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19 Cards in this Set
- Front
- Back
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Universal Life Insurance (example on back) -adjustable premium, death benefit, and cash value -mortality charges, based on insured's age and policy's net amount at risk, along with admin expenses, are deducted from cash value -policy's cash value credited with interest at policy's current interest rate -if current premiums paid plus existing cash value is not adequate to cover cost of continuing coverage, policyowner must deposit additional premiums to policy in force |
Universal Life Insurance Example • Peter currently owns UL policy with $600 cashvalue • He paid a current premium of $1,000 butlearns company’s mortality and administrativecosts to maintain policy are $1,900 • Peter must deposit additional $300($1,900 – $1,600) to keep policy in force |
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UL Death Benefits A and B (chart on back) Option A: pays level death benefit -net amount at risk (NAR) for insurance company = difference between CV and death benefit -Option a NAR decreases as cash value increases -Mortality charges lower under Option A than under Option B Option B: provides an increasing death benefit, which is NAR plus existing cash value -NAR remains level throughout policy period -Monthly mortality chargees greater than Option A because NAR is level but cost of insurance increases with age -Greater fund is required to keep policy in force |
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Variable Universal Life Insurance -As with all variable life. no guaranteed minimum interest rate (non variable UL has guaranteed rate) -if premiums paid though, policy guaranteed to not lapse -cash values not guaranteed -policy must be offered by prospectus with computer generated policy illustration |
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Endowment Life Insurance -whole life policies endows at age 100 -traditional endowment policies endowed much earlier, for example, at age 65 when individual was entering retirement -After 1984 Tax Act, endowments no longer classified as life insurance contracts and rarely used today because of resulting loss on income tax benefits |
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Adjustable Life Has characteristics of both UL and WL -Death benefit and premium amount chosen at time of application -Nonforfeiture values then calculated -Policyowner may elect to increase or decrease (adjust) death benefit and/or change premium Typically has cost-of-living rider -permits owner to increase death benefit (without proof of insurability) once every three years to keep pace with CPI |
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Survivorship (second-to-die) Life Insurance Commonly used to provide liquidity to pay estate taxes due at death of second spouse -estate tax liability of first spouse to die covered by unlimited marital deduction Less expensive than separate policies -attractive to couples who anticipate future estate tax liability Often owned by ILIT with independent trustee, keeping insurance death benefit from inclusion in gross estate of surviving spouse |
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First-to-Die Life Pays out at death of first spouse or individual to die Commonly used in buy-sell or business continuation agreements to provide liquidity for one business owner to buy out family of second owner |
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Policy Replacement Considerations Most states enacted NAIC model replacement regulation -must sign statement regarding replacement of existing policy (even if no replacement) and must be submitted with new (or original policy) application For each replacement policy -replacing company must provide 30-day free look of the new policy to the purchaser with a full refund if the purchase is cancelled -original company must be notified in writing of proposed replacement -replacing company may or may not subject the insured to a new suicide clause period |
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Comparing the Cost of Life Insurance Policies Traditional net cost method -does not consider the time value of money Interest-adjusted methods -surrender cost method -net payment method IRR on yield method |
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Life Insurance Taxation DURING LIFETIME (1 of 3) Annual Cash Value Increase: general rule: annual cash value increase not subject to current income taxation Premiums: generally not tax deductible -premiums considered alimony payments or separate maintenance are tax deductible by payor and taxable income to payee |
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Life Insurance Taxation DURING LIFETIME (2 of 3) Dividends -generally nontaxable -reduces policyowner basis in policy -if distributed dividends exceed premiums paid, excess taxable as ordinary income Withdrawals or loans -in regular contracts, withdrawals receive FIFO tax treatment -MEC contracts subject to LIFO and 10% penaltybefore age 59 1/2 |
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Life Insurance Taxation DURING LIFETIME (3 of 3) Surrender of the policy -Lump-Sum payment in excess of basis is ordinary income -Cost basis equals aggregate premiums paid less any dividends paid Sales of the Policy -Transfer for Value rule may apply -Insurance proceeds are includable in gross income of transferee to extent proceeds received exceed the purchaser's basis -exceptions: insured, partner, partnership, and corporation Gifts of the Policy: not same as lifetime sale because no consideration passes between donor and donee -transfer for value rule does not apply, but gift tax may be assessed on transfer |
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Insurance During Life Taxation Question (two sided) Laura divorced this year and she made a loan against her wholelife insurance policy in the amount of $20,000 to pay attorney’sfees. The policy also paid $2,000 in dividends in the current yearand she previously has received a total of $10,000 in dividends.She has paid a total of $58,000 in premiums during the life of thepolicy. What is her tax liability from the policy this year? A. $12,000 ordinary income B. $22,000 ordinary income C. $0 D. $12,000 capital gain |
Insurance During Life Taxation Question (answer) C. $0 Generally, dividends distributed from a life policy are considered a return ofpremium until the basis is exceeded. Loans may be received tax free. |
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Insurance During Life Taxation Question (two sided) Karla purchased a $500,000 life insurance policy in 1996.She has paid $28,000 in premiums and has received $14,000in dividends. She also has an outstanding policy loan of $8,000. Currently, the policy has a net cash value of $17,000.If Karla surrenders the policy, what is her gain if any? A. $17,000 ordinary income B. $3,000 capital loss C. $11,000 ordinary income D. $25,000 ordinary income |
Insurance During Life Taxation Question (two sided) C. $11,000 ordinary income Karla’s policy has a net cash value of $17,000. First, add back the loan of $8,000 toderive the policy’s total cash value of $25,000. Second, subtract Karla’s basis of$14,000 ($28,000 premiums – $14,000 dividends) from the policy’s total cash valueto derive a $11,000 gain ($25,000 – $14,000 = $11,000). |
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Insurance During Life Taxation Question (two sided) Tawni, age 49, decides to take a $7,000 policy loanfrom her modified endowment contract. The cashvalue of the contract is $78,000 and she has paidpremiums of $44,000. What are the tax liabilities fromthis transaction? A. $7,000 capital gain B. $7,000 ordinary income C. $7,000 ordinary income plus $700 penaltyD. $0 |
Insurance During Life Taxation Question (two sided) C. $7,000 ordinary income plus $700 penalty Modified endowment contracts are subject to LIFO characterization with a 10% taxpenalty for withdrawals or loans made before the owner attains the age of 59½. |
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Life Insurance Taxation AT DEATH Lump Sum Payment: excludible from income except in transfer for value situations Interest Only payment: -interest is fully taxable as ordinary income Installment or annuity payments: -each payment partially nontaxable return of basis and partially taxable interest -nontaxable return of basis equals exclusion ratio |
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Viatical and Life Settlements Viactical Settlement -sale of life insurance by terminally ill person -usually receives 50-80 percent face value -all of gain for purchaser is ordinary income -purchase price plus future premiums is cost basis -no taxable income for insured |
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Entering Viatical Settlement -investors usually make sure insured has owned policy for at least two years to avoid incontestability -insured must be terminally ill, remaining life expectancy of no more than two years from date of entering into agreement -insured must sign release permitting investor to access medical records -insured must sign waiver releasing investor from liability with changing existing beneficiary designations |
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Accelerated Death Beneits -terminally ill with expected life one year or less -insurance company usually pays out 50% face value in monthly increments (viatical is lump sum) -income tax free -remaining 50% is tax-free death benefit to bene |
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