Life Insurance Exchanges under Section 1035: Think Twice before You Surrender
![handle is hein.journals/conlr17 and id is 537 raw text is: LIFE INSURANCE EXCHANGES UNDER
SECTION 1035: THINK TWICE BEFORE YOU
SURRENDER
by Dorothy K. Dropick*
Prior to the passage of the Tax Equity and Fiscal Responsibility
Act of 1982 (TEFRA), section 1035 of the Internal Revenue Code,2
which defers recognition of gain on certain exchanges of insurance con-
tracts, had been an obscure and underutilized provision. In recent
years, however, this section has become the object of considerable
attention.
The inflationary milieu of the 1970's contributed to the accelera-
tion of replacement activity in the insurance industry.3 Concerned with
inflation, policyholders moved their investments from traditional life in-
surance products into products yielding better investment returns. Sur-
renders are procedurally simpler to accomplish than exchanges. It was
common, therefore, for policyholders to replace life insurance products
by surrendering their policies and then applying the proceeds of the
surrendered policy to the purchase of the replacement product. More-
over, the fact that the Internal Revenue Service (Service) did not re-
quire insurers to report payments of surrender proceeds4 contributed to
* Associate Counsel, Phoenix Mutual Life Insurance Company. B.A. Emmanuel College; J.D.
University of Connecticut School of Law; LL.M. New York University School of Law. Member
of the Connecticut Bar. The views expressed herein are those of the author and do not necessarily
reflect the views of Phoenix Mutual Life Insurance Company.
1. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324
(1984).
2. Unless otherwise stated, all statutory references will be to the Internal Revenue Code of
1954.
3. See Fenske, Replacement: The Career Agent's Albatross, BEsT's REv, June 1981, at 28:
Agents and companies contacted... acknowledged, with varying degrees of concern,
that replacement is on the rise. . . . [I]n its latest manifestation, replacement is a fairly
recent phenomenon brought on by inflation and high interest rates, and perhaps for that
reason, statistics on the amount and types of replacement that are occurring are hard to
come by.
4. Treas. Reg. § 1.6041-1(d)(1)(ii) (1984):
(d) Payments specifically included. (1) Sums paid in respect of life insurance, endow-](ViewImageLocal?handle=hein.journals/conlr17&div=24&collection=&method=preview&ext=.png&size=3)
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Life Insurance Exchanges under Section 1035: Think Twice before You Surrender
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