08/29/2024
Repurposing the cash value of whole life insurance through a tax-free exchange
Do you have any whole life insurance policies? Do you have less need for life insurance now that you are retired?
If so, there is a tax-efficient way to convert the cash value of old whole life insurance policies that may be worth a look: a 1035 exchange.
A 1035 exchange of life insurance for an annuity could, for example, provide a guaranteed future fixed income source for a 65-year-old who may live into his or her 80’s or 90’s.The guarantee may be appealing, especially if you win the longevity lottery and keep the ticker going past 90. As my book, Savvy Saver’s Guide to Deferred Annuities discusses, however, the guaranteed nature of payments comes at a price. That price includes not only fees and devaluation of future payments due to inflation, but the lost opportunity to participate in potential stock market gains over the long term.
A deferred variable annuity is another potential candidate for a 1035 exchange. It provides a chance to participate in the stock market. For example, Fidelity offers the Fidelity Personal Retirement Annuity® which offers the opportunity to invest in a family of over 65 mutual funds, including several stock and bond index funds.
No taxes are due until there is a withdrawal or an income payment. Even then, the taxable portion will exclude after-tax premiums paid into the former insurance product.
One interesting feature of the variable annuity is that it is NOT subject to Required Minimum Distributions (RMDs). This means that 100% of the value can work for you for as many years as the annuity contract allows—even into your 90’s, without any requirement that you start draining the account earlier to give the IRS its cut. This feature provides more flexibility and control over taxable events than does an IRA or 401(k) subject to RMDs.
What is the catch? There is a fee in addition to the normal fees charged by the mutual fund providers. In Fidelity’s case, the annuity fee is relatively low: 0.25% of the annuity value each year.
Any conversion should be handled by the financial institution receiving the converted funds. Make sure that you have a complete understanding of any fees and commissions assessed against the new product.
Consulting with an advisor might reveal that an alternative type of annuity or insurance product is a better fit for the insured.
Exchanging whole life insurance for a low-cost variable annuity, with a significant percentage invested in the stock market, may provide long-term benefits for someone living longer than average. Sure, the value will fluctuate. But as a potential inflation hedge and source of income in the 20-plus year range, the chances of seeing the value increase more in the variable annuity than as cash value of whole life insurance may be appealing.
Consider talking to a financial advisor about whether a 1035 exchange makes sense for you, and if so, about how to find your best exchange option. Nothing herein is to be construed as providing financial advice.
Get the book at https://www.amazon.com/Savvy-Savers-Guide-Deferred-Annuities/dp/B0D3BRTHX3
