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What Is The Best Way To Do A 1035 Exchange On A Life Insurance Policy? - YouTube
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Make sure you max fund first. In this
episode, I'm going to address the
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question what is the best way to do a
1035 exchange on a life insurance policy?
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This will help you understand why many
insurance agents do not do it correctly
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or do not maximize the benefit of
exchanging one life insurance policy for
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a better one.
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My name is Doug Andrew and I've been a
financial strategist, retirement planning
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specialist for more than 46 years. And
I've helped thousands of people
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determine which life insurance policies
or contracts are going to be the best
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for them to achieve their financial
goals. I was never a captive agent with
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any one company. I use several different
companies. I usually had about 200 at my
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disposal but there were generally
between 6 to 12 that were my favorites
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that I knew would perform best. And they
treated their customers well. Sometimes
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unfortunately many insurance companies
will change things through the years on
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the older policyholders. And they make it
not so attractive
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if you've sort of hung in there and I
thought that was wrong. And so, many times
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I would do an audit or a comparison to
see if it would behoove someone to
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replace, exchange an old outdated
non-performing life insurance policy for
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a better one. Now that could have been
policies that they actually had taken
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out through me 15 or 20 years earlier. Or
maybe people came to me after they read
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one of my books and got educated. And
they wanted to exchange their life
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insurance policy which maybe was
designed primarily for death benefit. And
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they learned about how you can use an
indexed universal life more for living
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benefits. And so, they wanted to exchange
a policy, a life policy for another
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policy that is provided under Section
1035 of the Internal Revenue Code hence
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it is called a 1035 exchange. If you've
ever heard of a 1031 exchange in real
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estate, that's where you can sell one
piece of property and buy another like
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piece of property. And the money goes
directly into the new property and you
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don't have to pay tax. It continues to
grow tax-deferred with real estate. With
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life insurance
is tax-free and your money will continue
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to grow tax-free as it moves from the
old policy to the new one. But there are
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some very specific rules or things you
need to consider if you're going to do
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this. So, the first thing that I would
strongly recommend is that with someone
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who's proficient, they order an end force
illustration from the insurance company
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that issued the existing policy that
you're considering doing a replacement.
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You want to have an illustration so you
could compare. And you want to make sure
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It's an apples to apples comparison. Now,
many people that would come to me and
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they wanted to change the objective. So,
you have to ask yourself, "When you took
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out this insurance policy that you're
looking at replacing, what was your
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objective?" Many times it was just for the
death benefit. Now, they want to change it
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for living benefits. And they want a
policy that will provide maybe double
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the net spendable retirement income than
their existing policy could ever
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generate. Because it wasn't designed to
do that. If you're wanting to maximum
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fund a policy for living benefits, here
is one consideration most insurance
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agents do not understand. If you had an
outdated universal life and it wasn't
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performing very well and the insurance
company was only crediting 3.5
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or 4 percent and you know you
could exchange it out and have a
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universal life that is linked to an
index where you could earn more like
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8, 9 or 10 percent, hello? That's a
no-brainer. You order an enforced
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illustration showing what this would do
even if you maximum fund it. If you threw
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a bunch of money in there. And you take
it out to age 65 or 70 whenever you're
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going to retire and then you illustrate the
the income that it would generate out to
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age 90 or 100 or age 120. And what's
interesting in these comparisons you'll
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see that traditional IRAs and 401Ks and
mutual funds, they crash and burn
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because they're they're taxable.
You want to see the net tax-free income.
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When you look at that, you realize I want
a better policy maybe. So, then you do a
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1035 exchange. So, all of the years,
all of the money that you put into the
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old policy, you'll get credit for in the
tax-free
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grandfathering. So, if you were to cash in
the policy, cash it out, surrender it and
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then you put that money into the new
policy, that is not a smart way to go
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because you're having to start from
scratch in the new policy and you have
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to fund it over a minimum of 5 years
to be able to access the money tax-free
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under the Tamara law that I explained in
other episodes. If you want to
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grandfather yourself for the 2, 3, 4
10, 15 years that you
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paid premiums into the old policy, you do
a 1035. You can just change it now. You
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can't take the money. The insurance
company must send it directly to the new
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insurance company. You can't touch it.
