Bank-Owned Life Insurance · BOLI
Can you do a 1035
exchange on BOLI?
Yes, and for banks holding older policies it is often the cleanest way to make a change. Here is how it works and what to weigh before you do it.
Quick answer
- Yes. Section 1035 of the tax code lets a bank exchange one life insurance policy for another without paying tax on the gain, as long as the owner and the insured stay the same and the exchange is done properly.
- Done properly means the cash value moves directly from the old carrier to the new one. The bank never takes the money in hand.
- Banks consider it when older policies are crediting less than newer ones, but surrender charges, new underwriting, MEC status, regulator expectations and board approval all need to be weighed first.
How a 1035 exchange works
Section 1035 of the Internal Revenue Code says no gain or loss is recognized when one life insurance contract is exchanged for another. In plain terms, the growth built up inside the old policy carries over to the new one, and the tax on that growth is not triggered by the exchange itself.
Two conditions matter most. First, the owner and the insured have to stay the same. The bank owns the old policy, and the bank owns the new one, on the same employee. Second, the exchange has to be done properly. That means the cash value moves directly from the old carrier to the new carrier. If the bank surrenders the old policy and takes a check, the gain is generally taxable, even if the money goes straight into a new policy.
Why banks consider it
Many banks bought BOLI 10 or 20 years ago. Crediting rates on older policies can fall behind what newer products pay, and older designs were built with the options of their day. Surrendering those policies outright would usually create a tax bill on years of growth. A 1035 exchange lets the bank move into a newer policy without that tax hit at the time of the exchange. An independent benchmark is usually how a bank finds out whether an exchange is worth a closer look.
What to weigh before an exchange
Surrender charges on the old policy
Some older policies still carry surrender charges, and a 1035 exchange does not erase them. Know what the old carrier will actually release before you compare.
New contestability and underwriting
The new policy is a new contract. Expect a new contestability period and some form of underwriting on the insured employees.
MEC status
A policy that is a modified endowment contract stays one after an exchange, and a new policy can become one if it is funded too fast. MEC status changes how withdrawals and loans are taxed, so confirm it on both sides.
Your regulator's expectations
The 2004 Interagency Statement expects a pre-purchase analysis, carrier credit review and concentration limits. A new policy from an exchange should go through the same review as any new BOLI purchase.
Board approval
Most banks take an exchange to the board or the right board committee, with the analysis and the reasons for the change on record.
Who should be in the room
An exchange touches tax, accounting and regulation at the same time. Review it with your CFO, your auditors, your legal counsel and your CPA or tax professional before anything is signed. They can confirm how the exchange is reported, how it affects the balance sheet, and how the Section 101(j) notice and consent rules apply to the new policy. Keep the concentration guideline in view too, since a new policy can change how much the bank holds with each carrier.
Not every review ends in an exchange. Sometimes the best answer is to keep what you have. For the basics on how BOLI compares with company-owned policies, see BOLI vs. COLI.
Frequently asked questions
Can a bank do a 1035 exchange on BOLI?
Yes. Section 1035 allows one life insurance policy to be exchanged for another without recognizing the gain, if the owner and insured stay the same and the cash value moves directly from carrier to carrier.
Why not just surrender the old policy and buy a new one?
Surrendering a BOLI policy generally makes the gain taxable. A properly done 1035 exchange avoids recognizing that gain at the time of the exchange.
Does a 1035 exchange restart the contestability period?
Usually yes. The new policy is a new contract, so a new contestability period and new underwriting typically apply. Ask the new carrier exactly what it requires.
Who should review a BOLI 1035 exchange?
Your CFO, your auditors, your legal counsel and your CPA or tax professional, with board approval and your regulator's expectations in mind. The pre-purchase analysis regulators expect for new BOLI applies to the new policy too.
Educational content only. This is not tax, legal, accounting or regulatory advice. Every bank's situation is different. Review any BOLI decision with your CFO, your auditors, your legal counsel, and your CPA or tax professional, and keep your regulator's expectations in view. Policy values depend on the terms of each contract and the financial strength of the issuing insurance company.
Find out where your BOLI stands
A short call, an independent comparison, and a clear answer. No change of agent of record is needed. Request a BOLI review, read the BOLI overview, or call +1 (586) 899-1003.
Keep Reading
More in Bank-Owned Life Insurance
Sources
Interagency Statement on the Purchase and Risk Management of Life Insurance (OCC Bulletin 2004-56) · 26 U.S. Code 101 · 26 U.S. Code 1035
Educational content only.