1035 Exchange with Life Insurance

When Should You Use a 1035 Exchange with Life Insurance?


Do you have a life insurance policy you’re concerned may not last, lacks guarantees, or may lapse, and you’re wondering how you could trade it in for a better model? The good news is that you have options, and you’re not stuck forever! Enter: the 1035 exchange. But, a strong word of caution: you need to understand what this entails and when it might hurt instead of help you.

In this episode, Bruce and I discuss when you should use a 1035 exchange with life insurance. If you want to know the pros and cons of a 1035 Exchange–tune in below!

In this episode, you’ll learn:

  • What a 1035 exchange is and how it works.
  • The reasons why (or why not) to do a 1035 exchange.
  • Challenges you may face during the process.
  • And more!

Where Whole Life Insurance Fits Into the Bigger Picture

A 1035 Exchange could be what allows you to ensure your life insurance is there for your entire life, however, Privatized Banking with whole life insurance is just one part of the bigger journey.

Privatized Banking

That’s why we’ve developed the 3-step Cash Flow System. It’s your roadmap to go from just surviving, to a life of significance, purpose, and financial freedom. 

The first stage is the foundation.  You first keep more of the money you make by fixing money leaks, becoming more efficient and profitable. 

Then, you protect your money with insurance and legal protection and Privatized Banking. 

Finally, you put your money to work, increasing your income with cash-flowing assets.

Understanding the 1035 Exchange

A 1035 Exchange is available through a provision in the IRS tax code, which allows you to transfer specific assets into assets of a like-kind without having to pay tax. Today, we’re talking specifically about the transfer of life insurance policies and why you would want to do a 1035 exchange in the first place.

Most often, a 1035 exchange is on the table when you have a policy that no longer seems like an ideal fit for you. If your insurance policy was not designed with you in mind or lacks guarantees, you are likely a candidate for a 1035. Regardless, if a policy isn’t working for you, know that you’re not stuck—you have options.

That said, it’s not always ideal to exchange a policy. It’s important to be informed about what a 1035 can and cannot do so that you’re not taken advantage of down the road.

Reasons for Exchanging

In some cases, it’s possible that you have a less-than-ideal policy design, and it feels like you’re continuing to pour in money with few guarantees. We see this often with universal life insurance. The problem is in the language of how some advisors pitch these products—flexible premiums aren’t all that flexible.

In the later years of an in-force IUL, the cost of maintaining your policy can increase because premiums are non-guaranteed. So even though you can make flexible premium payments, you could be under-funding it and lose your policy.

To get a better idea of how your policy is performing, we recommend requesting an in-force illustration of your life insurance policy from your company. This will show you how your policy has performed and the projections for future performance. You will also see which guarantees you have, and which ones you do not. Use this information to assess whether or not your policy is doing what you want it to do.

Ultimately, we see people exchanging policies that just aren’t living up to their expectations. If you don’t currently have a life insurance policy, take some time to think about what you want to accomplish—leaving a legacy, protecting your family, leveraging your cash value, or more? And if you do have a policy, check-in and make sure it’s accomplishing what you want.

Reasons Against Exchanging

Though the tax benefits of a 1035 exchange are important, we recommend erring on the side of caution when it comes to exchanging a policy. This often boils down to cost. When you first open a new life insurance policy, you’re paying for the cost of insurance upfront—this is why your cash value takes a few years to “break even.” After a certain point, your cash value breaks even and surpasses the amount you have paid in premium.

When you do an exchange, you start over with a new life insurance policy. Which means paying the costs up-front. And if you’re not yet at the break-even point on your first policy, you could be giving up alot of capital that you’ll never recover on that policy.

Another instance where the 1035 exchange may not be helpful? When the cost of insurance in your new policy is greater. You’ll have guarantees but at a much steeper cost. In which case other solutions might have better results. Regardless, know that you have options when a policy isn’t right for you. You’re not stuck.

What You Really Should Know

When it comes to a 1035 exchange, it’s important to note a few hoops you’ll have to jump through. The first is that you must still qualify for your new policy. You’ll have to go through the health exam and other application requirements to be insured. In some cases, you may qualify, but with a rated status. A “rated” insurance policy places more risk on the insurance company for insuring you, so the cost increases. However, in many cases, this doesn’t pose a problem large enough to prevent you from exchanging the policy. But, if the cost of insurance is too high, you may be better off keeping your insurance and do what you can to keep it from lapsing.

Additionally, in a 1035 exchange, you can’t expect to have 100% of your premium available to you. However, you can expect to access more than 90% of the cash value that is transferred.

The 1035 Exchange Process

The process of doing a 1035 exchange is time-consuming, and commissions are low so that advisors are not incentivized to do 1035 exchanges more than necessary. Insurance companies are, first and foremost, built to protect the interests of the insured (you).

Once you and your advisor have determined that this process makes sense for you, it’s time to start the exchange. Although cumbersome, the steps of the process are in your best interest.

You’ll start by applying for your new insurance policy as you normally would. Then on the application, you’ll list the policies you own and state that you want to 1035 a specific amount of money from a particular company.

The new company will then contact the old company, who will contact you for confirmation. They will list all the pitfalls of the exchange, as well as the regulations. Once you’ve agreed, the process will continue similarly to any other insurance application process.

Is a 1035 Exchange Right for You?

You should feel confident in your decision, and a financial advisor who listens to you and helps you learn is a good starting point. They can help you determine the best path, and how it fits into your entire financial picture.

At The Money Advantage, we exist to help wealth creators build time and money freedom with cash flow strategies, privatized banking, and alternative investments free of stock market volatility so you never have to worry about running out of money. Find out your next best steps by grabbing a slot on our calendar.

Follow us by subscribing and rating us on Apple Podcasts, or The Money Advantage on YouTube and Facebook to join us for live conversations.

Learn more about how Privatized Banking is an ideal place to store cash that gives you the most safety, liquidity, and growth, so you can leverage your cash and earn returns in 2 places at the same time.

Rachel Marshall

Rachel Marshall is the Co-Founder and Chief Financial Educator of The Money Advantage and President of Marshall's Insurance and Financial Services. She is known for making money simple, fun, and doable. Rachel has built a team of licensed professionals (investment advisors, insurance agents, attorneys, tax strategists) to help her clients create time and money freedom with cash flow strategies, Privatized Banking, and alternative investments. Rachel is the co-host of The Money Advantage podcast, the popular business and personal finance show. She teaches how to keep more of the money you make, protect it, and turn it into cash-flowing assets.
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