Discussion:1035 exchange of life insurance contract

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Discussion Forum Index --> Advanced Tax Questions --> 1035 exchange of life insurance contract


Discussion Forum Index --> Tax Questions --> 1035 exchange of life insurance contract

Larousse (talk|edits) said:

19 October 2009
Client exchanged both a life insurance contract with no cash value and an annuity contract with basis and tax deferred earnings for a new annuity contract. The life insurance had accumulated premiums of X, which the LI company verified and the old annuity contract had basis of Y, also verified by the company. The new annuity company only shows basis of Y and will not recognize the transferred basis in the life insurance policy because there was no cash value. My reading of Sections 72 and 1035 doesn't agree. It looks to me like the cost in the life insurance contract should transfer to the new annuity contract as well as the basis in the old annuity. I don't see any kind of exception for a LI contract with zero cash value. Do you agree?

Kevinh5 (talk|edits) said:

19 October 2009
no

Larousse (talk|edits) said:

19 October 2009
Kevin, can you give me a little hint as to why you have that opinion? As I said, i did read the code sections and didn't see why the basis in the life insurance wouldn't be included in the new account.

Kevinh5 (talk|edits) said:

19 October 2009
there was nothing to 1035 - absolutely no value in the insurance contract. Similarly, you can't 1035 term insurance.


it would have been smarter to have made sure that there was $1 in cash value before doing the 1035. But hey, the client probably just asked a 'salesman' and not a true financial planner.

KathiJud (talk|edits) said:

19 October 2009
Wouldn't life insurance with no cash value be simply a series of payments for insurance coverage that does not build any basis up? No investment feature of paying more than the coverage cost.

LH2004 (talk|edits) said:

October 19, 2009
I would think that you could validly exchange a contract which had value even though there was no cash surrender value. If the receiving company intended to surrender the policy for no value, though, that would certainly suggest that that policy had no fair market value.

Kevinh5 (talk|edits) said:

19 October 2009
it is the 'cash value' that people are trying to protect when they do a 1035

Kevinh5 (talk|edits) said:

19 October 2009
market value is totally different than cash surrender value - hence the whole 'life settlement' industry

Larousse (talk|edits) said:

19 October 2009
This is NOT a term life policy but a whole life policy which had not yet built and CSV. Nor is it a viatical settlement. Sect. 1035 permits a taxfree transfer of life insurance to annuity. Sect. 72 defines the cost in the annuity as the aggregate premiums paid. So why would the aggregate premiums paid for the life insurance policy not transfer in as part of the cost basis in the new annuity contract?

Kevinh5 (talk|edits) said:

19 October 2009
"there was nothing to 1035 - absolutely no value in the insurance contract"

maybe you missed that

Larousse (talk|edits) said:

19 October 2009
No, I didn't miss it, I just don't understand it in this instance because the new annuity company accepted the LI policy as part of the 1035 exchange; they're only being difficult with respect to the cost basis transfer.

Kevinh5 (talk|edits) said:

19 October 2009
the cost didn't matter, because there was no cash value 1035'ed. Not only didn't it matter, it didn't count.

Larousse (talk|edits) said:

19 October 2009
So if the policy had $1 of CSV, all the premiums would count?

Kevinh5 (talk|edits) said:

19 October 2009
in my opinion, yes

silly, isn't it?

Larousse (talk|edits) said:

19 October 2009
Yes, silly is the precise term. That's exactly why I wonder how that can be.

I do, humbly and respectfully, disagree with what you said above: Kevinh5 (talk

Larousse (talk|edits) said:

19 October 2009
Sorry - Kevin said that "cash vale" is what people are trying to protect in a 1035 exchange. But the CSV is usually recoverable tax free anyway since it is usually less than premiums paid. What drives people to 1035 a life insurance policy into an annuity contract is the ability to recover premiums paid tax free.

Kevinh5 (talk|edits) said:

19 October 2009
I disagree - they could recover the premiums paid tax free already from the cash surrender value of the existing life insurance contract. They desire to transfer the cash value to another replacement insurance contract free of tax. You and I know that this particular policy has a cash surrender value less than premiums paid, but that isn't always the case.

Kevinh5 (talk|edits) said:

19 October 2009
In any event, trust me, I'm a CLU.

Larousse (talk|edits) said:

19 October 2009
I thank you for your extensive input on this topic. Everyday is a learning experience!

Kevinh5 (talk|edits) said:

19 October 2009
and then you die.

I know.

LH2004 (talk|edits) said:

October 19, 2009
Conventionally, the new insurance company surrenders the old policy immediately after receiving it an a 1035 exchange, but there's no reason that has to be the case. If an insurance company wanted to sort-of get into the life settlement business itself, and was willing to issue a new policy in a straight exchange for an old one, I don't see why it would be taxable to the policy owner just because the old one had no cash value.

