Strategic Concepts: Corporate, Estate & Tax Mechanics
1035 Exchanges: Optimization vs. Drawbacks
Under Internal Revenue Code Section 1035, a client can execute a tax-free exchange of an existing life insurance or annuity contract for a new policy.
Why it's good: Allows a client to escape an old, expensive, underperforming policy and shift the cash value into a modern contract with lower fees, and arguably better index crediting strategies, or built-in hybrid long-term care riders.
Why it's dangerous: A 1035 exchange triggers new surrender charge periods (often 7–10 years). Additionally, it requires new medical underwriting for life insurance. If the client’s health has degraded, the new policy's insurance charges might outweigh the structural benefits.
Advanced Executive Compensation & Estate Use Cases
Key Man Insurance: A business purchases a policy on its top revenue generator or founder. The business pays the premium and owns the cash value. If the executive dies, the tax-free death benefit funds the search for a successor or replaces lost revenue.
Double Bonus REBA (Restricted Executive Bonus Arrangement) Plans: The company pays the premium on an IUL owned by a key executive. The premium is treated as a tax-deductible bonus to the executive (who is taxed on the bonus income in his or her W2). To create Golden Handcuffs, a restriction agreement prevents the executive from accessing the policy’s cash value or leaving the company for a set period (e.g., 10 years) without forfeiting or repaying the bonuses.
Business Disability Overhead Policies: Protects partners by funding a buy-sell agreement explicitly triggered by a permanent medical disability, forcing a buyout of the disabled partner's equity without draining corporate cash reserves. Without this, the nondisabled working partner may be forced to do business with a disabled partner’s spouse who may have power of attorney over the disabled partner’s assets and financial affairs. No one wants to do business with someone’s spouse.