Advanced Underwriting Consultants

Question of the Day – March 9

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers.  Here’s the question of the day.

Question: Can you take an existing universal life policy owned by an irrevocable life insurance trust (ILIT) and do a split Section 1035 exchange?  Half will go into a new policy owned by the ILIT, and the other half will go into an annuity owned by the grantor of the ILIT?

Answer: The answer is no, for three separate reasons.

The first reason is that the IRS has not approved the exchange of a life contract for one life and one annuity contract under Section 1035.  It has said that the trade of one annuity contract for two annuities is OK, though.

The second reason is that ownership of the exchanged policies must be the same both before and after the exchange.  In this case, you’re changing ownership on the annuity, so you can’t do a Section 1035 exchange.

The third reason has to do with the fact that I suspect you’re transferring the new annuity to the grantor of the trust.  Under an ILIT, the grantor has no right to get back the money or policy owned by the trust.  If the trustee allows a distribution to be made to the grantor, the trustee is violating its duty to the beneficiaries of the trust—and that’s not allowed.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.