CH 4. Life insurance policies- types of policies
At what point are death proceeds paid in a joint life insurance policy?
When first insured dies
How long does protection normally extend to under a limited pay whole life policy?
Age 100
What type of life insurance policy covers two or more persons and pays the face amount upon the death of the first insured?
A joint life insurance policy covers two or more individuals with the face amount payable upon the death of the first insured.
Who regulates an insurers claim settlement practices?
State insurance departments
Straight Whole Life
Straight whole life is whole life insurance providing permanent level protection with level premiums from the time the policy is issued until the insured's death (or age 100).
Three forms of whole life plans
Straight whole life, limited pay whole life single premium whole life.
The insurance coverage in a variable life insurance policy may vary based on the value of
its underlying investment
Death proceeds(benefit)
A death benefit is a payout to the beneficiary of a life insurance policy, annuity or pension when the insured or annuitant dies
Which is an accurate description of the premium in a graded premium life insurance policy?
Annual increases in premium for a stated number of years then remains level". With a graded premium life insurance policy, the premium increases yearly for a stated number of years then remains level.
Loading cost
Expense loading is the amount included in the premium charged by an insurance company to cover its administrative and maintenance costs. In order to cover for their operating expenses, the insurance companies include this as a portion of the total premium payable.
How long does one premium payment cover in a single premium whole life policy
Full life of policy
What type of life insurance policy covers two or more persons and pays the face amount upon the death of the first insured
Joint life
Juvenile insurance policy
Life insurance policy that insured the life of a minor. minor. Application for insurance and ownership of the policy rests with an adult (which does not require the minor's consent) , such as a parent or guardian . The adult applicant is usually the premium payor as well until the child comes of age and is able to take over the payments. A payor provision is typically attached to juvenile policies. It provides that in the event of death or disability of the adult premium payor, the premiums will be waived until the insured child reaches a specified age (such as 25) or until the maturity date of the contract, whichever comes first.
Under an adjustable life insurance policy, which of the following may NOT be changed without further underwriting?
The person insured
Single premium payment
`An insurance plan in which a lump sum of cash is paid up front to guarantee payment to beneficiaries. ..
Which statement regarding a single premium life insurance policy is NOT Correct
Additional premiums may be required under certain conditions. Only one premium payment is required with a single premium life insurance policy.
Which of these may NOT be deducted from premium payments or the cash value of a variable life insurance policy?
Federal premium taxes
Ordinary Life Insurance
Individual life insurance that includes Many types of temporary and permanent insurance protection plans written for individuals. Premiums normally paid monthly, quarterly, semiannually or annually. Principal type of life insurance purchased in the US and includes such types of insurance: whole, universal, and variable life coverege as well as endowment policies
Mortality charge (Cost of Insurance)
Mortality Charge is the amount charged every year by the insurer to provide the life cover to the policyholder on the life of the Life Insured. It can otherwise be called the Cost of Insurance.
How are level term policies able to provide level premiums?
Premiums are averaged over the term of the policy
Annuitant
The contract is based on the health and life expectancy of a specified person, who is called the annuitant. The owner might or might not be the same person.
Group insurance
Written for employer, employee groups, associations, unions and creditors to provide coverage for a number of individuals under one contract
Length of life insurance plans
Term Whole life (permanent) Endowment
What type of premiums are associated with individual mortgage protection life insurance policies
Level premiums
A life policy that has premiums that are lower than normal during the early years is called
Modified life
Which action will trigger a penalty tax on premature distributions from a modified endowment contract (MEC)?
Policy loans
How long does protection normally extend to under a limited pay whole life policy
Until age 100
National association of claim adjusters
is an association of independently-owned property and casualty claims adjusting companies located throughout the United States.
A premature distribution from a modified endowment contract (MEC) incurs a penalty tax
10%
Joint life policies
A joint life policy covers two or more people. Using some type of permanent insurance (as opposed to term), it pays the death benefit at the first insured's death. The survivors then have the option of purchasing a single individual policy without evidence of insurability. The premium for a joint life policy is less than the premium for separate, multiple policies. The ages of the insureds are averaged and a single premium is charged for each life.
