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1035 Exchange - Seeking Information

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TheKingfish
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1035 Exchange - Seeking Information  Reply with quote  

I am new to the forum but enthusiastic to partake. Iím just cruising for some initial info on the above; converting life insurance into an income annuity. My wife and I have three (3) long-held whole life policies and have interest in the short term income they could bring. Based on current/future need, we have no interest in the death benefit.

I know there are two policy components (face & cash value) and that one must shop the best annuity provider -- and thatís where I begin my trek. I thought Iíd first post here and then move forward with some personal research. Iíll see what this produces, then roll back and share what all Iíve found on the subject. I think 1035 exchanges might be a small topic, but appreciate any background you can provide.
Thank you,
TheKingfish
Post Mon Dec 08, 2014 3:08 pm
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oldguy
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You have violated the rule of investing - 'never mix life insurance and investing, you get the worst of both'.

As for annuities, they are also known as 'inappropriate' investments, a few years ago Congress was looking at making a law to prevent bankers from tricking senior citizens into buying annuities.

A 1035 Exchange allows you to exchange an annuity into a like-annuity and push the tax bill forward into the new one. But, unless you are into some major trust issues, generation skipping and so on, you may want to avoid these.

How about just cashing out the 3 insurance policies (if you have no need for the insurance) and invest the cash in a brokerage account - that avoids the huge fees, etc, and you get to keep & compound the returns.
Post Mon Dec 08, 2014 5:41 pm
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Wino
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oldguy is 100% correct.
Post Tue Dec 09, 2014 3:07 am
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TheKingfish
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Thanks for your feedback. Rest assured I would be the last to take issue with your oil & water premise of insurance and investment. I am a longtime investor (mutual funds) and annuities are anathema to me. Given the need to repurpose my existing whole life policy Iím wedded to the task of investigating the 1035 exchange; to see whatís there and what isnít there. A full cash-out is an option. The gains will be taxed, so that becomes a current/future consideration.

Following some research, hereís what it appears to look like. To exact the formal 1035 exchange is to move into a totally new vehicle, the purchase of an annuity. The annuity incorporates fees & penalties and contractually is not much different than the policy it replaces.

The more attractive alternative appears to be annuitizing the current contract. Because the existing policy has some advantaged longevity (issued in 1968), thereís the prospect for an attractive interest rate. Thatís basically the hook (attraction), plus the ability to dictate the term. The insurance company will soon issue what they call an illustration (quote) that will structurally define the vehicle. When it comes I will share that general info and my decision going forward. Your comments continue to be welcome.
Thank you,
TheKingfish
Post Thu Dec 18, 2014 3:56 am
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oldguy
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I would probably sell them outright, pay the taxes - then invest in an unencumbered, no hooks, SP500 Index Fund that earns about 11%/yr, grows tax-deferred, and gets cap gains preferential treatment if/when you sell some of it.

There's a reasonable chance that a couple yrs of earnings will pay the tax for you - and everything forward will be gravy.

Like that old saying - "don't let the tax tail wag the dog." Very Happy
Post Thu Dec 18, 2014 11:18 pm
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TheKingfish
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Thanks again for the feedback. Final input on this topic. The formal Ď1035 exchangeí as a mechanism has no real substance (trading one insurance vehicle for another). Normally a public instrument has consumer value, but this industry item has little benefit. Itís largely a misnomer.

On the best alternate path, hereís how my insurance company annuitization shook out. My policy cash-value was $19k. My cost basis was $2k, so Iíll pay taxes (about 11%) on the gain. The tax-free death benefit was $27.5k. Comparing live-money versus dead-money, thatís a $10.6k difference.

Doing a Time-Value-of-Money analysis, my $2k made about 5.5 percent annually over those 46 years. Thatís a rough calculation with premiums paid during the early years. The market did about 6.7 over that time minus dividends, so mine was an 18 percent comparative shortfall (5.5/6.7). Not bad I suppose, given the low risk insurance represents.