Kevinh5 (talk|edits) said:

19 October 2009
I don't understand your question, LH. Starting with 'I don't see why...'.

It isn't taxable. There was no gain in this contract.

LH2004 (talk|edits) said:

October 20, 2009
OK. Suppose I have a life insurance contract with no cash value, a basis of $100,000 and a fair market value (based on what third parties are actually willing to pay for it) of $1 million. (I realize those numbers may be unlikely but they are not impossible.) I transfer it to an insurance company in exchange for a variable annuity worth $1 million; of course, the insurance company must be planning to hold it as an investment, the way a life settlement buyer does. (I realize most insurance companies aren't interested in doing that, but it would seem to be perfectly legal.) If I am reading you correctly, you are saying that that is not a 1035 exchange, and no other nonrecognition provision would seem to apply; therefore, I have $900,000 of taxable income from the exchange. I say that is a valid 1035 exchange.

Kevinh5 (talk|edits) said:

20 October 2009
LH

1) No insurance company would do this - the annuity beginning investment has to come from the cash surrender value of the life policy (assuming no other funding). So there is $0 to trade for $1,000,000? Not a chance. It is the cash value that gets transferred n a 1035, and that was my point above to Larousse. Then the cost basis follows the cash value. So your example doesn't even make sense, sorry.

2) Suppose you found someone who WAS willing to make the deal you're imagining. That wouldn't be a 1035 exchange. So you're right, there would be a taxable gain. There is no 1035 in your example.

LH2004 (talk|edits) said:

October 20, 2009
There is a huge difference between what some insurance company will do and what you can accomplish by walking into your local MetLife agent's office.

There are companies out there today offering to do life settlements -- that is, paying significantly more than a policy's cash value -- as 1035 exchanges. I don't know whether they're doing that the way I suggest, that is, through their own insurance company which will just hold on to the policy you exchange; by purchasing an annuity from a "real" insurance company for you through an escrow agent, 1031-style; or by just giving you a check and telling you to buy an annuity and rely on the oddly-reasoned Greene v. Commissioner, 85 T.C. 1024 (1985).

If you have some authority for your conclusion that these are not valid 1035 exchanges, I'd love to see it. Certainly a lot of people think that they are. The Code and regs don't say anything about requiring cash value, and I have not seen any PLR's on that issue.

Kevinh5 (talk|edits) said:

20 October 2009
There would be no need to do a 1035 if the sale of the life policy qualified under ยง101 as a tax-free death benefit for a terminally or chronically ill individual, as a viatical settlement typically is for. The Life Settlement industry, however, extends far beyond the ill. I also don't know what they're offering, but I do know that there are a lot of shady characters involved in that industry, so I'd suspect their tax advice entirely.

Kevinh5 (talk|edits) said:

20 October 2009
I find it interesting that the experts refuse to answer the question, as the provided link shows quite a bit of waffling. Also read the last section of this article.

LH2004 (talk|edits) said:

October 20, 2009
What question, what link and what article?

Kevinh5 (talk|edits) said:

21 October 2009
the ones right above your last question - can't you see the words in blue are ready for you to click on them to follow the hyperlinks? Or do you just think I type in blue?

LH2004 (talk|edits) said:

October 21, 2009
Aha. No blue on my screen in Firefox: your prior post appears just as "I find it interesting that the refuse to answer the question, as the provided link shows quite a bit of waffling. Also read the last section of article." A little bit of sleuthing leads me to the conclusion that TaxAlmanac's forum software is emitting invalid CSS and relying on some Internet Explorer-specific hacks, for no apparent reason.

Both articles raise doubts about the validity of a 1035 exchange where the policyholder receives cash (actually or constructively) and applies the cash to the purchase of a new contract. I agree that that is dubious, though I don't agree that Greene can be read not to permit it; I think that the issue was clearly raised in Greene, and the taxpayer won. I just think that the decision is wrong, but the IRS has acquiesced, so it's the law of the land at least for now.

But that has no bearing on the issue we're talking about, if there is no actual or constructive receipt of cash. I think that the taxpayer in the OP can include the premiums paid on the no-cash-value policy toward the new one, if it can be established that the old one had market value. If the insurance company was willing to make the same deal without the surrender of that policy, that would be strong evidence that the policy had no market value.

Tdoyle (talk|edits) said:

October 21, 2009
LH2004:

I use Firefox and I can see the links perfectly. Have you tried forcing a refresh of the page with Ctrl-F5? It may be that the CSS file was corrupted when it download to your system. You might also try clearing your cache and coming back to this page. If neither of those work, please let me know on my talk page which version of Firefox you are using and any extensions you have loaded (select Tools - Add-ons from the pull-down menu).

Thank you!

- Tim Doyle, TaxAlmanac Moderator - Talk to me 10:26, 21 October 2009 (CDT)

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