Which statement regarding the cash value of a whole life insurance policy is correct?
Available to the policyowner when policy has been surrendered
Which type of life insurance policy is best suited for paying off the outstanding balance of a 30-year mortgage in the event of the insured's death?
30-year decreasing term Decreasing term life insurance provides a death benefit that gradually decreases over the span of the policy. Decreasing term life insurance is commonly used for paying off an outstanding mortgage balance in the event of an insured's death (mortgage insurance
Whole life premiums
As noted, whole life is designed as if the insured will live to age 100. Accordingly, the amount of premium for a whole life policy is calculated, in part, on the basis of the number of years between the insured's age at issue and age 100. The shorter the payment period, the higher the premium.This time span represents the full premium-paying period, with the amount of the premium spread equally over that period. This is known as the level premium approach. As is the case with level premium term insurance, this approach allows whole life insurance premiums to remain level rather than increase each year with the insured's age.
Industrial Life Insurance
Characterized by Comparatively small issue amounts, such as $1000, with premiums collected on a weekly or monthly basis by the agent at the policy owners home. Often marketed and purchased as burial insurance
What kind of life policy typically offers Mortgage protection
Decreasing term
What would be considered an advantage of purchasing term life insurance
The intital premium is lower compared to an equivalent amount of whole life coverage
Single premium whole life
The most extreme form of limited pay policies is a single-premium policy. A single-premium whole life policy involves a large one-time only premium payment at the beginning of the policy period. From that point, the coverage is completely paid for the full life of the policy. Here are the common traits of a single premium whole life policy: • An immediate nonforfeiture value is created • An immediate cash value is created • A large part of the premium is used to set up the policy's reserve • The advantage offered by a single premium policy is that the policyowner will pay less for the policy than if the premiums were stretched over several years
Maturity at age 100
Whole life insurance is designed to mature at age 100. The significance of age 100 is that, as an actuarial assumption, every insured is presumed to be dead by then. (While some people live beyond age 100, the number of people who do live that long is not a statistically significant portion of the population.) Consequently, the premium rate for whole life insurance is based on the assumption that the policyowner (usually the insured) will be paying premiums for the whole of life, to the insured's age 100. At age 100, the cash value of the policy has accumulated to the point that it equals the face amount of the policy, as it was actuarially designed to do. At that point, the policy has completely matured or endowed. No more premiums are owed. The policy is completely paid up.
Which of these statements accurately portrays an adjustable life insurance policy
Policy can alternate between forms of term and whole life insurance Adjustable life insurance allows the policy owner to adjust the policies face amount, premium and any type of protection without having to complete a new application or exchange policies. Ex. Converting a term life policy to a whole life policy or vice versa
Which statement regarding an adjustable life insurance policy is NOT true?
Policy loans are not permitted If the adjustable life policy has cash value, the policyowner is permitted to take out a policy loan.
Straight whole life insurance can be accurately described in all of these statements EXCEPT
Policy protection normally expires at age 65
Survivorship policy
Survivorship life insurance policies are useful in estate planning because they can provide money to pay taxes on assets. Variable survivorship life insurance does NOT pay any benefit when the first policyholder dies.
Joint life and survivor policies
A variation of the joint life policy is the last survivor policy, also known as a second to die policy. This plan also covers two lives, but the benefit is paid upon the death of the last surviving insured. This type of coverage is sometimes referred to as a "survivorship life insurance policy" and normally will cover two lives. As with a joint life policy, the premium for a survivorship life policy is lower than the combined premium for separate life insurance policies on two individuals. Survivorship life insurance policies are useful in estate planning because they can provide money to pay taxes on assets.
