1035 Exchange with Loans

[capnjim01]

I have a client that I'm writing a policy on who has several polices that I am going to roll the cash value into a new policy.

1st question is that one of the policy he has taken out a loan on how will that be affected?

2nd is what happens if he takes to cash value of one of the policies and uses it to pay an annual premium.

 

[BNTRS]

I have a client that I'm writing a policy on who has several polices that I am going to roll the cash value into a new policy.

1st question is that one of the policy he has taken out a loan on how will that be affected?

2nd is what happens if he takes to cash value of one of the policies and uses it to pay an annual premium.

1. Depending on the new company, you may be able to carry the loan over or you may be forced to payoff the loan and then transfer.

2. If the surrender goes beyond the tax basis, then there will be a taxable event. If the surrender does not go beyond the taxable basis, then there would simply be a reduction in cash value and the loan would be gone.

 

[maxherr]

1. Depending on the new company, you may be able to carry the loan over or you may be forced to payoff the loan and then transfer.

This is not a likely scenario. Company A gave up some of its cash assets to loan money to a policyowner. It will want those cash assets restored if the policy is going off the books. The unpaid loan and interest will almost certainly be taken from the surrender value of the contract.

Note also, that 1035 Exchanges do not alter surrender charges. If a policy is being surrendered for a replacement contract, even with the same insurance company, the cash value transferred to the new policy will be reduced by the amount of the surrender charge imposed. The benefit of the 1035 Exchange is that the original cost basis transfers to the new policy, so the recapture of surrender charges can occur in a non-taxable environment. That would not be the case if the cash value were used to fund a stock purchase or bank savings account.

You also ask

what happens if he takes to cash value of one of the policies and uses it to pay an annual premium.

I assume you are talking about a surrender and not a policy loan. This would complicate a 1035 Exchange, but if the original policy were merely terminated, it would not be a problem unless the surrendered amount is more than the terminated policy's cost basis. Transferring cash value in a 1035 Exchange, and then using those moneys to pay premiums results in a policy loan in the new contract, which will bear interest, or in a withdrawal, which would not only reduce the cash value but also reduce the death benefit of the new policy $-for-$.

It generally makes no sense to use the cash value in one policy to pay premiums in another, unless there is no other source of funds to prevent a policy lapse. In other words, it would be like using one's VISA card to pay one's MasterCard bill this month, then reversing the equation next month. The debt remains the same, and more interest is owed on both accounts.

 

[BNTRS]

This is not a likely scenario. Company A gave up some of its cash assets to loan money to a policyowner. It will want those cash assets restored if the policy is going off the books. The unpaid loan and interest will almost certainly be taken from the surrender value of the contract.

There are several carriers that allow a transfer of a policy with an outstanding loan.

 

[VolAgent]

This is not a likely scenario. Company A gave up some of its cash assets to loan money to a policyowner. It will want those cash assets restored if the policy is going off the books. The unpaid loan and interest will almost certainly be taken from the surrender value of the contract.

There are some incorrect assumptions here.

You seem to think that the loan with Company A is still outstanding, it is not. The loan will be settled out, with Company B creating a new loan on the policy. Company A is only going to send the net cash value to Company B. Company B will then create the policy with the correct basis, cash value and loan.