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Ask the expert: settle or do a 1035 exchange?

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The question was: I am considering a 1035 exchange for a 72-year-old client who has a $1 million universal life policy that is not performing well based on current expectations. His health has not changed much since the original policy was issued 5 years ago so should I be considering a life settlement as an alternative to a 1035 exchange? If so, what are the pros and cons of the two options?

The answer is: The short answer is yes. You should always evaluate the life settlement option. Part of the role of an experienced advisor is to investigate prudent options to solve their client’s needs. An important part of this investigation is policy appraisal. Appraising the policy for its fair market value provides the client with more information to use in making an educated decision on what to do with the policy. If the appraisal determines that the policy’s market value is greater than its cash surrender value, then a life settlement may be an appropriate option.

Here are a few considerations regarding the life settlement option:

Clients should be aware that if they choose to pursue a life settlement, the original $1 million will still be in-force so it is important to review the financial justification of a life settlement as well as the tax consequences. Many “alternative to a 1035 exchange” life settlement replacement cases involve policies that are underwater where the cash value is less than basis and the fair market value is recovering all or part of their original basis.

Careful assessment of the potential purchaser must be considered as well. Clients should only consider institutional purchasers who demonstrate a strong track record of completing transactions and hold the proper licenses to conduct business within their state of residency.

Finally, life settlements have traditionally been thought of as applicable only for the older and sicker client. However, they now present a viable option for healthy lives as well because purchasers are more experienced in managing longer life expectancies. This opens the option to a greater number of clients, including the prospect you describe.


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