Special use policies
Joint life policies Joint life and survivor policies Credit life insurance Survivorship policies
The death proceeds of a credit life insurance policy are typically paid to the
Lender
How does the cost for a survivorship life policy compare to the cost of combining two separate individual life insurance policies
Survivorship life policy is lower
Which of these is NOT an advantage of term life insurance
Term life insurance does NOT permit a cash benefit at the end of the policy period
Term life features
Term policies are issued for a specified period, defined in terms of years or age. Most contain two options that can extend the coverage period. These are the option to renew and the option to convert the policy
Cash value vs face value
The amount of accumulated funds at any given time is referred to as the cash value. The face value (aka death benefit) is the amount of insurance proceeds the policy pays to your beneficiaries upon your death. Therefore, the face value is also referred to as the death benefit.
A nonparticipating whole life insurance policy was surrendered for its $20,000 cash value. The total premiums paid had totaled $16,000. What were the federal income tax consequences to the policyowner on receipt of the cash value?
The correct answer is "$16,000 was received tax-free and $4,000 as ordinary income". In this situation, the policyowner would receive $16,000 tax free and $4,000 as ordinary income.
Premium periods
The length of the premium-paying period also affects the growth of the policy's cash values . The shorter the premium paying period (and consequently, the higher the premium), the quicker the cash values will grow. This is because a greater percentage of each payment is credited to the policy's cash values. By the same token, the longer the premium paying period, the slower the cash values grow.
Which type of life insurance policy allows a policyowner the choice of investments along with flexible premium payments?
Variable universal life". Variable universal life involves a guaranteed death benefit plus premium and investment flexibility.
Taxable income may be the result from all of these modified endowment contracts (MEC) transactions except for
When the policy is surrendered for less than what was paid into it
Auto premium loan
an insurance policy provision that allows the insurer to deduct the amount of the outstanding premium from the value of the policy when the premium is due.
decreasing term insurance
characterized by benefit (face) amounts that decrease gradually over the term of protection and have level premiums. A 20-year $50,000 decreasing term policy, for instance, will pay a death benefit of $50,000 at the beginning of the policy term. That amount gradually declines over the 20-year term and reaches $0 at the end of the term Credit life insurance, sold to cover the outstanding balance on a loan, is based on decreasing term insurance. • Decreasing term insurance is commonly used to protect an insured's mortgage.
Mortgage protection life insurance premium
helps guarantee your loved ones a tax-free benefit in the event of your death — funds they can use to help with mortgage payments. Policy terms are available for 15 or 30 years. Premiums can be paid monthly, quarterly, semi-annually, or annually.
Premium payment
Your premium payment will be automatically deducted from your bank account each month insurance premium is the amount of money that an individual or business must pay for an insurance policy. The insurance premium is income for the insurance company, once it is earned, and also represents a liability in that the insurer must provide coverage for claims being made against the policy.
Which of these life insurance policies does not contain a cash value provision.
Decreasing term life. Term life products do not have the ability to gain cash value so cash value provisions would not be found in any type of term insurance product
Endowment premiums
Due to their rapid cash value build-ups to provide early policy maturity, endowment policies have comparatively high premiums. Remember that the shorter the policy term, the higher the premiums. It should be noted that the purchase of endowment policies has been on the decline for several years. This is because they no longer meet the income tax definition of life insurance, and consequently, they no longer qualify for the favorable tax treatment life insurance is given.
Interest- sensitive-whole-life
Interest-sensitive whole life is characterized by premiums that vary to reflect the insurer's changing assumptions with regard to its death, investment, and expense factors. However, interest sensitive products also provide that the cash values may be greater than the guaranteed levels. If the company's underlying death, investment, and expense assumptions are more favorable than expected, policyowners will have two options: lower premiums or higher cash values. An interest-sensitive life insurance policyowner may be able to withdraw the policy's cash value interest- free. The provision that allows this is called the Partial Surrender provision.
Which of the following is a TRUE statement regarding universal life insurance?
Policy states how much of each premium is used toward company expenses". Premium payments are separated and paid toward the insurance protection. The loading cost and the remaining balance is used to build the cash value.
