Can You Transfer Life Insurance Policies to Another Company?

Policyholders can transfer life insurance policies between companies to adapt coverage to evolving financial needs or take advantage of new product features. This process allows adjustments to an insurance portfolio without triggering immediate tax liabilities. Understanding the rules and procedures is important for any policyholder considering such a change.

Understanding Policy Transfer Mechanisms

The primary method for transferring a life insurance policy between companies while maintaining its tax-advantaged status is a “1035 exchange.” This provision, found in Internal Revenue Code Section 1035, allows for the exchange of certain insurance contracts without immediate recognition of gain. A 1035 exchange enables the movement of a policy’s cash value from an existing insurer to a new one. This ensures accumulated gains continue to grow on a tax-deferred basis, which would otherwise be taxable if the policy were surrendered.

A 1035 exchange differs from other policy transfers like an absolute assignment or a change of beneficiary. An absolute assignment transfers all rights and ownership of a policy to another individual or entity, typically without moving it to a different company while retaining tax-deferred status. Changing a policy’s beneficiary redirects death benefit proceeds without altering ownership or transferring it to a new insurer.

Determining Policy Eligibility

For a tax-deferred transfer to qualify as a 1035 exchange, specific “like-kind” exchange rules must be met. A life insurance policy can be exchanged for another life insurance policy, an endowment contract, a non-qualified annuity, or a qualified long-term care insurance policy. This flexibility allows policyholders to adjust their financial instruments as their needs change, such as converting a life insurance policy into an annuity for retirement income. However, an annuity contract generally cannot be exchanged for a life insurance policy.

The exchange must be a direct transfer between insurance companies, meaning the policyholder cannot receive cash or constructive receipt of the funds at any point during the transaction. If the policyholder receives funds directly, the transaction is treated as a taxable event, and any gains may become immediately taxable. Additionally, the same policyholder(s) must be involved in both the original and the new policies, and the policies must be on the same insured individual(s). Changes in ownership or insured status during the exchange typically disqualify it from tax-free treatment.

Tax Considerations for Transfers

A qualifying 1035 exchange offers a significant tax benefit: no immediate income tax is recognized on the gain in the policy’s cash value. The growth within the policy remains tax-deferred, allowing the cash value to compound without being reduced by current taxation. The original investment, known as the “cost basis,” carries over to the new policy in a 1035 exchange. This preservation of cost basis is important because it determines the portion of future distributions that will be considered a tax-free return of principal.

If a transfer does not qualify as a 1035 exchange, such as when the policyholder receives cash or if the exchange is not “like-kind,” the gain in the policy’s cash value may become immediately taxable. This gain is taxed as ordinary income, not capital gains. Policyholders should also be aware of potential surrender charges from the original policy, which are fees imposed by the insurer for early termination. These charges are not tax-deductible and can reduce the amount of cash value available for transfer to the new policy.

Executing a Policy Transfer

Executing a life insurance policy transfer through a 1035 exchange involves several steps. First, the policyholder contacts the new insurance company to apply for a new policy that meets their current needs. As part of this application, the new insurer will provide the necessary paperwork, including specific 1035 exchange forms. These forms authorize the direct transfer of funds from the old policy to the new one.

It is important for the policyholder to not receive the funds from the old policy directly. Instead, the completed 1035 exchange forms instruct the new insurance company to request the cash value or funds directly from the original insurer. The new company then facilitates this transfer, ensuring that the funds move directly between the two insurance carriers. Once the transfer is complete, the policyholder receives confirmation and should review the new policy to ensure all details are accurate and the exchange has been properly executed. The entire process can take several weeks or even months.