Ch 7.4

Accelerated Benefits

Allow policyowners to use their policy's death benefits tax-free while they are still alive, or if they are terminally or chronically ill. The Health Insurance Portability and Accountability Act of 1996 (HIPAA) requires that proceeds from accelerated benefits are exempt from federal income tax.

Lump Sum

Cash payment of the policy proceeds is still prevalent today. If the PO doesn't choose a settlement option for the benef, the policy proceeds default to lump sum payment. Not taxed.

Policy proceeds paid upon the insured's death

Lump-sum proceeds paid to a beneficiary are exempt from federal income tax. If the policy contains a double indemnity rider or paid-up additions, those policy proceeds are also exempt. Policy proceeds that are reinvested and paid out to the beneficiary as an installment are subject to federal income tax, only up to the amount of each benefit that is interest (annuity rule - the portion of proceeds that formed the principal are not taxable, but the portion of proceeds that form interest are taxable). With the interest-only life insurance settlement option, installment payments are taxable because they are 100% interest earned on the principal, but the principal when paid out in a lump-sum is not taxable.

5 Settlement Options:

1. Lump Sum 2. Interest Only 3. Fixed period installments 4. Fixed amount installments 5. Life income

Life Settlement

A life insurance policy is sold to a third party in exchange for a large portion of the death benefit, except that the insured is not terminally or chronically ill.

Transfer for value rule

If a life insurance policy is assigned for valuable consideration and the insured under the life insurance policy dies, the new owner of the policy will be responsible for paying taxes on the amount of proceeds (including premiums that were paid by the original owner) paid that exceed the valuable consideration. The exceptions to this rule are: transfers to the insured, a business partner of the insured, or a corporation in which the insured is a stockholder or officer.

Fixed period installments/Period certain

Uses an annuity to pay the policy proceeds to the benef for a certain number of years. Payments consist of principal and interest, and the principal reduces to zero by end of period. Amount of each installment is based on length of period, the amount of proceeds, and interest rate. Longer payments = lower payments. If recipient dies before period ends, then a contingent benef would continue to receive payments until period lapses.

Settlement options

Ways the life insurance policy proceeds are paid out to beneficiaries upon insured's death or when the policy endows. Allow policy proceeds to be retained by insurer and paid out gradually. Bc proceeds are reinvested, they earn interest, and the interest portion of payments is taxable.

Policy proceeds paid while insured is alive

When a life insurance policy is surrendered for its cash value, taxes apply to any portion of the proceeds that exceed the cost basis. Policy proceeds received as an accelerated death benefit or viatical settlement for chronically or terminally ill insureds are not subject to federal income tax. However, for chronically ill insureds there is a maximum amount, indexed annually, that may be tax-sheltered for an accelerated benefit. In 2010 this amount was $290 per day.

Dividends are..

not taxable because they are a return of overcharged premium; however, if the dividend is reinvested with the insurer, any growth earned on the dividend (interest) is taxable.

Viatical Settlements

A terminally or chronically ill insured can sell his life insurance policy to a third party in exchange for payment of a large portion of the death benefit. The insured may receive anywhere from 50-80% of the death benefit. This may be a feasible option for insureds that need a large sum of money to pay medical bills prior to death. Viatical settlements are completely separate from life insurance contracts. HIPAA requires that proceeds from a viatical settlement are exempt from federal income tax.

1035 Policy Exchanges

The gains on exchanges of life insurance policies, endowments, or annuities, are in most cases subject to taxation. Section 1035 of the Internal Revenue Code allows for certain exchanges without recognizing a gain or loss for tax purposes. The following exchanges may occur without tax consequences: -Life insurance policies may be exchanged for another life insurance policy or endowment. -Endowments may be exchanged for another endowment. -Annuities may be exchanged for another annuity.

Life Income

uses an annuity to pay the policy proceeds. The beneficiary is provided with income that cannot be outlived: income is guaranteed for the beneficiary's entire life. The amount of each payment depends on the beneficiary's life expectancy (age and gender), the amount of the policy proceeds, interest rate, and any payout guarantees. There is some risk inherent in the life income option. If the beneficiary lives well beyond his expected lifespan, the insurer must pay out-of-pocket after the principal has been depleted. However, if the beneficiary dies earlier than expected, the balance of the principal is forfeited to the insurer.

Interest Only

Insurer retains the policy proceeds, which become the principal, and pays out only the growth on the principal to the benef on a scheduled basis. Principal is paid out in cash or something else at some point in the future. Minimum guaranteed interest rate is quoted to the benef. Used when more than one person is receiving payments from policy proceeds. If benef dies before funds are depleted, then a contingent benef will receive payments.

Insured's estate

Upon the insured's death, life insurance and any accumulated dividends are includable in the insured's gross estate for federal estate tax purposes.

Fixed Amount Installments

Uses an annuity to pay policy proceeds, but the payment amount is specified instead of period of time. Payments consist of principal and interest and are paid until the principal and interest reach zero. The length of time installments will be paid is based on the amount of the policy proceeds, the amount of each payment, and the interest rate. The larger the payment amount, the shorter time period payments will be received. More favorable interest rates will lengthen the payout period. This settlement option guarantees that the entire amount of the policy proceeds will be paid out. If the beneficiary dies before the balance reaches zero, then a contingent beneficiary will receive the remaining payments.period of time. Payments consist of principal and interest