Q. I have money on a variable life insurance policy. I want to get out of politics. It looks like I can move it through a 1035 exchange to an annuity, which would not be my long term goal. I was told after a predetermined time of five to seven years that I could use a 1035 exchange to move it from the annuity to a regular IRA. Is this correct?
A. A 1035 exchange is a provision available in the Internal Revenue Service (IRS) code that allows for the tax-free exchange of similar products.
Some of the permitted exchanges include exchanging one life insurance contract for another life insurance contract, annuity or qualifying long-term care insurance contract, or exchanging one annuity for another annuity or qualifying long-term care insurance contract, said Deva Panambur, a paid planner at Sarsi, LLC in West New York and adjunct professor of finance at Montclair State University.
But, he said, you can’t trade an annuity for a life insurance contract.
“Since a 1035 exchange is tax free, if the contract you are trading has a cash value, you can defer the normal taxes due on those earnings and you can preserve the basis, which can be a benefit if your contract not have a gain,” he said.
If there is an outstanding loan on the life insurance policy, it can lead to a realized gain, and sometimes waiving a policy might be a better idea, he said.
A 1035 exchange doesn’t help avoid penalties and surcharges charged by the insurer for early withdrawals, he said, although if you exchange for a product from the same company those fees may be waived. That’s something you want to clear up before making a 1035 trade, he said.
“A 1035 exchange does not allow you to move a life insurance contract, a annuity product or proceeds from any of these products in an IRA,” said Panambur.
The way you fund an IRA is by using earned income or rolling over assets from another qualifying plan, such as a 401(k) plan. The exception to this is an IRA spouse, where a working spouse can contribute funds to the IRA account of a non-working and non-earning spouse,” he said.
Also, under section 1035, you cannot exchange a life insurance contract or an annuity for a regular mutual fund, outside of a life insurance contact or annuity, he said.
If you decide to forgo your variable life insurance policy, you must consider several factors, most importantly, your need for insurance coverage, Panambur said.
“These policies have various costs associated with them, such as mortality and expense fees, account fees, investment management fees, administrative fees and charges for any unique features the policy may have,” he said. “You must evaluate all of these to make sure they are reasonable.”
Also, be sure to review the investments in the policy to see if they performed well, net of all fees, he said, though you should also consider your age, risk profile and liquidity needs.
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Karin Price Mueller writes the Bamboozled column of NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. sign up for NJMoneyHelp.com‘S weekly electronic newsletter.