1035 exchange

Restructuring US life insurance for UK residents

Here is a case study based on a British client who acquired a life insurance portfolio containing cash values whilst he was working in the US. This case study demonstrates the difference in treatment by the IRS and HMRC for life insurance policy valuations.

Scenario

Philip is a British citizen who was based in New York City for 15 years, working at an international investment company. During this time, he benefited from the US life insurance market and obtained multiple permanent life insurance policies that have since accumulated cash value. The policies enabled him to achieve two aims: having life insurance coverage to benefit his family whilst simultaneously achieving internal investment growth with accessible cash values.

Philip has now moved back to the UK and taken a job at a different investment house, although he regularly travels back to the US for work. Due to family commitments and a different market segment, his financial priorities evolved.  He has taken a lower salary and has higher general expenses, such as school fees and a mortgage. Philip’s existing US life insurance portfolio requires annual premiums payments to continue the coverage.

Policy design issue

Vie International identifies that the cash values of Philip’s US permanent life insurance policies had grown to over $1m. This is a meaningful asset, but one which now required careful consideration in the context of living in the UK.

Vie International advises Philip that the UK treats cash value accumulation differently to the US, namely HMRC’s chargeable event rules apply. If Philip were to pass away in the UK, the cash value would be subject to income tax on the value of the growth over the premiums paid.

Recommended action

Vie International recommends that Philip execute a 1035 exchange so his life insurance becomes more compliant and tax efficient for UK purposes. Philip agrees to take a medical exam and have his medical history assessed by a range of life insurance underwriters. He achieves the best risk rates from underwriters, which influences the cost of  life insurance. Under the proposed exchange, Vie International can arrange that the $1m of cash value within the existing policies is transferred to the new insurance company as a single premium, which will then guarantee $5m of death benefit for life with no further premiums required.

The transaction is tax-exempt from a US perspective as it is processed as a 1035 exchange.

From a UK perspective, the transaction benefits from time-apportionment relief.  This means that the income tax due on the gain following the policy transfer is minimal because the majority of the cash value accumulation occurred whilst Philip was not resident in the UK,

Philip now has a fully paid $5m life insurance policy in place to benefit his family, suitable for UK residency.  He no longer obligated to pay further annual premiums so his cashflow is freed up for other purposes.

There are additional trust ownership considerations that Vie will help further improve the tax efficiency.

Internationally mobile clients

For those who have spent time working across jurisdictions, life insurance arrangements that were entirely appropriate in one country can become misaligned and potentially costly when a person’s country of residence changes.

At Vie International, we are knowledgeable and qualified to give tax-efficient advice to policy holders of life insurance containing cash values. Time-apportionment relief, chargeable event legislation and the mechanics of a 1035 exchange each require careful navigation to devise the optimum solution to provide greater protection, reduced cost and genuine cross-border tax efficiency.

Vie International advises internationally mobile professionals, families and returning expatriates on these matters.

Contact Vie International today to request a complimentary life insurance policy review.