1. Exchange of Life Insurance Policies with Loans
- You must be careful when exchanging policies with loans that are in a gain position - a policy is in a gain position if the total cash value is greater than the adjusted cost basis.
- If the loan is extinguished (discharged) on the exchange, the lesser of the loan or the gain in the policy will be taxable income to the policy owner. This will generate a Form 1099-R from the carrier.
- If the loan is carried over on the exchange to the new carrier, the exchange will be accomplished tax free. However, the new policy will be issued with an outstanding loan from the start. Many carriers have loan to value limits that must be met before they will accept a Section 1035 carry over loan.
- Multiple policies with the same owner and the same insured can be exchanged for a new policy and one policy can be exchanged for multiple new policies. The cost basis of the contracts will be carried over to the new carrier and adjusted cumulatively (i.e. 2 for 1; 3 for 1) or proportionally (i.e. 1 for 2; 1 for 3) as the case may be.
In our next blogpost, we will discuss when an 1035 exchange should be considered.