Which statement concerning adjustable life insurance is accurate?
The face amount and premiums can be changed simultaneously by the policyowner Adjustable life insurance combines features of both term and whole life coverage. Length of coverage, accumulated cash value, and the premiums can be adjusted to fit specific needs.
Option to convert
The second option common to most term plans is the option to convert. The option to convert gives the insured the right to convert or exchange the term policy for a whole life (or permanent) plan without evidence of insurability. This exchange involves the issuance of a whole life policy at a premium rate reflecting the insured's age at either the time of the conversion (the attained age method) or at the time when the original term policy was taken out (the original age method). The option to convert generally specifies a time limit for converting, such as 10 years in force or at age 55, whichever is later.
An individual who purchases a modified life insurance policy expects
an improvement in future income". The purpose of modified whole life policies is to make the initial purchase of permanent insurance easier and more attractive, especially for individuals who have limited financial resources, but the promise of an improved financial position in the future.
An advantage of owning a flexible premium life insurance policy would be
The policy owner can make policy changes without difficulty
Policy loans
A policy loan is issued by an insurance company that uses the cash value of a person's life insurance policy as collateral. Sometimes these loans are referred to as a "life insurance loan." ... If a borrower fails to repay a policy loan, the money is withdrawn from the insurance death benefit.
Which of these is NOT a reason to buy a term life policy?
To accumulate savings
Equity index Whole life
type of whole life insurance where 80% to 90% of the premium is invested in traditional fixed income securities and the remainder of the premium is invested in contracts tied to a stipulated stock index
When a 10 year renewable life insurance policy issued at age 45 is renewed, the premium rate will be the current rate for
Another ten year term insurance for a person aged 55. A ten year renewable term policy permits the policyowners to renew the same coverage for another 10 years at the end of the first 10 year term. The premiums for the renewal period will be higher than the initial period
When does the insured stop making payments under a thirty-payment whole life policy
At the time of death or 30 years after the policy's inception, whichever comes first
What is the guaranteed cash value of a whole life insurance policy when the insured turns 65 years old?
Less than the policy's face amount. When an insured reaches the age of 65, the guaranteed cash value of a whole life policy will be less than the face amount of the policy.
Limited pay whole life
Limited pay whole life policies have level premiums that are limited to a specified number of years. This period can be of any duration. For example, a 20-payment life policy is one in which premiums are payable for 20 years from the policy's inception, after which no more premiums are owed. A life paid-up at 65 policy is one in which the premiums are payable to the insured's age 65, after which no more premiums are owed. This type of coverage would best suit a prospective insured who desires permanent insurance but does not want to pay premiums indefinitely. Keep in mind that even though the premium payments are limited to a certain period, the insurance protection extends until the insured's death, or to age 100.
What typically changes at the re-entry option date found in some term life policies
Premium A re-entry option gives me insured the opportunity to provide evidence of insurability at the end of the term to qualify to renew the policy at a lower premium
Types of Life Insurance policies
Ordinary life insurance Industrial life insurance Group life insurance
These are all accurate statements regarding universal life insurance except
Policy loans are NOT permitted. This is incorrect because policy loans are allowed in universal life insurance policies
All of these are considered features of whole life insurance EXCEPT
Initial premium is lower than for an equivalent amount of term insurance The initial cost of whole life insurance is actually HIGHER than an equivalent amount of term insurance.
Term/temporary Life Insurance
Simplest type of insurance plan. Provides low cost insurance protection for a specific period (or term) and pays a benefit only if the insured dies during that period. Ex. Steve buys a 20 year $50,000 level term policy on his life naming his sister the beneficiary. If Steve dies at any time within the policies 20 year period his sister receives the $50,000 death benefit. If Steve lives beyond that period nothing is payable. If he cancels or lapses the policy during the 20-year term nothing is payable. Term policies do not build cash values Advantage of term life insurance is the initial premium is lower than for an equal amount of whole life insurance Term life provides greatest amount of death benefit per dollar of initial cash outlay Also called temp life insurance since it provides protection for a temp period of time. Period for which these policies are issued can be: 1 year, 5 yesr, or 20 year term) Or can be in terms of age (term to age 45, 55, or age 70. Term policies specified for a number of years provide coverage from their issue date till end of the year specified.
