Before wisdom comes knowledge and before knowledge comes…Big Mi$take$. We’ve all made them and hopefully, we are all the wiser for them. So what if one of those Big Mistakes was a whole life insurance policy you bought during medical school? Or an annuity (cloaked in fees) that sounded like the answer to all of your financial woes?
This kind of mistake tends to weight down your balance sheet for years and years. Insurance executives knew policyholders would cancel policies when they found out what a bad deal they had just made. That’s why early surrender penalties were invented!
And we hate to see those premiums we’ve already paid go to waste. Plus cancelling a tax-deferred annuity you bought when your income was lower will cost you some serious tax dollars now that you’re an established attending. Are you stuck with your Big Mistake?
Not necessarily. IRS Code Section 1035 allows you to exchange either of these products into another one. I bet you’re wondering if I’ve just lost my mind. Why you would want to exchange one miserable product for another?
Here’s why: there are companies in the marketplace today that sell low cost annuities and low cost life insurance. They strip these policies of all the extra fees and commissions, focus on volume and sell products that qualify for a 1035 exchange, typically charging a low flat fee. The IRS allows you to:
- Exchange a life insurance policy into another life insurance policy or into an annuity, and
- Exchange one annuity contract for another annuity contract as long as the annuitants don’t change
Even better, you have a wide variety of low cost investment choices inside these policies. You or your financial advisor can manage your investments rather than relying on a company you don’t trust for oversight.
Here’s something else you may not be aware of: losses on life insurance policies are not deductible but losses on variable annuities are. By 1035-exchanging your sorry whole life insurance policy to a variable annuity, you’ll not only have a better investment portfolio, you’ll get to take advantage of the loss built in to your Big Mistake.
So – what’s the catch? If your policy is not out of the “surrender period”, you’ll pay a penalty when you exchange. The longer you’ve owned the policy, the lower then penalty, eventually going to zero.
But watch out – insurance salesmen are expert at moving you to a different product when the surrender period is nearly over, locking you in for more time, fees and commissions. Do not allow this!
A couple of companies I can recommend for a 1035 exchange are:
Both of these businesses market to fee-only CFPs, which is quite unusual in this industry.
As you can see, a 1035 exchange can be complicated, but you can be well-rewarded. Be sure to run this strategy by your CPA or fee-only financial planner so that you can incorporate it into your comprehensive financial plan.