Section 1035-Your Way Out of Obsolete Life Insurance Trusts
One possibility is the fact that the gift exemption may change in the future and revert back to his previous level of between $5 and $6 million. Another factor for clients is that many reside in states that are subject to separate state estate and inheritance taxes, and the majority of these states kept their thresholds at the same level as they were before the tax reform. Meaning that if state taxes were an issue for the client pre-reform, they continue to present the same issues now. Taxpayers with liability concerns regarding a business should also consider asset protection.
The process of dismantling a life insurance trust is very straight forward. The client could choose to give the policy to his or her spouse, and if there are no other assets held in the trust, that would be the end of it. Sometimes there are issues with remainder beneficiaries. But even if they do want to dismantle the trust, clients understand that they will, continue to have ongoing life insurance needs, be it providing for loved ones or using the cash value of the policy during retirement. Enter the 1035 exchange.
The IRC Section 1035 exchange rules allow the owner of a financial product, such as a life insurance or annuity contract, to exchange one product for another without treating the transaction as a sale. No gain is realized, thus there is no tax liability. To qualify, the policy owner must stay the same, except the IRS has allowed a change when the original policy insured two lives in a second-to-die policy and the exchange policy is a single product due to the death of the second person.
See William H. Byrnes and Robert Bloink, Section 1035-Your Way Out of Obsolete Life Insurance Trusts, Think Advisor, April 17. 2019.
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.) for bringing this article to my attention.