When can a life insurance policy be issued without the insureds consent
When a parent purchases a policy on the life of a minor child
Forms of term life
Distinguished by the amount of benefit payable Level term Decreasing term Increasing term
Modified Whole Life
policies distinguised by premiums that are lower than typical whole life premiums during the first few years (usually 5) and then higher than typical thereafter during the intial period, the premium rate is slightly higher than that of term insurance. afterwards, premium is higher than the typical whole life rate at age of issue purpose of these life policies is to make initial purchase of permanent insurance easier and more attractive, especially for individuals who have limited financial resources, but the promise if an improved financial position in the future
Re-entry term insurance
Re-entry term insurance has a low premium for a stated period of time, but is renewable only if the insured passes a medical examination at the re-entry option date. If the insured fails the medical exam, the premium will increase.
Assets that back the non-guaranteed values of variable life insurance products are held in which account?
Separate account set up by the insurer Assets that back the non-guaranteed values of variable life insurance products are held in a separate account set up by the insurer.
whole life insurance
A second type of life insurance plan is whole life insurance (also known as permanent insurance). Whole life insurance is called this because it provides permanent protection for one's entire life-from the date of issue to the date of the insured's death. The benefit payable is the face amount of the policy, which remains constant throughout the policy's life. Premiums are set at the time of policy issue, and they too remain level for the policy's life. There are certain features of whole life insurance that distinguish it from term insurance: Cash Values and Maturity at age 100. These two features combine to produce living benefits to the policyowner.
Non-traditional life policies
Interest sensitive— whole life Face amount plus cash value Adjustable life Universal life Variable insurance products
Increasing term insurance
term insurance that provides a death benefit that increases at periodic intervals over the policy's term. The amount of increase is usually stated as specific amounts or as a percentage of the original amount. It may also be tied to a cost of living index, such as the Consumer Price Index. Increasing term insurance may be sold as a separate policy, but is usually purchased as a cost of living rider to a policy.
Laura added a children's rider to her life insurance policy. What type of coverage was added?
"Level term". Level term is provided by adding a children's rider to a life insurance policy.
Adjustable life
Adjustable life policies are distinguished by their flexibility that comes from combining term and permanent insurance into a single plan. The policyowner determines how much face amount protection is needed and how much premium the policyowner wants to pay. The insurer then selects the appropriate plan to meet those needs. Another option would be the policyowner may specify a desired plan and face amount. The insurer would then calculate the premium. As financial needs and objectives change, the policyowner can make adjustments to the coverage, such as: • increasing or decreasing the premium, the premium paying period, or both • increasing or decreasing the face amount, the period of protection, or both (increasing the face amount normally requires providing proof of insurability)
Level Term Insurance
Provides a level amount of protection for a specified period, after which the policy expires Level term policies are able to offer level premiums because the premiums are averaged over the term of the policy . A $100,000 10-year level term policy, for example, provides a straight, level $100,000 of coverage for a period of 10 years. A $250,000 term to age 65 policy provides a straight $250,000 of coverage until the insured reaches age 65 If the insured under the $100,000 policy dies at any time within those 10 years, or if the insured under the $250,000 policy dies prior to age 65, the insured's beneficiaries will receive the policy's face amount benefits. If the insured lives beyond the 10-year period or past age 65, the policies expire and no benefits are payable.
state attorney general
chief legal officer of a state enforces state consumer protection laws; collects court-ordered child support; and administers the Crime Victims' Compensation Fund.
John received a one-time distribution of $50,000 from his modified endowment contract (MEC). Prior to that, the contract's cash value was $150,000, the contract investment amount was $100,000, and the death benefit was $500,000. What percentage of the $50,000 distribution was taxable as ordinary income?
