Fw: Offshore Variable Life Insurance policies /

Dear Sir,
We have been to several offshore seminars offered by Attorneys that suggested 
the advantage of 1035 existing variable life insurances off shore for better 
alternative investments as well as lower cost of insurance. 
Can you tell us the truth about that, is it legal and do we really have 
advantage? My researches show that offshore life insurances have a segregated 
account that allow better money managers. 
Hoping you can clarify the legal question for us it would be greatly 
appreciated it. 
david ingram replies:
You mention a 1035 exchange which implies that you have an existing policy which you are thinking of exchanging.  Although, there may indeed be a good reason for doing this, your first decision is to decide whether this is better for you or for the person trying to sell you on the idea.
These are some reasons why the replacement of an existing insurance policy may not be a good idea:, 
  a.. Your existing cash value built up in the original policy may be applied to the new life insurance policy's first year expenses, including commissions.
  b.. Life insurance policies (other than term policies) almost always have early surrender charges, which reduces the amount of cash value available toward the new policy. The new policy will probably have its own new surrender charge schedule, which will extend beyond that of the original policy. 
  c.. You may pay higher premiums for the insurance portion if, for example, your health has declined since the purchase of the current policy. 
  d.. The new policy will have a new contestability period - a two-year period from the issuance of the new policy during which the insurance company could challenge a death claim based upon a misstatement on the application. 
  e.. There could easily be unfavorable tax consequences caused by surrendering an existing policy, such as a potential tax on outstanding policy loans.
You should only exchange an existing life insurance policy when, after knowing all the facts, that the exchange is better for "you" and not just better for the person who is trying to sell the policy to you. 
Remember that both variable life insurance and variable universal life insurance are securities, not just life insurance. Therefore the salespeople must follow SEC, NASD, and state securities regulations, in addition to state insurance law. The broker must tell you all the important facts about the pros and cons of the exchange. Your agent should recommend such an exchange only if it is in "your" best interest and only after evaluating your personal and financial situation and needs, tolerance for risk, and your financial ability to pay for the proposed insurance policy. 
Your broker or insurance agent may recommend that you use your existing cash value, by using loans or withdrawals, to pay premiums for the new life insurance policy. This activity is generally called "financing" premiums. It may not be appropriate for you. Withdrawals from existing policies may be subject to federal income tax and may reduce the death benefit. 
Borrowing money from an existing policy reduces the death benefit. Withdrawals or loans may make it more difficult to keep the original policy in force without additional out-of-pocket premium payments. If you can't keep the original policy in force, you will lose the insurance protection and the loans themselves may give rise to tax consequences.
For a transaction to qualify as a 1035 exchange, the old policy must actually be exchanged for the new policy. Many states and brokerage firms require forms to reflect customer acknowledgement of a replacement transaction. These forms typically are signed by the insurance policy owner and the broker or agent. These forms may provide a comparison of the features and costs of an existing policy to a proposed policy, and point out what you need to focus on when considering an exchange.
Brokerage firms provide brochures and educational material designed to outline the possible advantages and disadvantages of the transaction. You should review these forms and materials closely. 
Even with a brochure, "you" should specifically ask the person recommending that you exchange or replace your existing policy to provide you with illustrations for your existing policy and the new policy. You should also ask: 
  a.. What is the total cost to me of this exchange?
  b.. What are the new features being offered? 
  c.. Why do I need those features? 
  d.. Are these features worth the cost?
  e.. Can the existing policy be modified or supplemented to provide some or all of these same features?
  f.. Will you be paid a commission for the exchange, and if so, how much is it? 
You should not sign any exchange form or agree to exchange or purchase an insurance policy until you study all of the options carefully, have all of your questions answered, and are satisfied that the exchange is better than keeping your current policy.
OFFSHORE Policies 
The tax treatment for a U.S. investor who buys a foreign life insurance is substantially the same as a life insurance contract issued by a U.S. insurance company if the foreign policy contains provisions that comply with the U.S. law definition of life insurance. Amounts earned by the cash value of a life insurance policy accumulates tax deferred until the policy is surrendered. At that time, the amount in excess of the total premiums paid would be taxable as ordinary income.
BUT, if the policy remains in force until your death and the "face amount" is paid to your beneficiary, the benefit is generally not taxable as income to the beneficiary. After all, if you had bought the policy on Monday and died on Friday, it would not have been taxable either. If the policy is not a "modified endowment contract" (MEC), the policyowner can borrow against the cash value without paying a tax on the amount of the loan. Single premium life insurance policies are MECs and the tax treatment will be similar to annuity contracts. All loans against a MEC policy will be taxed like annuity distributions. 
A life insurance contract that requires a minimum of seven or more equal annual premium payments will not be a MEC. 
Although not taxable for income tax purposes, the face value of a life insurance policy that is paid to a named beneficiary will normally be included in the gross estate of the policyowner and insured and will be subject to estate taxes if the estate is larger than the lifetime estate tax exemption. This result occurs when the insured is also the owner of the policy and has the power to surrender the policy, to exchange the policy or to change the beneficiary. 
On the other hand, if the policy is owned by the beneficiary - or by a trust in which the heirs are  beneficiaries - then the policy face amount (the death benefit) will usually not be included in your estate. 
One key difference between a foreign life insurance policy and a domestic policy is that there is an excise tax on the premiums paid to a foreign life insurance. The tax is 1% of the amounts paid to the foreign company and it must be paid with a quarterly return (Form 720) that is intended for an assortment of excise taxes. A treaty with Switzerland exempts Swiss life insurance policies from this excise tax. However, use of the treaty to avoid payment of the excise tax requires that the policyowner include Form 8833 with his or her tax return in each year when premium payments are made.  failure to file the form 8833 has a penalty provision of $1,000 minimum like a parking ticket.
Until the 1997 Taxpayer's Relief Act, it was legal to make a tax deferred exchange of a U.S. life insurance contract for a foreign life insurance contract. The 1997 law included a provision that some commentators believe prohibits tax free exchanges of life insurance or annuity contracts from a U.S. to a foreign insurer. Section 1131(b)1(c)(1) of the 1997 act amended IRC Section 1035(c) by changing it to read 
  "EXCHANGES INVOLVING FOREIGN PERSONS: To the extent provided in regulations, subsection (a) shall not apply to any exchange having the effect of transferring property to any person other than a United States person". 
Subsection (a) is the section that permits a tax free exchange of life insurance and annuity policies. 
There is a difference of opinion about whether you can exchange a domestic policy for a foreign one.  Do not do so without very "expert" opinion.  If the IRS ruled against you for a significant policy, there could be extreme penalties. In my opinion, the IRS would win.
The last part of your question was more of a statement where you suggested that this technique would give you access to better money managers. I know of no evidence which would indicate that the manager of an offshore account is going to be a better money manager than the manager of  an onshore account.
If someone makes this statement to you, I would be extremely distrustful.  Make them prove this with documentation showing that the funds they are suggesting have done better than all other funds.  For instance, if you had your money in Canadian equities for the last five years you would have done 20 to 30% better than in American Equities.
That was the country, not the money manager.
david ingram
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PS - much of this was taken (with minor changes) from 
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