24 July 2012 0 Comments

A Second-To-Die Replacement

In my last entry I discussed IRC Section 1035 and how it’s applied when replacing one life insurance policy with another. One criterion to qualify for the potential tax advantages of Section 1035 is that the insured party must be the same on both the policy being replaced and the new policy. This means that if you are applying for a new second-to-die policy and are replacing single life coverage on the husband and/or wife, you do not qualify for a 1035 transfer. But, here’s an interesting case in which I was personally involved.

A husband and wife had a $5Million second-to-die policy in force for eight years when the husband died. When the policy was issued he was rated up for a health condition and the wife was a preferred risk. The policy was one of the original Universal Life contracts that did not have good guarantees. The son of the widow was assisting his mother with her financial affairs and asked me to look at the policy. Based on the current premium being paid, the policy’s death benefit was guaranteed for only another 10 years and on a projected basis it would expire when the widow was age 88. At this time she was age 69 and in great health.

I discovered a policy with a Best’s A+ rated company that—after transferring the current policy’s cash value to—would provide her with the same $5Million death benefit guaranteed to her age 121 for a premium approximately 15% less than she had been paying, or we could substantially increase the guaranteed death benefit by continuing the same premium. I made her aware of the new contestable/suicide clause in this policy and that its cash value would be substantially less than if she kept the current contract. She told me that cash value was not important. The policy would stay in force until her death and lower premiums and a lifetime guaranteed death benefit were very important to her.

Even though there was no gain when surrendering the current policy, I wanted to apply in accordance with IRC Section 1035. I was able to do so because at the time of replacement one of the two insured’s on the second-to-die policy had died, so it only had a single life insured. This took a little explanation to the new company, but when we provided the husband’s death certificate, they agreed that it was a qualified Section 1035 transfer.

I’ve come to the end of discussing life insurance-for-life insurance replacements. Next I’ll tell you how you might save a lot of tax by replacing life insurance with annuities.

Leave a Reply