10 Jun How can I get out of my variable life insurance policy?
Q. I have money in a variable life insurance policy. I want to get out of the policy. It looks like I can move it via a 1035 exchange to an annuity, which would not be my long-term goal. I’ve been told after a predetermined time of five to seven years 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 like products.
Some of the exchanges allowed include exchanging a life insurance contract for another life insurance contract, annuity or qualified long term care insurance contract, or exchanging an annuity for another annuity or qualified long term care insurance contract, said Deva Panambur, a fee-only planner with Sarsi, LLC in West New York and an adjunct professor of personal finance at Montclair State University.
But, he said, you cannot exchange an annuity for a life insurance contract.
“Since a 1035 exchange is tax free, if the contract you are exchanging out of has a cash value, you can postpone the ordinary taxes due on those gains and you get to preserve the basis, which can be a benefit if your contract does not have a gain,” he said.
If there is a loan outstanding on the life insurance policy, it may lead to a realized gain and sometimes surrendering a policy may be a better idea, he said.
A 1035 exchange does not help you avoid penalties and surcharges levied by the insurance company for early withdrawal, he said, although if you exchange into a product of the same company those fees could be waived. This is something you want to clarify before making a 1035 exchange, he said.
“A 1035 exchange does not allow you to move a life insurance contract, an annuity product or proceeds from either of these products into an IRA,” Panambur said.
The way you fund an IRA is using earned income or by rolling over assets from another qualified plan such as a 401(k) plan. The exception to this is a spousal IRA where a working spouse can contribute funds to the IRA account of a non-working spouse without earned income,” he said
Also, under section 1035, you cannot exchange a life insurance contract or an annuity to a regular mutual fund, outside of a life insurance contact or annuity, he said.
If you decide to surrender your variable life insurance policy, you must consider several factors, most importantly, your need for insurance coverage, Panambur said.
“These policies have several costs associated with them such as mortality and expense charges, account fees, investment management fees, administrative fees, and charges for any unique feature the policy may have,” he said. “You must evaluate all these to make sure they are reasonable.”
Also be sure to review the investments in the policy to see if they have performed well, net of all fees, he said, while you should also consider your age, risk profile and liquidity needs.
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This story was originally published on June 10, 2021.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.