I don't know if this situation has been discussed much on the board. Please tell me if my understanding of the tax law is correct. My is 56 years old. He is in great health. He has a whole life policy with a $115,000 death benefit, $50,000 cash value, $30,000 loan, and $29,000 basis.
We are considering a 1035 to UL or VUL because the current policy is going to implode (we've run the inforce).
What will be the tax consequence if he just transfers the NET cash value? As I understand it, the "boot" received by the loan being eliminated is taxable up to the amount of gain in the policy. In this case, he would owe income tax on $21,000. Am I correct in this assumption? If we go with a VUL, we may just transfer the loan with the 1035 and not have this tax problem. The VUL runs fine with the loan and an assumed return of 6.5%. Your thoughts?
So I can't post a thread on financial-planning.com and this one at the same time? Sorry, I didn't see that in the fine print.
The client will be getting a higher death benefit with less premiums by executing the 1035. It is in the best interest of the client if he can qualify for Preferred or Standard. Implode was too strong of a word. The policy will require ongoing premiums for life with a reduction in death benefit according to the inforce illustration.
Does anyone want to answer the question? I believe I am correct in my assumptions, but one of my collegues said there would be no tax implications. I don't trust her answer though. Thanks in advance for thoughtful replies.
Last edited by loginname : 01-07-2008 at 02:22 PM.
Yea, I was wondering that also? Oh, yea they want to transfer it to a VUL or UL, of course they never implode!
I don't know if this situation has been discussed much on the board. Please tell me if my understanding of the tax law is correct. My is 56 years old. He is in great health. He has a whole life policy with a $115,000 death benefit, $50,000 cash value, $30,000 loan, and $29,000 basis.
We are considering a 1035 to UL or VUL because the current policy is going to implode (we've run the inforce).
What will be the tax consequence if he just transfers the NET cash value? As I understand it, the "boot" received by the loan being eliminated is taxable up to the amount of gain in the policy. In this case, he would owe income tax on $21,000. Am I correct in this assumption? If we go with a VUL, we may just transfer the loan with the 1035 and not have this tax problem. The VUL runs fine with the loan and an assumed return of 6.5%. Your thoughts?
I'm no tax expert but, I think your tax considerations is just a little off, on the high side. Now is the WL policy a Par WL? Or, what is the issueing company of this WL Policy. I can not imagine if this WL is half way decent how you can beat it now with CV nearing half of the DB? I'm assuming a 3% guarantee rate and the Dividends (if it is a Par WL with PUA), it should be performing around 6.5% at a lower cost then a VUL. Maybe there is a good reason, if the CV is no longer needed or desired (yet since there is already a loan in place I would have to guestion that) and a greater DB is the only need, maybe but, I would be careful before ending a WL Policy.
So I can't post a thread on financial-planning.com and this one at the same time? Sorry, I didn't see that in the fine print.
The client will be getting a higher death benefit with less premiums by executing the 1035. It is in the best interest of the client if he can qualify for Preferred or Standard. Implode was too strong of a word. The policy will require ongoing premiums for life with a reduction in death benefit according to the inforce illustration.
Does anyone want to answer the question? I believe I am correct in my assumptions, but one of my collegues said there would be no tax implications. I don't trust her answer though. Thanks in advance for thoughtful replies.
The most I see in tax implications is base on $1,000. $29,000 cost basis with a loan of $30,000. I wouldn't transfer the loan if you was to roll over the policy meaning the difference of $1,000 tax liability, that I see. Once again I am not a tax expert. If you rolled over the loan if possible, I don't see why there would be any tax involved?
Comparing 2 options: 1. Keep the current policy 2. 1035 to secondary guarantee UL or VUL run 6.5%
The client is able to get a higher death benefit (he likes that idea because this is his only permanent coverage) and stopping premium payments after 10 years (instead of paying premiums for life on the whole life). I have explained the possibility of needing additional premiums if the VUL subaccounts do not perform. He is comfortable with this risk.
I am putting the client in a better position regarding death benefit and premium payments. I just want to make sure of tax implications.
I'm not a tax expert, but I would research withdrawing the basis, paying the loan. There might be an easier way to do it, but in general, that would leave you a $1000 loan value to worry about.