100%". Funds withdrawn from an MEC are subject to last-in first-out (LIFO) tax treatment, which assumes that the investment or earnings portion of the contract's values is withdrawn first (making these funds fully taxable as ordinary income).
Group credit life insurance is typically a form of
Decreasing term insurance
Universal Life Insurance
Universal life insurance is essentially a term policy with cash value, characterized by flexible premiums and an adjustable death benefit. Part of the premium goes into an investment account that grows and earns interest. You are able to borrow or withdraw your cash value. Universal life allows its policyowners to determine the amount and frequency of premium payments and adjust the death benefit up or down to reflect changes in needs. Consequently, changes may be made with relative ease by the policyowner and no new policies will need to be issued when changes are desired. Each month, a mortality charge is deducted from the policy's cash value accumulation for the cost of the insurance protection. This mortality charge may also include a company expense, or loading charge. A universal life policy pays a death claim in the amount of the death benefit plus the savings element. Like term insurance premiums, the universal life mortality charge steadily increases with age. Even though the policyowner may pay a level premium, an increasing share of that premium goes to pay the mortality charge as the insured ages. The policy specifies the percentage of each premium that goes toward the insurance protection and that which is used to build cash value. As premiums are paid and as cash values accumulate, interest is credited to the policy's cash value. This interest may be either the current interest rate declared by the company (and dependent on current market conditions) or the guaranteed minimum rate, specified in the contract. As long as the cash value account is sufficient to pay the monthly mortality and expense costs, the policy will continue in force, whether or not the policyowner pays the premium If the cash value account is not large enough to support the monthly deductions, the policy terminates. Another factor that distinguishes universal life from whole life is the fact that partial withdrawals can be made from the policy's cash value account
Face amount plus cash value
A face amount plus cash value policy is a contract that promises to pay at the insured's death the face amount of the policy plus a sum equal to the policy's cash value.
Which statement concerning a decreasing term life policy is accurate?
Face amount decreases over the policy period". With a decreasing term policy, the face amount of the policy decreases throughout the policy period. Mortgage insurance is the most common use of decreasing term insurance.
Which statement regarding universal life insurance is correct
Cash value accumulations have a guaranteed minimum interest rate
Credit life insurance
Credit life insurance is designed to cover the life of a debtor and pay the amount due on a loan if the debtor dies before the loan is repaid. The beneficiary of such a policy is usually the lender. The type of insurance used is decreasing term, with the term matched to the length of the loan period (though usually limited to 10 years or less) and the decreasing insurance amount matched to the outstanding loan balance. Credit life is sometimes issued to individuals as single policies, but most often it is sold to a bank or other lending institution as group insurance that covers all of the institution's borrowers. • The cost of group credit life insurance usually is paid entirely by the borrower.
Variable insured product policy
With a variable life policy, premium payments are fixed. Part of the premium is placed into a separate account, which is invested in a stock, bond, or money market fund. The death benefit is guaranteed, but the cash value of the benefit can vary considerably according to the ups and downs of the stock market. Your death benefit can also increase if the earnings of that separate fund increase. *Variable insurance products do NOT guarantee contract cash values, and it is the policyowner who assumes the investment risk *By placing their policy values into separate accounts, policyowners can participate directly in the account's investment performance, which will earn a variable (as opposed to a fixed) return. * variable insurance products are considered securities contracts as well as insurance contracts. Therefore, they fall under the regulatory arm of both state offices of insurance regulation and the Securities and Exchange Commission (SEC). *To sell variable insurance products, an individual must hold a life insurance license and a Financial Industry Regulatory Authority (FINRA) registered representative's license (FINRA was formerly known as the National Association of Securities Dealers, or NASD). S
Renewable option
A guaranteed renewable policy allows the policyowner to renew the term policy before its expiration date, without having to provide evidence of insurability (that is, without having to prove good health). For example, a five year renewable term policy permits the policyowner to renew the same coverage for another five years at the end of the first five-year term. The premiums for the renewal period will be higher than the initial period, reflecting the insurer's increased risk. Renewal options with most term policies typically provide for several renewal periods or for renewals until a specified age. The advantage of the renewal option is that it allows the insured to continue insurance protection, even if the insured has become uninsurable.
