The tax code can be your friend if you think you are locked into a high-cost insurance product. Here's what to do.
What are your "Big $ Mistakes" (B$M)? For an awful lot of doctors, it seems to be some kind of high-fee, high-commission product. Nobody is immune from making B$Ms but, hopefully, we are all the wiser for them.
So what if one of those B$M's was a whole life insurance policy you bought during medical school? Or an annuity (cloaked in fees) that sounded like the solution to all your financial problems? This kind of B$M tends to weight down your balance sheet for years and years. Insurance executives knew policyholders would cancel policies when they found out what a bad deal they had just made. That’s why early surrender penalties were invented!
We hate to see those premiums we’ve already paid go to waste. Plus cancelling a tax-deferred annuity you bought when your income was lower will cost you some serious tax dollars now that you’re an established attending. Are you stuck with your big mistake?
IRS Code Section 1035 allows you to exchange either of these products into another one. You may be wondering if I’ve just lost my mind. Why you would want to exchange one miserable product for another?
Here’s why: there are companies in the marketplace today that sell low cost annuities and low cost life insurance. They strip these policies of all the extra fees and commissions, focus on volume and sell products that qualify for a 1035 exchange, typically charging a low flat fee. The IRS allows you to:
Even better, you have a wide variety of low cost investment choices inside these policies. You or your financial advisor can manage your investments rather than relying on a company you don’t trust for oversight.
Here’s something else you may not be aware of: losses on life insurance policies are not deductible but losses on variable annuities are. By 1035-exchanging your sorry whole life insurance policy to a variable annuity, you’ll not only have a better investment portfolio, you’ll get to take advantage of the loss built in to your Big Mistake.
So — what’s the catch? If your policy is not out of the “surrender period”, you’ll pay a penalty when you exchange. The longer you’ve owned the policy, the lower then penalty, eventually going to zero.
But watch out — insurance salesmen are expert at moving you to a different product when the surrender period is nearly over, locking you in for more fees and commissions over another surrender. Do not allow this! And just because your policy is still within the surrender period, don't assume that you won't benefit by going ahead with the exchange. You should run a cost-benefit analysis, including projecting returns from a healthier investment portfolio, before making your decision.
A couple of companies I can recommend for a 1035 exchange are:
Both of these businesses market to fee-only CFPs, which is quite unusual in this industry. They will also help assess your current policy and cut through the legalese so you can understand the exact cost to you.
As you can see, a 1035 exchange can be complicated, but you can be well-rewarded. Be sure to run this strategy by your CPA or fee-only Certified Financial Planner so that you can incorporate it into your comprehensive financial plan.
For more information, visit For Doctors Only at Fox & Co. Wealth Management.