants are insurable. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 1/2 are subject to a 10% penalty.
You may now find coverage with lower premiums and/or a larger death benefit if it's been a while since you purchased your life insurance policy. People living longer or underwriting guidelines that acknowledge medical advances and other factors can account for this. Or, maybe you no longer need life insurance protection, but would be better served by an income-generating product like an annuity.
If you sell or surrender a life insurance policy, it may trigger taxes since investment earnings in insurance policies grow tax-deferred. If so, you'll have to pay tax on any gains you receive above what you've contributed. This reduces their effective value to you.
You can get around this taxation by doing a Section 1035 (IRS) exchange. It allows for the direct, tax-free transfer of accumulated funds in a life insurance policy (or annuity policy) to a different life insurance contract or even to an annuity contract.
Under a 1035 exchange, you convert 'tax free' either to a more appropriate life insurance policy or turn its cash value into an income generating annuity to bolster your retirement income.
*Cost basis and gains :
The cost basis of your life insurance policy is the total gross premiums you paid less any dividends or partial surrenders (loans) you've received. You can have the cash value of this policy transferred directly into your new insurance policy or contract by the insurance company so you never have possession of the money. Note too, that if the cash surrender value of the old policy is high and you do the tax free exchange the preserves and transfers your tax basis in your old policy into the new one, you'll minimize eventual taxation of the new policy if and when you decide to surrender it down the road.
As a hypothetical example, assume you've paid $1,000 per year for 20 years for your old policy and received $4,000 in dividends. Your cost basis in the policy is $16,000 (20 years multiplied by $1,000, less $4,000) compared to the policy's cash surrender value of $10,000. If you surrender the old policy and purchase a new one with the $10,000 surrender value, the cost basis of your new policy would be the $10,000.
But if you "exchange" the old policy for the new under a tax free 1035 exchange, you can retain the $17,000 cost basis of the old policy. Preserving your cost basis will shelter a lot of future gains you may earn.
You can exchange several policies for one new one too. But, realize that all the policies must have the same insured party and owner.
Also, recognize that the purchase and exchange of life insurance involves costs, fees, expenses and potential surrender charges and depends on the health of the applicant. Not all applicants are insurable. If a policy is structured as a modified endowment contract, withdrawals will be subject to tax as ordinary income and withdrawals prior to age 59 1/2 are subject to a 10% penalty.
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