Peter, age 50, surrenders his modified endowment contract (MEC). How is the gain treated in terms of federal income taxes?
The gain is treated as taxable income and a penalty tax is imposed on the gain If an MEC is surrendered prior to age 59 1/2, the gain is taxable as well as a 10% penalty imposed on that gain.
Endowment policies
Besides term and whole life insurance, life insurers also issue endowment policies. An endowment policy is characterized by cash values that grow at a rapid pace so that the policy matures or endows at a specified date (that is, before age 100). An endowment policy provides benefits in one of two ways: • As a death benefit to a beneficiary if the insured dies within the specified policy period (known as the endowment period) • As a living benefit to the policyowner if the insured is alive at the end of the endowment period, at which time the policy has fully matured Because an endowment policy pays a death benefit if the insured dies during a certain period, it can be compared to level term insurance. The new concept presented here is that of pure endowment. Pure endowment insurance is a contract that guarantees a specified sum payable only if the insured is living at the end of a stated time period. Nothing is payable in the case of prior death. These two elements (level-term insurance and endowment) together provide the guarantees endowment contracts offer. Endowment policies can be compared to whole life policies with accelerated maturity dates; age 65 is a common maturity age. At the maturity age, the cash value has grown to match the face amount, just like what occurs at age 100 with a whole life policy.
Annually Renewable Term (ART)/ or Yearly renewable term(YRT)
common type of renewable term insurance is annually renewable term (ART). This is also called yearly renewable term, or YRT. Essentially, this type of policy represents the most basic form of life insurance. It provides coverage for one year and allows the policyowner to renew coverage each year, without evidence of insurability.
Modified Endowment Contract (MEC)
By redefining life insurance, Congress effectively created a new class of insurance, known as modified endowment contracts, or MECs. A modified endowment contract is considered to be a policy that is overfunded, according to IRS tables. For the producer who sells life insurance and the consumer who purchases life insurance, the significance of this is the way a life policy will be taxed if it is deemed an MEC. Historically, life insurance has been granted very favorable tax treatment, as shown in the following: • Cash value accumulations are not taxed to the policyowner as they build inside a policy. • Policy withdrawals are not taxed to the policyowner until the amount withdrawn exceeds the total amount the policyowner paid into the contract. • Policy loans are not considered distributions and are not taxed to the policyowner unless or until a full policy surrender takes place, and then, only to the extent that the distribution exceeds what was paid into the policy. However, for those policies that do not meet the specific test (described below) and consequently are considered MECs, the tax treatment is different. It is the policyowners who pay. • Penalty taxes (10%) on premature distributions prior to age 59 ½ from a modified endowment contract (MEC) normally apply to policy loans. • Any gains received from a Modified Endowment Contract (MEC) is included in the insured's gross income for the year and a 10% tax penalty is assessed on the gain if the insured is under the age of 59 ½.
Cash values
Unlike term insurance, which provides only death protection, whole life insurance combines insurance protection with a savings element. This accumulation, commonly referred to as the policy's cash value, builds over the life of the policy. This is because whole life insurance plans are credited with a certain guaranteed rate of interest. This interest is credited to the policy on a regular basis and grows over time. Income taxes may be due when the policy is surrendered. Though it is an important part of funding the policy, the cash value is often regarded as a savings element because it represents the amount of money the policyowner will receive if the policy is ever surrendered. The amount of a policy's cash value depends on a variety of factors, including: • The face amount of the policy • The duration and amount of the premium payments • How long the policy has been in force The larger the face amount of the policy, the larger the cash values. The shorter the premium-payment period, the quicker the cash values grow. The longer the policy has been in force, the greater the build-up in cash values. The reason for these things can be clarified with an understanding of the maturity of a whole life policy.
