Do you own an annuity or cash value life insurance policy? Are you concerned about protecting your assets from the risk of rising long-term care expenses? You may be in luck.
Section 1035, a little-known provision of the federal tax code, allows policyholders who meet certain requirements to trade in their existing contract or policy tax-free for long-term care insurance.
Learn more about the value of 1035 exchanges and how this provision may benefit you.
What Is a 1035 Exchange?
The 1035 provision allows individuals to transfer funds from a non-qualified annuity (one bought with after-tax dollars) to another annuity which could better meet their needs. Or, they may transfer funds from a life insurance policy to an annuity or other life policy without paying current income tax on the investment gains earned on the original contract.
The Pension Protection Act of 2006 expanded 1035 exchanges to include qualified long-term care insurance which began in 2010. It allowed for the tax-free exchange of one qualified LTC policy for another, and for the exchange of an existing life or annuity policy to an LTC policy.
Those with an annuity can transfer funds in part or in full to buy LTC insurance, leaving anything that remains in their current annuity. Those with life insurance must exchange their entire policy during a 1035 exchange, but only a portion needs to be directed to the LTC policy. Anything that remains can be used to buy another life insurance policy or annuity. It can also be taken in cash, though it may trigger a taxable event.
Benefits of a 1035 Exchange
1035 exchanges defer the internal build-up of gains associated with an annuity or life insurance policy. Due to the tax-free nature of long-term care insurance, a 1035 exchange ensures a taxable gain disappears completely.
Individuals who have an existing life or annuity policy with a gain may want to complete a full or partial 1035 exchange. In a partial 1035 exchange, the annual long-term care insurance premium is paid which gains preferable tax treatment for funding a person’s LTC coverage.
Who Can a 1035 Exchange be Good for?
A 1035 exchange may make sense for individuals with adequate savings and kids who are financially independent. They are good for those with an existing life insurance policy which is no longer needed or may have significant cash build-up. Or, those with a non-qualified annuity with a significant tax-free build-up. The funds can then be used to pay for long-term care insurance.
Any gains in your life or annuity will disappear (i.e. no tax consequences). Keep in mind, the rules for tax-qualified long-term care insurance allow benefits to be received tax-free. There is no formal cash value from an LTC policy which could be taxable. These changes offer a significant tax advantage for individuals.
“Before executing a 1035 exchange, speak with a trusted financial advisor and look into policy specifications and contract language.”
Who May Not Benefit from a 1035 Exchange?
A 1035 exchange may not be a good move if your health has declined since buying life insurance. This could result in higher premiums for a replacement policy which could include both life and long-term care insurance.
Before executing a 1035 exchange, speak with a trusted financial advisor and look into policy specifications and contract language. In addition, make sure the long-term care insurance carrier will accept 1035 exchanges.
At LTC Consumer, we help individual navigate the long-term care insurance process. Contact us to speak with an LTC Specialist about your options today.