5 - Life Insurance Premiums, Proceeds, and Beneficiaries Overview

Living Benefit Options

Accelerated Benefit - Allows someone that a physician certifies as terminally ill to access the death benefit. The amount of benefit received will be tax free. Viatical Settlement - Allows someone with a terminal illness to sell their existing life insurance policy to a third party for a percentage of the face value. The new owner continues to make the premium payments and will eventually collect the entire death benefit. Note: The original policy owner is called the Viator and the new third party owner is called the Viatical, sometimes called the Viatee.

Accelerated Death Benefit:

Accelerated Death Benefit: When benefits are paid under a life insurance policy to a terminally ill person, the benefits are received tax free.

► Annual ► Semi-Annual ► Quarterly ► Monthly Note: The higher the frequency of payments, the higher the premiums.

Premium Payment Options:

Qualifications

The beneficiary of a life insurance policy is the person or entity designated in the policy to receive the death proceeds. There are few restrictions on who may be named a beneficiary of a life insurance policy. The owner of the policy is the ultimate decision maker and may change the beneficiary at any time, unless designated as irrevocable. However, in the underwriting process, the underwriter may consider the issue of insurable interest. When the policyowner lists themselves as the beneficiary, they will require proof of insurable interest.

1035 Exchange

1035 Exchange: When an existing life insurance policy is assigned to another insurer for a new contract, the transaction may be treated for tax purposes as a Section 1035 exchange. Policy exchanges that qualify as a 1035 exchange are not taxable. ► A Section 1035 exchange enables the postponement of tax consequences

Types of Beneficiaries

A beneficiary can be either specific (a person identified by name and relationship), or a class designation (a group of individuals such as the "children of the insured"). If no one named, or if all beneficiaries die before the insured dies, death benefit will go to insured's estate. By Order of Succession: ► Primary: First in line to receive death benefit proceeds ► Secondary (contingent): Second in line to receive death benefit proceeds ► Tertiary: Third in line to receive death benefit proceeds. If no one is named, death benefit will go to insured's estate

Mortality Factor

A measure of the number of deaths in a given population. Mortality is based on a large risk pool of people and time. Insurance companies use mortality tables to help predict the life expectancy and probability of death for a given group.

Distribution by Descent

Per Stirpes: (meaning by the bloodline) In the event that a beneficiary dies before the insured, benefits from that policy will be paid to that beneficiary's heirs. Per Capita: (meaning by the head) Evenly distributes benefits among all named living beneficiaries.

Changing a Beneficiary

Revocable Beneficiary - The policy owner may change the beneficiary at any time without notifying or getting permission from the beneficiary Irrevocable Beneficiary - An irrevocable designation may not be changed without the written consent of the beneficiary. The irrevocable beneficiary has a vested interest in the policy, therefore the policyowner may not exercise certain rights without the consent of the beneficiary.

Simultaneous Death

If the insured and the primary beneficiary die at approximately the same time for a common accident with no clear evidence as to who died first, the Uniform Simultaneous Death Act law will assume that the primary died first, this allows the death benefit proceeds to be paid to the contingent beneficiaries.

Irrevocable Beneficiary

An irrevocable designation may not be changed without the written consent of the beneficiary. The irrevocable beneficiary has a vested interest in the policy, therefore the policyowner may not exercise certain rights without the consent of the beneficiary.

Tax Treatment of Cash Values

If cash value is surrendered, the portion that exceeds the premiums paid is taxable. The total of the premiums paid into the policy minus total dividends received in cash or used to offset premiums is referred to as the cost basis. For policies that are not surrendered, the cash value grows tax-free. As long as the cash value stays in the policy, taxes will never be imposed on any portion, not even the amount that exceeds the cost basis.

Expense Factor

Insurance companies are just like any other business. They have operating expenses which need to be factored into the premiums. The expense factor is also known as the loading charge.

Mortality Factor, Interest Factor, Expense Factor

Life insurance premiums are calculated based on the following three primary factors:

Taxation of Proceeds Paid at Death

Life insurance proceeds paid to a beneficiary are generally exempt from taxes if taken as a lump sum. The exception to this rule is the transfer for value rule, which applies when a life insurance policy is sold to another party before the insured's death.

Age: The older the person, the higher probability of death and disability Sex / Gender: Women tend to live longer than men, so their premiums are usually lower Health: Poor health increases probability of death and disability Occupation: Hazardous job increases the risk of loss Hobbies: High risk hobbies also increase the risk of loss Habits: Tobacco use presents a higher risk than non-smokers

Other factors that impact the premium amount include:

Death Benefits:

paid out in a variety of ways. These methods are known as settlement options. The policyowner may select a settlement option at the time of the application and may change the option at anytime during the life of the insured. Once selected, the settlement option cannot be changed by the beneficiary.

