In my previous article I discussed the benefits of tax-free exchanges under Section 1035 of the revenue code. Over the years, I have completed more than a few exchanges that truly helped the policyholder. Here are a few examples and one or more of these might apply to you:

Many whole life insurance policies, particularly older ones, do not pay dividends or credit excess interest. Premiums usually are payable to ages ranging from 90 through 100. The cash values, usually sizable are included in and not in addition to the death benefit. Assuming one’s insurability, transferring the existing cash value to a new contract will enable you to utilize an updated product with lower insurance costs and dramatically improved benefits.

In the example above, let’s assume the policy is no longer needed, but the cash surrender value is less than total premiums paid. That loss is not deductible. Maybe this policy had cost you $40,000 in premiums over time with a cash surrender value of $25,000. Moving these values to an annuity will allow the carryover of your $40,000 basis leaving room for $15,000 of tax-deferred growth. Note that the annuity has to be non-qualified.

You also have the option to exchange these funds for income by using an immediate annuity. Again, the basis may be carried over so most, if not all, of your monthly income could be tax-free due to exclusion ratio. This ratio, used with non-qualified annuities, provides that a portion of each payment is considered a tax-free return of principal. The only negative with this arrangement is that interest rates are near zero, so calculations for an immediate annuity will reflect that.

Many life policies have had significant loan activity. Repayment is not required and the loan is cancelled when the insured dies. If the outstanding loan causes the policy to implode, the loan then becomes Forgiveness of Debt. If the policy loan and remaining cash value exceeds the premiums you have a taxable event and that can get ugly.

It’s fairly easy to tell if there are problems on the way. If the annual statement doesn’t help, the carrier will provide a projection of what is required to clean up the policy. More often than not, it will take too much in premiums to make things work, so look for a carrier that will consider taking over the policy loans.

A cleaner way of handling this problem is to confirm your insurability, and after the new policy issues, just surrender the old contract if you don’t have a taxable event. Each situation is different and requires the service of a professional advisor.

There have been many situations recently where older universal life policies issued in the 1980s and 1990s are still paying the same premium from the issue date. Due to lack of service not only by the agent but also from the carrier, these policies are “at risk” in this low interest environment. In many cases, the writing agent may have left the business, retired, or even died, so the carrier has to shoulder a lot of the blame here.

Because older universal life policies have no underlying guarantees, it’s very hard to catch up on 15 to 20 years of underfunding. If life insurance is still needed, it’s probably best to look at a new policy and use the 1035 Exchange to transfer the remaining cash values to reduce premiums. New policies will offer greatly improved features with lower mortality costs.

Don’t be surprised if you have one or more of these problems in your insurance planning. Again, every situation is different, so consult an insurance professional for a specific review of your situation.

Lassiter is a Chartered Life Underwriter and Chartered Financial Consultant. He is a Licensed Insurance Counselor and a Registered Investment Advisor. He can be reached locally at 770-786-2781