When you do that, that money transfers
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totally tax-free. Now, you want to make
sure the cost of the new policy, the
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acquisition costs are worth it and then
you'll make up those acquisition costs
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sooner than later.
That's usually a no-brainer to analyze
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that. But here's the secret that many
insurance agents do not consider. If
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you're looking to maximum fund it, under
the IRS rules, we have Tefra, Defra and
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Tamra tax citations that were passed
back in 1982, 1984 and 1988. Tamra is the
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one passed June 21st 1988 that made us
slow the flow because there were a lot
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of banks and brokerage firms that were
whining back then. We can't compete with
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these maximum-funded insurance policies.
They pay higher interest, they're tax
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free. They blossom when you die and on
and on and on.
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So, we don't want to kill them. Why?
Because this is where they put some of
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their money, okay? They wanted to slow the
flow of money out of their institutions.
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Because back before 1988, if I had a
client that had a huge lump sum... Let's
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say 500,000. I have many
clients in the 1980s that could throw in
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500,000 before 1988. They
were earning 11 earning 10 percent and they
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immediately started taking 50,000 a year
of tax-free income, 10% of 500,000. After
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1988, you couldn't do that. If you had a
lump sum and you threw it into policy
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and you took the least amount of
insurance the IRS would let you get away
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with under Tefra, Defra, it would grow
tax-deferred. But if you started taking
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income, it would be taxable LIFO, like
an annuity. Last in first out.
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That's money you're earning the interest
every year is the first money coming out.
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Now, when you die, it would transfer
tax-free and the remainder. But if you
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want tax-free income, Tamra said you have
to spread it out if it's universal life
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over usually about 5 years to be
exact. If you put in 100,000
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of the 500,000, the first
day of the first year, you can put it in
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the last 100,000 on the first
day of the fifth year which is
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technically 4 years and one day later.
If you do that, 100,000 the
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next year another 100, 100, 100, 100; you
don't have to put that much in. Then you
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can take out tax-free income the rest of
your life. That's called the Tamra rule.
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What does that have to do with this
concept? If your old policy has already
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had 5 years, those 5 years of water
under the bridge,
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you don't have to wait 5 years again.
You can maximum fund, you could put in
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the money in 1 fell swoop into the old
policy which isn't going to perform well.
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You don't want to leave it there. But you
can maximum fund it if you have someone
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who understands how to get those numbers.
You could throw in a big lump sum of
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money into the old policy. And then do a
1035 exchange immediately into the new
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policy once it's approved. You have to
wait till if the new one's approved. And
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when you do that, now you've had all
those 5 years of water under the
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bridge taken care of. You hit the ground
running and any other room you made, you
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can then put in that money according to
the Tamra guidelines. If you don't do
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what I just said, you may have to start
all over with the 5-year waiting
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period because you didn't maximum fund
the policy before you
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the 1035 exchange. That is what many
agents do not understand. So, if you have
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an older policy that's underperforming
and you want to consider a replacement
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with a new better one, make sure you have
an enforced illustration, you have a proper
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comparison. And then if it makes sense to
do it, you do it correctly and you
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maximum fund it perhaps before you do
the exchange if that's your objective
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for the new policy. So, the takeaway here
is to be careful but consider doing an
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audit regularly on your insurance
policies to see if it behooves you to do
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a 1035 exchange. But I would recommend
that you look at the best way to do that
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and do it properly.
I prefer maximum-funded indexed
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universal life which I affectionately
call the Laser Fund. Because lays remains
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liquid asset safely earning returns. And
so, this is my eleventh book on this
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topic. "How to diversify and create the
foundation for a tax-free retirement?"
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Where every million bucks can generate a
hundred thousand a year of tax-free
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income for as long as you live.
I would love to gift you free a copy of
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this book. It's a 300-paged book comprised
of charts and graphs and explanations. On
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this side of the book is actually 12
chapters with 62 actual clients stories.
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And so, if you go to laserfund.com and
pay 595 shipping and handling, I'll pay
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for the book and you'll also have
options to get the audio version or some
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video training whatever you would like.
But start out by learning this for
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yourself and consider if this is a
better way for you to go.
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