1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

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Aak732
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1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Aak732 »

Question regarding 1035 exchange from a Whole Life Insurance policy to a Variable Annuity with Fidelity (no Surrender Charge).

I want to close my Whole Life policy and claim a tax loss on my tax return for 2021 - as the Premium Paid minus the Policy Surrender Cash Value is approximately a 5 thousand dollar Loss. I do want to close the Whole Life Policy, no doubt about that. But I also want to claim the Tax loss of approximately 5 thousand.

I did a separate 1035 exchange in late-April/early-May - moving money from my Variable Annuity with MetLife/Brighthouse to Fidelity. My plan is to open a new Variable Annuity account in Fidelity, and then move the Surrendered Cash Value from the Whole Life Policy to this new account. The goal is to eventually close out new Annuity account and claim the 5 thousand loss on my 2021 tax return.

During my call with Fidelity to open the new account, the Customer Service person informed me that the IRS has new rules stating that if a person opens two separate Variable Annuity accounts in the same year with the same investment company (Fidelity), they cannot claim the loss from one account. Meaning, the gain/loss has to be taken across all accounts opened that year (i.e. Year 2021). I wanted to ask if this is true.

I also wanted to ask if I can simply close out my Whole Life Policy, take the Surrendered Cash Value and claim the loss on my 2021 tax return WITHOUT having to open a new Variable Annuity account.

Any advice, or recommendations will be appreciated.
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noraz123
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by noraz123 »

Be warned that the irs no longer allows you to claim the complete loss after the 1035 exchange. Rather, the loss is limited to the excess of 2% of your agi.



From Pub 575 (https://www.irs.gov/publications/p575/ar02.html):
Losses.
You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant’s cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant’s cost and the amount of the cash distribution, if any.

To claim the loss, you must itemize deductions on Schedule A (Form 1040). Show the loss as a miscellaneous deduction subject to the 2%-of-adjusted-gross-income
Thus if you have an agi of $200,000, then you can only deduct the loss above $4,000. So if have a $10,000 loss, you can deduct $6000.

The good news is that this is not capital loss, so believe this deduction can be applied to all income.
Rex66
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Rex66 »

Just keep it in the new low cost annuity unless you have a tiny gain. Then surrender.

The other issue becomes the step doctrine meaning that if the government could prove you did the 1035 just to claim the tax loss than it isn’t allowed. Some worry about that if you do it immediately back to back like you are planning.
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Stinky
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Stinky »

Here's what I found at the link referenced above. Note especially the highlighted text below.

"Losses. You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant's cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant's cost and the amount of the cash distribution, if any.

However, for tax years 2018 through 2025, miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit are suspended and therefore not deductible on Schedule A (Form 1040)."

I am personally unaware that a person could do a 1035 exchange from a whole life policy into an annuity, then surrender the annuity and claim any kind of current year tax deduction. I don't know that what OP wants to do can be done.

I had thought that the loss on a whole life policy could only be "recovered" by doing the 1035 exchange into another contract (like an annuity), and then waiting until the value of the replacement contract equalled the basis on the original whole life contract. At that point the replacement annuity could be surrendered, and no taxes would be due on the "gain" on the replacement annuity.

I'd love to hear from any tax experts on this one. I'm definitely not a tax expert.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
fabdog
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by fabdog »

you are correct, this is not allowed currently.

NoraZ posted a portion of the answer from Pub 575, but didn't post the sentence directly below, which Stinky provided. As noted, the complete passage on this is as follows
Losses.

You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant's cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant's cost and the amount of the cash distribution, if any.

However, for tax years 2018 through 2025, miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit are suspended and therefore not deductible on Schedule A (Form 1040).
To cross check, you can check out the current Schedule A instructions, which don't have this as a loss that qualifies under "other itemized deductions

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Aak732
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Aak732 »

Stinky wrote: Wed Aug 04, 2021 6:54 am Here's what I found at the link referenced above. Note especially the highlighted text below.

"Losses. You may be able to claim a loss on your return if you receive a lump-sum distribution that is less than the plan participant's cost. You must receive the distribution entirely in cash or worthless securities. The amount you can claim is the difference between the participant's cost and the amount of the cash distribution, if any.

However, for tax years 2018 through 2025, miscellaneous itemized deductions subject to the 2%-of-adjusted-gross-income limit are suspended and therefore not deductible on Schedule A (Form 1040)."

