When you apply for a life insurance or annuity product utilizing a 1035 exchange, you can expect the following steps to occur:
1. Application: During this step, you will sign documents authorizing an insurance company to become the holder of your non-tax qualified funds. You will need to sign a 1035 Exchange form in which you assign the new insurance company as custodian of your funds.
2. Underwriting: If your exchange involves life insurance, you’ll likely need to go through a health underwriting process before the funds can be transferred. The process will vary by insurance company. There is a possibility that you won’t be approved for life insurance, at which point the process will stop. Annuity products do not require health underwriting.
3. Request for Funds: Once underwriting is complete and the paperwork is found to be in good order, the new insurance company will request the funds from the ceding insurance company. They will send the 1035 exchange form you signed along with their request for the funds.
4. Conservancy: Most insurance companies will try to conserve your business before they transfer the funds they are holding in your name. You may be required to verify your intention to transfer funds before they are released. Keep in mind that an insurance company may legally be able to take 6 months before they transfer the funds.
5. Fund Transfer: The ceding insurance company will send the new insurance company a certified check to the address indicated on the 1035 exchange form. The ceding company will forward the “cost basis” of your funds. The cost basis is the amount of the original dollars deposited into the insurance or annuity contract. Any growth above the tax basis will be taxable if funds are ever withdrawn.
6. Compliance: The new insurance company will review the policy for compliance. For example, they will need to ensure that the owner of the previous policy is also the owner of the new policy. The owner and insured of the exchanged policy must also match the new policy. The beneficiary of the policy, as long as it is has not been deemed irrevocable, can be changed at any time upon the discretion of the policy owner.
7. Policy Issuance: Once funds have been received and underwriting requirements have been fulfilled, the insurance company will issue your new life insurance policy or annuity policy.
8. Free Look Period: All insurance policies have a free look period, as determined by your state of residence. This provision allows you to cancel your newly issued policy and receive your funds. Keep in mind, if you receive your 1035 exchange funds prematurely and do not properly deposit the funds into another compliant insurance or annuity policy, you can be subject to penalties from the IRS.
As with all investment decisions, please remember to consult a certified tax advisor and your licensed insurance agent.