Individual Policy 1035 Funds Joint Policy


Earlier this week, I was asked if there is a way to fund a joint policy using a 1035 exchange from an individual policy.  Before I go any further, the basic rules for a 1035 exchange are:

  • the exchange must be “like for like”, and
  • life insurance to life insurance or annuity or PPA qualified LTC, or
  • annuity to annuity or PPA qualifed LTC

I will adhere to these principles with the funding solutions that I am about to share.

A husband and wife are both age 64 and have adequate life insurance in place and want to “trim their sails” and redeploy some of cash value from one of their life insurance policies into their LTC plan.   Simply, the value of a joint life policy will be realized.

In this case, the policy is a single life UL on the life of Mrs. with a cash surrender value of $98,350 of which $48,000 is gain.  Both are healthy and can qualify for either Asset-Care with no rating or Annuity Care. Check out our underwriting guide.

Possible solutions for this include:

  1. 1035 exchange into Annuity Care II 
  2. 1035 exchange into Indexed Annuity Care
  3. 1035 exchange into Asset-Care II
  4. 1035 exchange into Single Premium Immediate Annuity to fund Asset-Care IV

Solutions 1 & 2 are similar as the 1035 exchange directly funds the annuity which does not create a taxable event.  In the case of Annuity Care II  where the COB is required, the total benefit period will be 138 months; Indexed Annuity Care will offer the lifetime Continuation of Benefit Rider and will be funded with additional out-of-pocket premium.

Solutions 3 & 4 are similar in that they require an 1035 exchange from the existing policy into an annuity which will be used to fund the LTC solution.  In this case, the distribution will create a taxable event for the monies that are considered to be gain.  In both scenarios, the “base” policy will be funded using the $98,350 from the existing life policy with out of pocket premiums funding the Continuation of Benefit Rider and produce an unlimited lifetime LTC benefit.

Solution 1 Annuity Care II 

The 1035 exchange into Annuity Care II  funds the base annuity.  On a monthly basis, charges for the Continuation of Benefit Rider are deducted from the account value of the annuity.  The base benefit period will be 30 months with the COB offering another 108 months.  Remember, this is the only solution that does not include additional premium to fund the COB, that does not include inflation on the COB, and does not offer lifetime benefits.  This breaks down to a monthly LTC benefit of $3,298 per person creating a pool of $455,124 available for either of them.  

Solution 2 Indexed Annuity Care

The 1035 exchange funds only the base for Indexed Annuity Care; additional premiums for the lifetime COB Rider which includes 2% compound inflation will be $3,933 annually.   Remember, Indexed Annuity Care will have increased value year-over-year (on a guaranteed basis) and the COB includes an inflation option. The initial LTC benefit day 1 of the policy will be $3,179 per person with an unlimited duration; over time the benefits available will be greater in subsequent years.

Solution 3 Asset-Care II

Asset-Care II is a two stage product where the 1035 exchange funds a deferred annuity with guaranteed crediting rate of 3.0% which is used to fund over a 20 year period of time a joint Asset-Care policy producing LTC benefits.  This funding will be done via withdrawals and will create a taxable event (tax will be paid on the gain which will generate a 1099 until the gain is no longer present).  Additionally, funding for the lifetime COB Rider which includes 2% inflation will be $4,470 paid out-of-pocket for 20 years. The base post tax LTC benefit of the policy will be $4,503 per person with the lifetime COB Rider increasing over time.

Solution 4 Asset-Care IV funded via SPIA

This strategy creates a taxable event similar to option 3 however, the 1035 exchange funds a SPIA which then generates $6,330 (using the basis information noted above the exclusion ratio is 31% which translated into approximately $1,975 as basis; $4,355 as gain; using an assumed 20% tax rate, the 1099 generated for the distribution will be $871).  As with Solution 3, funding for the lifetime COB Rider which includes 2% inflation will be $3,788 paid out-of-pocket for 20 years. The base LTC benefit of the policy will be $3,755 per person with the lifetime COB Rider increasing over time.

The answer isn’t as simple as 1, 2, 3, or 4.  It really comes down to the underlying wants an needs of the clients.  If they are looking for the lowest tax impact at point of funding then Solution 1 (Annuity Care II ).  If they are looking at the best opportunity to hedge inflation, then Solution 2 (Indexed Annuity Care).  If they are looking for the largest death benefit and monthly LTC payout, then Solution 3 (Asset-Care II). And, if they are looking for the most stable, guaranteed, and predictable plan, then Solution 4 (Asset-Care IV).  Below, you will find an overview of the options.  This comparison does not include all of the policy level details.

  Solution 1 Solution 2* Solution 3 Solution 4
1035 98,350 98,350 98,350 98,350
Taxable Distribution 0 0 6,418 (20 yrs) 6,330 (20 yrs)
COB Premium none 3,933

(all yrs)

4,470 (20 yrs) 3,788 (20 yrs)
Total 1099 ** 0 0 17,600 17,600
Total Premiums Y20 98,350 177,010 217,760 202,360
Total Premiums Y30 98,350 216,340 217,760 202,360
LTC – Base  – Y1 3,298 3,179 5,222 **** 4,355
LTC – COB – Y1 3,298*** 3,179 5,139 4,355
LTC Pool – Y1 455,185 unlimited unlimited unlimited
LTC – Base – Y10 3,390 3,598 4,931 **** 4,355
LTC – COB – Y10 3,390*** 3,799 6,141 5,205
LTC Pool – Y10 447,604 unlimited unlimited unlimited
LTC – Base – Y20 3,137 4,721 4,503 4,355
LTC – COB –  Y20 3,137*** 4,631 7,487 6,344
LTC Pool – Y20 414,134 unlimited unlimited unlimited
Death Benefit – Y1 **** 98,350 94,417 174,063 145,150
Death Benefit – Y10 **** 91,518 98,134 164,365 145,150
Death Benefit – Y20 **** 84,675 113,328 150,086 145,150

*Indexed Annuity Care is a fixed indexed annuity; values presented in this comparisons represent GUARANTEED values; actual performance of base policy will be dependent upon the actual performance of the accumulation strategies elected .

** Total 1099 represents assumption of 20% tax assessed on the taxable gain of $48,000 accumulating at a rate of 3.0% tax-deferred annually then distributed annually to fund Asset-Care premium for 20 years.

**** A portion of the LTC Benefit will be taxable.

***** Death proceeds from an annuity may trigger a taxable event; death benefit from life insurance is tax-free