I am personally unaware that a person could do a 1035 exchange from a whole life policy into an annuity, then surrender the annuity and claim any kind of current year tax deduction. I don't know that what OP wants to do can be done.

I had thought that the loss on a whole life policy could only be "recovered" by doing the 1035 exchange into another contract (like an annuity), and then waiting until the value of the replacement contract equalled the basis on the original whole life contract. At that point the replacement annuity could be surrendered, and no taxes would be due on the "gain" on the replacement annuity.

I'd love to hear from any tax experts on this one. I'm definitely not a tax expert.

I see, so this means the best course of action is to do the 1035 transfer from the Whole Life Policy to a new Annuity account, and then wait until the value of the replacement contract equaled the basis (my Premium payments).
It seems that I will NOT be able to take/declare the loss on the 2021 Schedule A by surrendering the Whole Life contract (provide the Premium paid minus the Cash Value evidence). Then, I would have invested the money in a taxable account, and be done with this whole matter.

Regarding this point "waiting until the value of the replacement contract equalled the basis on the original whole life contract. At that point the replacement annuity could be surrendered, and no taxes would be due on the "gain" on the replacement annuity."
-----> Is the Basis noted by the company when opening the Variable Annuity account, or are the Basis and the Value to be provided by the company on the 1099-R form when surrendering the Annuity, Or do I need to remember what the Basis was and put this on the Cap Gains form along with the Value - to figure out the gain or loss.
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Stinky
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Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Stinky »

See answers embedded below.
Aak732 wrote: Wed Aug 04, 2021 1:55 pm I see, so this means the best course of action is to do the 1035 transfer from the Whole Life Policy to a new Annuity account, and then wait until the value of the replacement contract equaled the basis (my Premium payments).
I agree.

It seems that I will NOT be able to take/declare the loss on the 2021 Schedule A by surrendering the Whole Life contract (provide the Premium paid minus the Cash Value evidence).
I agree.

Then, I would have invested the money in a taxable account, and be done with this whole matter.

Regarding this point "waiting until the value of the replacement contract equalled the basis on the original whole life contract. At that point the replacement annuity could be surrendered, and no taxes would be due on the "gain" on the replacement annuity."
-----> Is the Basis noted by the company when opening the Variable Annuity account, or are the Basis and the Value to be provided by the company on the 1099-R form when surrendering the Annuity, Or do I need to remember what the Basis was and put this on the Cap Gains form along with the Value - to figure out the gain or loss.
I have not done a 1035 exchange myself. However, I believe that the basis from the whole life policy would be communicated from the whole life issuer to the annuity issuer. You could check this when you initiate the 1035 process.

Also, you use a variable annuity, such as the low cost one from Fidelity, if you want equity exposure. Or you could use a multi year guaranteed annuity (MYGA) if you want fixed income exposure.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Rex66
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Joined: Tue Aug 04, 2020 5:13 pm

Re: 1035 exchange - Whole Life to Variable Annuity - then Sell to claim loss

Post by Rex66 »

Stinky wrote: Wed Aug 04, 2021 6:40 pm See answers embedded below.
Aak732 wrote: Wed Aug 04, 2021 1:55 pm I see, so this means the best course of action is to do the 1035 transfer from the Whole Life Policy to a new Annuity account, and then wait until the value of the replacement contract equaled the basis (my Premium payments).
I agree.

It seems that I will NOT be able to take/declare the loss on the 2021 Schedule A by surrendering the Whole Life contract (provide the Premium paid minus the Cash Value evidence).
I agree.

Then, I would have invested the money in a taxable account, and be done with this whole matter.

Regarding this point "waiting until the value of the replacement contract equalled the basis on the original whole life contract. At that point the replacement annuity could be surrendered, and no taxes would be due on the "gain" on the replacement annuity."
-----> Is the Basis noted by the company when opening the Variable Annuity account, or are the Basis and the Value to be provided by the company on the 1099-R form when surrendering the Annuity, Or do I need to remember what the Basis was and put this on the Cap Gains form along with the Value - to figure out the gain or loss.
I have not done a 1035 exchange myself. However, I believe that the basis from the whole life policy would be communicated from the whole life issuer to the annuity issuer. You could check this when you initiate the 1035 process.

Also, you use a variable annuity, such as the low cost one from Fidelity, if you want equity exposure. Or you could use a multi year guaranteed annuity (MYGA) if you want fixed income exposure.
you do need to confirm the new insurance company acquires the cost basis data. they will do it but just be sure they do.
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