Should You Cancel Your Old Life Insurance Policy?

If you’re thinking about canceling an old cash-value life insurance policy because you no longer need the death benefit, you may want to take another look at your options. We’ve got an idea that just might be better for you.

You may already be familiar with a 1035 exchange, which involves exchanging one non-qualified annuity for another annuity in order to avoid taxation on the gains accumulated in the first policy. But did you know that you can do the same thing with a life insurance policy?

You can exchange an old life insurance policy with gains for either a new policy or an annuity. If you truly no longer need the death benefit from your cash-value life insurance policy, then a 1035 exchange into an annuity or a life insurance policy with long-term care benefits may make a lot of sense.

Here’s an idea that might work, although it might seem counterintuitive. Let’s say you have an old life insurance policy with a big loss instead of a gain. If you just cash in the policy for its cash value, you realize the loss but it is not tax deductible and doesn’t offset other gains you might have. But if you instead 1035 exchange the cash value of that policy into an annuity, you get to carry over the loss to the annuity, making at least a portion of any future interest earned tax-free.

Here’s an example of how this might work. Let’s say you’ve paid $5,000 per year in life insurance premiums for the last 20 years (for a total of $100,000 of basis). But let’s assume your policy’s cash surrender value is currently $75,000. That means the policy has a $25,000 loss. You could always surrender the insurance policy to take the $75,000 cash value and run.

But if you wanted to take advantage of that $25,000 loss, you might 1035 exchange that $75,000 cash value into a new annuity. And because the cost basis carries over, the cost basis of the new annuity is $100,000—even though you only paid $75,000 for the annuity. That means you’ll ultimately be able to withdraw the first $25,000 of any interest earned in the annuity tax-free because it’s treated as a return of basis.

Of course, any insurance replacement or exchange should come with careful consideration of a variety of factors—not just taxation. If you’re thinking about canceling an old life insurance policy, give us a call and we’ll be happy to help you with that analysis.

Information presented should not be considered specific tax, legal, or investment advice. You should always seek counsel of the appropriate advisor prior to making any investment decision. All investments are subject to risk including the loss of principal. This material was gathered from sources believed to be reliable, however, its accuracy cannot be guaranteed.

This information is for educational purposes only and no tax payer shall use it for unlawful tax reporting.

Insurance product guarantees are subject to the claims-paying ability of the issuing insurance company, and are subject to their terms and conditions.

Annuities are long-term investment products designed for retirement purposes. Guarantees are based on the claims-paying ability of the issuer subject to their terms and conditions. Early withdrawals may be subject to surrender penalties and, if taken prior to age 59½, may be subject to an additional 10% federal tax. Annuities are not FDIC insured. Certain terms and conditions apply, so please read insurance company materials carefully.

Long Term Care coverage policies and provisions may not be available in all states. Approval may be subject to the terms and conditions of the insurance company.

Insurance products offered through Lucia Insurance Services, LLC (CA Insurance Lic. #0H40817)

No client or prospective client should assume that the presentation (or any component thereof) serves as the receipt of, or a substitute for, personalized advice from LCG or from any other investment professional.

Raymond J. Lucia Jr. is chairman of Lucia Capital Group, a registered investment advisor and CEO of its affiliated broker-dealer, Lucia Securities, LLC, member FINRA/SIPC. Advisory services offered through Lucia Capital Group. Securities offered through Lucia Securities, LLC. Registration with the SEC does not imply a certain level of skill or training.

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