Recording a 1035 Exchange of Incentive Life Insurance cash value into Annuity

David Lerner

I have had incentive life insurance for around 35 years and have decided to do an IRC 1035 tax-free exchange of the accumulated cash value (thus terminating the life insurance) as the purchase price of a lifetime variable annuity from another insurance company. I have been tracking the investments constituting the cash value of the policy as a brokerage account. How do I record this transaction in QW ver. R32.12 (Win10 PC)?

Frankx

Hi @David Lerner,

My understanding of IRC Sec.1035 is that your basis in the new annuity will be the basis in the original insurance contract that is exchanged for the new annuity contract.

So, since you have been "tracking" the accumulated cash value of the life insurance policy in Quicken, I would believe that the value of that account - on the date of transfer - would be your cost basis in the new variable annuity.  In Quicken I would suggest that you should just change the name on the account that was formerly the life insurance accumulated value to indicate that it is the new variable annuity.

BTW - I am not providing any tax advice, or related service, by virtue of making this comment on this public forum.

Frankx

David Lerner

Thanks for the quick and imaginative reply, Frankx. But there are a few wrinkles that may make that less than ideal: 1) there are actually 2 policies from Insurer A that will go through the Exchange to purchase a single lifetime annuity contract from Insurer B; 2) there are mutual fund holdings in each of the policies that comprise their respective cash value and when the policies are Exchanged, those funds will be replaced with different fund holdings (although I suppose I could record each sale and purchase *before* changing the name of the “brokerage” account (from Insurer A to Insurer B) but that wouldn’t solve problem #1).

Finally, since the Annuity pays (an initially variable) annual amount (eventually becoming a fixed annual amount for life), then even with any growth in the new "investment account" I couldn’t record payouts from the renamed “brokerage” account (e.g., as transfers to a checking account) because a time will come when the brokerage account balance would show $0 yet the payments will keep coming (assuming I live that long, of course).

But you’ve given me some interesting ideas to think about.

Thanks again.

Jim_Harman

You might want to review these discussions
https://community.quicken.com/discussion/7408241/new-york-life-premier-variable-annuity-ii
https://community.quicken.com/discussion/7384696/recording-annunity-investment-income

about tracking variable annuities in Quicken. 

David Lerner

Thank you very much. This will be very useful once the annuity is established. What I'm trying to figure out is how to record the actual exchange from the insurance policies to the annuity. The way I'm tracking the policies, the initial death benefit is just an asset, while the cash values are tracked as investment accounts. The asset just disappears on the Exchange. I suppose I can just record a sale of all of funds held in the account portfolios and then record the creation of the annuity as a purchase using the proceeds realized upon the sale, but that will technically show that my basis in the annuity is the purchase price, whereas under the 1035 Exchange the basis is the rollover basis from the insurance policies. Additionally, the sale of the funds in the policies will show a capital gain, whereas under the 1035 Exchange that gain is deferred and becomes ordinary income on payout. Any suggestions?

Jim_Harman

The sale of securities with a gain in a tax deferred account would show as a gain in Quicken's Capital Gains report but not in the Tax reports, because tax deferred accounts are excluded by default in the Tax reports.

To preserve the original cost basis with an exchange and purchase of new securities like this, you may have to resort to manual Removed and Added transactions in Quicken. Hopefully you will receive a statement from the annuity company that shows your initial holdings and the cost basis they have recorded for each.
 
The taxation of payments from an annuity can be complex. You should consult a tax advisor and/or review this page
https://www.annuity.org/annuities/taxation/

David Lerner

The tax-deferred selection that I made initially! That was the missing piece on the exit side! Thank you! As for taxation on the payouts, I'm relatively conversant in that space and am comfortable with how payouts will be taxed (or not, and then again).

As powerful as QW is (and I've been a QW user since around 1995), I always find it pleasantly amazing that even by now they haven't thought of everything, and that manual kludges are still needed for some things.

Jim_Harman

Maybe someday Quicken will provide better support for distributions from IRAs, Roth conversions, and the like!

If you are not concerned with Quicken's ability to estimate the taxes on the payouts, then you don't need to worry about preserving the original cost basis through the transfer. You could simply Sell in the old accounts, transfer the cash, and Buy in the new account.

If you want to see your performance over a period that spans the transfer, you should include both the old and new accounts in the selection for the report.

David Lerner

I set up an Excel spreadsheet to track the tax/no-tax/tax characteristics of each year's payouts so I don't technically need Quicken to do that, but it's always reassuring when the two agree. In QW I generated a very detailed Planning report based on the Excel spreadsheet (obviously on a pro forma anticipated, rather than actual, basis), so I have a way to roughly predict future tax consequences, but otherwise I don't see any way Quicken can deal with that kind of information with that level of granularity in real time. But if you can think of a way to actually preserve original basis and deferred gain information on the date of the Exchange, that would be fabulous.

Jim_Harman

One way to handle the transfer would be to Remove all the old securities from the old accounts, then Add the new ones in the new account. This is similar to what the Shares transferred between accounts action does.

Say you learn for the annuity manager that they have purchased 100 shares at $12.00 per share and the cost basis is $500.

In the Added transactions, you would enter the transfer date and the name of the new security with 100 for the number of shares, $12.00 for the price each, and $500 for the total cost. Set the date acquired to a year or more before the transfer, so the gain will be treated as long term. 

Disclaimer: This may or may not produce results that match the taxes on the distributions, but it should be close.

David Lerner

Thanks, Jim, but I'm not sure I follow. If I Remove, rather than Sell, shares from the existing Insurance account, I'll end up with a balance of $0 with nothing to transfer on the Exchange. And if I Add different shares in the annuity account, Quicken won't permit me to enter $500 as Total Cost if I have 100 for shares added and $12 for cost per share. It asks me whether I want to adjust Total Cost, Shares, or Purchase Price. Obviously I'm missing something here.

Jim_Harman

Right - the Remove transactions clean out the old accounts

Sorry, I was mistaken about the Adds. You should leave the price per share blank and enter the total cost basis, letting Quicken calculate the price per share on the acquisition date. This will set the cost basis for the new securities. Make sure the share price for the transfer date is correct in the security's price history.

David Lerner

So this would be instead of Selling the shares in the Insurance account as we discussed earlier, correct? On Day 1 of the Exchange, the Insurance accounts would drop to $0 and I would simply create a new Annuity account and Add whatever shares the manager acquired, utilizing the method you just described (which would recreate the carryover basis), and then immediately reprice the securities to the FMV on the Exchange date (or the next day) to recapture the built in gain? Since all taxable payouts (i.e., all payments in excess of basis regardless of when received) are taxed at ordinary income rates anyway, I don't think it matters if I capture capital gains characteristics. That about sum it up?

Jim_Harman

Yes that sums it up. If the capital gains don't matter, you cans simply Sell in the old accounts, transfer the cash, and Buy in the new ones.

But you said
"But if you can think of a way to actually preserve original basis and deferred gain information on the date of the Exchange, that would be fabulous."

and I was proposing a way to do that.

David Lerner

Thanks. The reason for the deferred gain information isn't to capture capital gains tax treatment (because there isn't any) but to know when the aggregate payouts equal the amount of deferred gain (those payouts are taxable), because subsequent payouts eat into the original basis of the exchanged insurance policy (and so are nontaxed), before resuming their status as taxable payouts at ordinary income rates once the basis is exhausted.