Question 25

A whole life policy is replaced with an annuity without incurring a tax penalty, which is referred to as a 1035 Exchange.

A 1035 Exchange allows for the tax-free transfer of cash value from one insurance policy or annuity to another, making it a suitable option for individuals looking to replace a whole life policy with an annuity.

A) a Cross-Purchase Plan.

A Cross-Purchase Plan is a method used in business succession planning where co-owners agree to buy each other's shares of the business upon death or exit. It does not pertain to the tax-free exchange of life insurance policies for annuities, thus making it an incorrect option.

B) an Endowment Contract.

An Endowment Contract is a type of life insurance policy that pays out a lump sum after a specified period or upon the insured's death. This concept is unrelated to the exchange of policies for tax purposes and does not describe the process of replacing a whole life policy with an annuity.

C) a Transfer of Value.

A Transfer of Value refers to the transfer of a life insurance policy that may trigger tax consequences, particularly related to the gain in value of the policy. This term does not relate to the tax-free exchange of policies as outlined in the question, making it an incorrect choice.

D) a 1035 Exchange.

A 1035 Exchange specifically refers to the IRS code that allows for the tax-free exchange of life insurance policies and annuities. It facilitates the transfer of cash value from one policy to another without incurring tax penalties, making it the correct answer to the question.

Conclusion

The 1035 Exchange is the definitive correct answer as it directly addresses the tax-free exchange of a whole life policy for an annuity. In contrast, the other options fail to represent this specific tax provision, either relating to different concepts or incurring tax implications. Thus, understanding the 1035 Exchange is crucial for individuals considering such financial strategies.