Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.
Question: My client has a whole life contract with a separate deferred annuity rider. She wants to exchange her whole life policy for universal life under Section 1035. May the client use both the cash value from the base policy and the money in the deferred annuity rider for the Section 1035 exchange?
Answer: It appears that the answer is no.
Section 1035 allows one life policy to be exchange for another life policy on a tax-free basis. While a life policy can also be exchanged for a deferred annuity under Section 1035, the rules do not permit an exchange of an annuity for a life policy.
Certain kinds of life insurance policy riders are considered to be part of an underlying life insurance policy. Any values associated with such riders would be eligible for a Section 1035 exchange from life policy to life policy.
Section 7702 of the Internal Revenue Code describes the kind of riders that would be considered to be an integral part of the underlying life policy. Here’s a list:
(5) Qualified additional benefits
(A) In general
The term “qualified additional benefits” means any—
(i) guaranteed insurability,
(ii) accidental death or disability benefit,
(iii) family term coverage,
(iv) disability waiver benefit, or
(v) other benefit prescribed under regulations.
Annuity riders are not listed as qualified benefits—so the cash value associated with the rider would be most likely be treated, for tax purposes, as if it is in a stand-alone annuity contract, and not in a life contract.
Thus, the cash in the annuity rider is probably not be eligible for Section 1035 treatment if transferred to a new life policy.
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