Tax-Free Exchange Of Insurance Products
What Does Tax-Free Exchange Of Insurance Products Mean?
The tax-free exchange of insurance products is governed by Section 1035 of the Internal Revenue Code (IRC) under the Internal Revenue Service (IRS). This allows individuals to swap one insurance contract for another of a similar type to defer taxes. For the transaction to be legal and recognized by the IRS, it must be properly documented, with all necessary paperwork finalizing the exchange.
While the products exchanged may share similar features, they do not always have equivalent financial values. Typically, an insurance agent facilitates the exchange, coordinating between the individual transferring their contract and the entity providing the replacement policy.
Insuranceopedia Explains Tax-Free Exchange Of Insurance Products
For an exchange to qualify as a legal tax-free exchange under Section 1035 of the Internal Revenue Code, the person exchanging their insurance product must not receive cash or a check. If cash or money is involved, the transaction will be considered a sale, not an exchange, and will therefore be subject to taxes.
The IRS also imposes strict guidelines on what constitutes “similar products” for such exchanges. First, as noted, no monetary transaction should occur. Second, the products must align in type. For instance, a life insurance policy can only be swapped for another life insurance policy or an annuity (a financial product providing periodic payments as per the contract). However, an annuity cannot be exchanged for a life insurance policy.
Common reasons for exchanging an insurance policy include:
- Lower Costs: The policyholder considers themselves healthy and unlikely to require significant medical treatment or hospitalization. They opt for a lower-cost policy that still provides sufficient coverage.
- Better Benefits: The new insurance product offers superior benefits compared to the current policy, prompting the policyholder to make the exchange.