Premium Mode

refers to the policy feature that permits the policyowner to select the timing of premium payments. Insurance policy rates are based on the assumption that the premium will be paid annually at the beginning of the policy year and that the company will have the premium to invest (interest factor) for a full year. If the policyowner chooses to pay the premium more than once per year (example monthly, quarterly, semi- annually) there normally will be an additional charge because the company will have additional charges in billing and collecting the premium payments. This is sometimes referred to as the Mode of Premium provision.

Tax Treatment of Premiums

remiums paid on individual life insurance policies are generally not deductible. Premiums for life insurance used for business purposes are generally not tax-deductible. Here are the exceptions to these rules: ► Premiums used for a charity are tax-deductible ► Life insurance premiums paid by an ex-spouse as court-ordered alimony are tax- deductible ► Employer-paid premiums used to fund group life insurance for the benefit of employees are tax-deductible

Tax Treatment of Proceeds

► Premiums: Not tax deductible ► Death Benefit: Normally tax-free if taken as a lump sum. Subject to federal estate tax under certain circumstances and normally included in the policyowners gross estate. ► Death Benefit Installments: Principal is tax free - interest is taxable

Taxation of Proceeds Paid During the Insured's Lifetime

Policy Surrender Accelerated Death Benefit 1035 Exchange Note: Most states still require a viatical company to inform the client that under a viatical arrangement, the proceeds could be taxable in certain situations and recommend they consult a tax advisor.

Policy Surrender:

Policy Surrender: When a policy is surrendered for the cash value, some of the cash value received may be taxable, if the value was more than the amount of the premiums paid for the policy.

Who can be beneficiaries?

►Individuals ► Businesses ► Trust (Provides management of the proceeds; Policy proceeds may be reduced by trust administration fees) ► Estates (Creditors have rights to life insurance policy proceeds when the beneficiary is the insured's estate) ► Charities ► Minors (Guardian may need to be appointed)

Living Benefits:

A living benefit is the option to use some of the future death benefit proceeds when they may be most needed, before their death, when the insured has a terminal illness.

Interest Factor

Insurance companies invest the premiums they receive in an effort to earn interest. This interest is one of the ways an insurance company can lower the premium rates.

Reserves vs. Cash Value

Reserves: Money set aside (required by the state's insurance laws) to pay future claims. Cash Value: Cash value applies to the savings element of whole life insurance policies that are payable before death. The cash value of a whole life insurance policy during the early policy years typically will be less than the premiums paid.

Spendthrift Clause

Spendthrift Clause: Prevents a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period of time. A spendthrift clause in a life insurance policy would have no effect if the beneficiary receives the proceeds as one lump sum payment. ►A spendthrift clause is also a statement in a settlement agreement that indicates that the proceeds of the policy will be free from attachment or seizure by the beneficiary's creditors

Level Premium Funding:

Policies that have a level premium average premiums over the policy period. The policyowner pays more in the early years for protection to help cover the cost in later years, which allows the premiums to remain level throughout the life of the policy.

Revocable Beneficiary

The policy owner may change the beneficiary at any time without notifying or getting permission from the beneficiary

Single Premium Funding:

The policyowner pays a single premium that provides protection for life as a paid-up policy. Normally associated with whole life insurance.

Facility of Payment

Typically found in industrial policies, it allows the insurance company to pay all or part of the proceeds to someone not named in the policy that has a valid right. This is usually done on behalf of a minor.

Common Disaster Provision

With a common disaster provision, a policyowner can be sure that if both the insured and the primary beneficiary die within a short period of time, the death benefits will be paid to the contingent beneficiary. It also states that the primary beneficiary must outlive the insured for a specified period of time in order to receive the proceeds.

Death Benefit Settlement Options

► Lump Sum: Death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. ► Interest Only: Insurance company holds death benefit for a period of time and pays only the interest earned to the named beneficiary. A minimum rate of interest is guaranteed and the interest must be paid at least annually. ► Fixed Period: Also called period certain, the death benefit proceed is paid in equal installments over a set period of years. Part of the installments paid to a beneficiary consists of interest calculated on the proceeds of the policy. The dollar amount of each installment depends upon the total number of installments. ► Fixed Amount: The fixed amount installment option pays a fixed death benefit in specified installment amounts until the principal and interest are exhausted. The larger the installment payment, the shorter the payout period. ► Life Income: The life income option provides the beneficiary with an income that they cannot outlive. Installment payments are guaranteed for as long as the recipient lives. The amount of each installment is based on the recipient's life expectancy and the amount of principal. This gives the potential for a greater return, or the potential for greater loss, based on how long the insured lives. A joint and survivor option guarantees that benefits will be payed on a life-long basis to two or more people. This option may include a period certain and the amount payable is based on the ages of the beneficiaries.