I'd love to better understand why people think whole-life policies don't implode, especially if they are increasing value policies, with a few 'missed-payments'.
I'm not a tax expert, but I would research withdrawing the basis, paying the loan. There might be an easier way to do it, but in general, that would leave you a $1000 loan value to worry about.
I'd love to better understand why people think whole-life policies don't implode, especially if they are increasing value policies, with a few 'missed-payments'.
Dan
Well, I don't know what kind of contract doesn't implode or cancelled if you stop paying??? Yet, with $30,000 in CV, one would have to miss a lot of payments for it to be cancelled not implode. I think in common terminology when people talk about UL imploding it doesn't mean that payments were missed.
Most agents have no idea how WL works or for that matter how UL's work, here is a good site to actually see how WL works.
2. Cash or “Boot” Received by the Client. An exchange that otherwise qualifies for tax-free treatment under section 1035 may not be tax free to the extent the client receives cash or other “boot.” Boot means cash or other valuable non-qualifying property received in a section 1035 exchange. A problem can arise if the client receives cash (even temporarily) in connection with the surrender of the old contract. This trap (when recognized by a savvy agent) can be easily avoided by having the old contract’s cash surrender proceeds transferred directly by the old insurer to the new insurer to purchase the new contract. Another problem can arise if an outstanding loan encumbering the old contract is extinguished upon surrender of the old contract. The Internal Revenue Service (the “IRS”) has ruled that such an extinguished loan is treated as boot. Therefore, gain will be recognized by the client up to the amount of the extinguished loan less the amount of any loan encumbering the new contract. To avoid this trap, you may want to suggest to the client that either the loan should be repaid before the exchange or the new contract should be encumbered by a loan of an equal amount.
I concur with the last post. How can anyone disagree with a couple of Philadelphia lawyers? Seriously, IMO the information is 100% correct. One cannot have possession of funds even for a nanosecond to qualify as a Sec. 1035 exchange. I have done a few of them, in each case the funds were exchanged between the insurance companies and were never in the possession of the insured.
The IRS interpretation of the extinguishing of the loan being deemed "booty" is quite logical even though the insured does not technically receive any funds.
They did receive funds when they took out the loan and extinguishing the loan with cash value during the 1035 exchange eliminates the need to ever pay it back.
Well, of course they received the funds when they made the loan. However, because they did not extinguish the loan (according to your last post) prior to the 1035 exchange, but used the cash value in the policy at the time of the exchange, the payoff of the loan is considered booty. The cash value to payoff the loan has the same effect as if the client had received the cash (money) from the cash value and subsequently used it to payoff the loan, i.e., it becomes of the recognizable gain. Although the client did not receive the actual cash funds even momentarily, it is treated by the IRS as if they had actually received the money that was used to make loan repayment.
Agreed Arnguy. That's why I said there will be a taxable gain if the loan is extinguished during the 1035. It sounds like we are in agreement. I've run some more illustrations and it looks like it will work out fine to just transfer the loan during the 1035 thus avoiding any taxable situation.
Okay, the tax should be base the amount above the basis, last I look life insurance still goes by FIFO. Which would be $1,000 taxable, is this not correct?
Okay, the tax should be base the amount above the basis, last I look life insurance still goes by FIFO. Which would be $1,000 taxable, is this not correct?
Only if you use the basis to pay off the loan, I believe. This is not necessarily the same thing. If the loan is unpaid and not transferred, then the full amount of the loan should be taxable, but the basis would still be intact.
I am not an expert in this area, but it makes sense. Unfortunately, tax laws don't always make sense.
Only if you use the basis to pay off the loan, I believe. This is not necessarily the same thing. If the loan is unpaid and not transferred, then the full amount of the loan should be taxable, but the basis would still be intact.
I am not an expert in this area, but it makes sense. Unfortunately, tax laws don't always make sense.
Dan
Okay I'll agree, yet if you are moving money from a WL to a SGUL type of policy you might as well use the basis. Not like you'll ever get cash or should get cash from a SGUL, NLPG type of plan.
Tax implications of 1035 with loan
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