If you have money in a life insurance policy, you can easily switch your insurance into an annuity. The IRS does not want to restrict your investment options and lets you switch policies through a 1035 exchange. This tax rule keeps you from getting locked into one contract and helps you get the most out of your money.
To switch your life insurance policy into an annuity, you should use a 1035 exchange. This transaction immediately converts your life insurance into an annuity and moves your life insurance cash value into the annuity account. A 1035 exchange is an easy transaction. Simply tell your annuity agent that you want to exchange your life insurance policy into your annuity and he will give you the appropriate forms for the transaction. Be warned, a 1035 exchange is a one-way street. You can't change your mind later on and convert your annuity back into life insurance.
The beauty of a 1035 exchange is it avoids any income tax on your switch. If you tried to convert your life insurance manually, by cancelling the policy, moving the cash to your bank account, then buying an annuity, you would owe income tax on all the gains of your life insurance policy. The 1035 exchange avoids this hefty tax bill as it delays taxes on your gains until you decide to start taking money out of your annuity.
Reasons to Switch
An obvious reason to convert your life insurance is that you don't need life insurance anymore. Part of your life insurance cash gains are going towards paying for life insurance. By switching to an annuity, all your investment gains will go towards building your cash. This makes annuities a better choice if your goal is to grow your money. Annuities also have better payout options. If you want to start cashing out your life insurance savings, an annuity has more options to guarantee a certain number of payments.
Reason Not to Switch
Once you convert your life insurance, there's no going back. You can't undo a 1035 exchange down the road. Also, it gets more difficult and expensive to buy life insurance as you get older. The life insurance policy you currently own is most likely a huge bargain compared to any new policy you would be able to buy in the future. While an annuity has nice income features, it doesn't provide anywhere near the inheritance that your family would receive from life insurance.
David Rodeck has been writing professionally since 2011. He specializes in insurance, investment management and retirement planning for various websites. He graduated with a Bachelor of Science in economics from McGill University.