A Life Insurance Policy Replacement
A policy replacement is a transaction where a policy holder buys a new life insurance policy, thus notifying an insurance carrier that an existing policy is or will be surrendered or partially surrendered. The old policy may also have lapsed, or been forfeited by the policy holder.
Replacement is actually defined as being any transaction that involves the sale of a new insurance or annuity policy where the consumer’s existing insurance or annuity is being lapsed, forfeited, surrendered, terminated, or converted to a different amount. The plan may also be being amended in order to effect a reduction of benefits or term or coverage, or reissued with a reduction in the policy’s cash value.
In general, Section 1035 of the Internal Revenue Code allows the investment and gain or loss in a non-qualified life insurance policy, endowment policy, or annuity contract to be transferred to another policy or contract – including tax-qualified long-term care insurance – without having to pay tax on any gain at the time of the exchange.
The United States tax code allows individuals to exchange one life insurance policy for another (or a life insurance policy for an annuity) without triggering current tax liability. This is known as a Section 1035 exchange.
A 1035 exchange allows an individual to move to a new policy or contract as their needs or circumstances change. It is important to note, however, that exchanges may be suitable in some situations, but not in others.
Typically, a life insurance policy may be exchanged for another life insurance policy, a modified endowment contract, an annuity contract, or a long-term care insurance policy.
The contracts that are involved in the exchange must meet the basic definitions of life / long-term care insurance contract, endowment contract and / or annuity contract, as set forth in Internal Revenue Code (IRC) Section 1035. In all cases, the policy that is received must relate to the same insured as the policy that is being given up in the exchange. However, the contract issuer may be different.