I selected a three-year payout term. That came with 1.2 percent annual interest, a reasonable current bank rate. In the end (for me) it was a convenient way to go for the short term cash flow. It allows a comparable amount in my investment portfolio to stay engaged and not be diverted.

So in a nutshell, thatís my experience. I hope this post provided some small insight for others considering the path.
Thank you,
TheKingfish
Post Thu Jan 08, 2015 8:33 pm
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littleroc02us
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Sounds messy to me. My wife and I both have 500k 20 year Term life insurance should we need income while our children live with us. We invest seperately in Index funds that have average over the last 6 years around 20% and before that 8%.

Insurance for death is only needed when someone else relies on your income to survive. We have a 20 year policy which gives us more then enough time to self insure, plus by then the kids will have moved out and won't need to live on our dough.

I would sell the whole life policies and pay the tax and start investing your money at a low expense ratio. Too many fees and commissions to pay with Whole Life.

Risk comes from not knowing what you're doing. (Warren Buffet)
Post Thu Jan 08, 2015 9:30 pm
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oldguy
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quote:
I would sell the whole life policies and pay the tax and start investing your money at a low expense ratio. Too many fees and commissions to pay with Whole Life.


Yeah,that!! Very Happy
Post Thu Jan 08, 2015 10:14 pm
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TheKingfish
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Thanks again for the feedback. Capping the annuitization transaction details Ė there were no fees or commissions incurred (FYI). There would have been, had I moved toward the new insurance-vehicle 1035 exchange.

As it turns out, I have followed your excellent advice. I sold the whole life policy (over three years) and have invested the money (current portfolio funds remain working; not diverted for short-term income needs).
Thank you,
TheKingfish
Post Fri Jan 09, 2015 10:42 am
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TheKingfish
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I thought I was done here, but am now adding a prologue to my last post for folks who embark upon this process with their (dreaded) insurance company. Initially I spoke with representative Angela and, although I pursued it by name, she repeatedly eschewed the 1035 process. It was a time saver and I was lucky because she ultimately said: ďIf it were me......I would do such & such.Ē

I love when that happens because you now have Ďthe expertí graciously coming down to your level and offering what will often be heartfelt (good) advice. So once I fully understood the 1035, I was all ears for the proposed annuitization and, the rest is history.

Nonetheless, hereís the small recent lesson-learned. Following my procedure, Ms. Kingfish pursued the very same with her policy. However there was no early ĎAngelaí at her company. Her rep was oblivious to the annuitization option and was adamant in funneling her toward a new-contract 1035 vehicle, presumably with all the aforementioned fees & penalties.

So, be prepared (1) for that diversion and (2) to hard-pursue the annuitization Ė itís an option that exists; you just need to get to the right person, someone in the know. I hope that helps.
Regards,
TheKingfish
Post Sat Jan 17, 2015 9:22 pm
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craigd
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TheKingfish,

I always appreciate a well-informed and educated consumer, as they tend to be very fiscally responsible and shrewd investors. "Annuitization" of your whole life policy was certainly the best option in your specific situation. This process is known as an accelerated death benefit and is largely unknown to the masses whom view life insurance as a money pit, rather than a viable cash accumulation vehicle with tax advantages.

I was thrilled to see you discussing your internal rate of return (IRR) of 5.5%, as this analysis yields a measurable outcome to compare the very low risk with solid, sustainable returns. In a whole life policy the insurer bears the entire risk that the instrument may not yield the guaranteed contractual rate; however, the insured also bears the risk of the opportunity cost of stronger gains they may have achieved elsewhere.

I am glad that you brought up that cogent point, so individuals can see that these decisions are based upon risk tolerance, financial goals, current needs, and financial means with not one set way to approach this analysis.

Craig Donnelly
(972) 757-5237 (Cell)
donnellyct@yahoo.com
Craig@ameritasfc.net
Post Thu Nov 26, 2015 3:52 pm
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