Module 1 C4 Insurance - Life Insurance
Why would a client might want to take a loan out from a whole life insurance policy? What are the consequences of that loan?
A loan allows a client to access his or her money and avoid all tax consequences. Additionally, the loan carries a favorable interest rate. If the insured dies before the loan is paid back, the outstanding amount owed plus the accumulated interest is subtracted from the death benefit.
Income tax consequences associated with whole life insurance plans p.117
Both the growth in the cash value of a whole life policy and the death benefits are exempt from federal income tax. If one takes money out of a whole life policy, one can avoid taxes up until the withdrawn amount exceeds the basis in the account. Alternatively, one can withdraw the money as a loan but must pay back the loaned amount. If not paid back before the insured's death, the balance will be deducted from the death benefit.
Benefits associated with group life insurance plans p.121
Cost savings are the biggest benefit derived from group life insurance plans. Moreover, if the employer pays the premiums for the employee, the employer is permitted to deduct the premiums AND the employee does not pay income tax on premiums paid for death benefits up to $50,000.
At what threshold is an employee taxed on group term life insurance provided by an employer?
If the employer provides the group term insurance, the insured may receive up to $50,000 of group term with- out having to pay income tax on the premiums paid by the employer.
What differentiates variable life insurance from variable universal life insurance?
Variable life's premium amount is fixed, while variable universal life's premium amount is variable and subject to a required minimum.
7 Settlement options that are available to life insurance beneficiaries p.128
• Lump sum. • Interest only. • Fixed amount annuity. • Life income annuity. • Fixed period annuity. • Life income with period certain annuity. • Joint and last survivor annuity.
Modified endowment contract (MEC) p.120
A cash-value life insurance policy that has been funded too quickly via a lump-sum payment. Lifetime benefits are taxable. Whether a life insurance policy is "punished" and treated as an MEC depends on the Corridor Test and 7-pay test. A lump-sum payment is not the only way to create an MEC.
What are the tax implications of life insurance?
Life insurance proceeds are not taxable as income to the recipient. The interest accumulated on a cash-value life insurance policy is tax-deferred until the cash value is withdrawn. If the insured dies without ever surrendering the policy and withdrawing the cash value, the cash-value accumulations are usually not subject to tax (transfer for value exception).
Benefits of Term Life Insurance p.107
Term life insurance is generally less expensive than whole life insurance, and if one has a temporary need versus a life-long need for life insurance, term insurance may make more sense.
What is the structure and purpose of an entity purchase, or redemption, buy-sell agreement? p.137
The simplest form of buy-sell agreement is the entity purchase, or redemption, agreement. This type of buy-sell agreement obligates the business entity to purchase an owner's interest in the entity upon that owner's death. To fund the purchase obligation under an entity-purchase buy-sell agreement, the business can acquire a life insurance policy on the owner's life with a death benefit sufficient to cover the purchase amount. Life insurance is an ideal vehicle to use for this purpose, since it provides funds at the exact time they are needed (the death of the insured). Furthermore, using the death benefit to meet the purchase obligation under the buy-sell agreement does not affect cash holdings that the company may need for continued business operations.
What are the various contractual provisions and options that pertain to life insurance contracts?
There are various contractual features that may be available in a life insurance contract. Examples include renewability features, convertibility, grace periods, incontestability clauses, suicide clauses, reinstatement and loan provisions, exclusions, non-forfeiture, dividend and cash options.
Benefits of whole life insurance p.113
Whole life insurance lasts as long as one pays the premiums, while term insurance lasts only for the term. Whole life insurance is generally more expensive than term insurance. Moreover, whole life insurance has a savings component, which allows for un-taxed growth.
Five types of term life insurance
1) Annual renewable term 2) level premium, 3) term-to-65/70 4) decreasing term 5) increasing term.
Four options available with term life insurance P.109-113 ALDU
1) Annual renewable term (ART) 2) Level-term insurance 3) Decreasing-term insurance 4) Universal life insurance, which approximates whole life insurance in that it has a savings component.
Three life-cycle stages p.97
1) Asset accumulation phase begins when a person finishes his or her schooling and enters the workforce. It generally ends when the person reaches his or her mid to late forties or early fifties. This phase is characterized by high debt and low savings. 2) Conservation/risk management phase follows the asset accumulation phase, and lasts until retirement. At this stage, one's earnings have generally peaked, mortgages are generally smaller, and one is less inclined toward aggressive investments. 3) Distribution phase begins at retirement and ends at death, and is characterized by spending and gifting.
Six provisions commonly found in life insurance policies p.124 GISRPB
1) Grace period to pay premiums - generally one month. 2) Incontestability - generally one's misrepresentations and omissions, etc., are absolved after two years, and instead the insured's beneficiaries will be required to pay the difference associated with the misstatement of age or gender. 3) Suicide or anti-selection clause - states that if the insured dies within a specified amount of time, no benefits will be paid out, rather the premiums paid will be "refunded" to the beneficiary(ies). 4) Reinstatement - allows for a specified time after the grace period's expiration. 5) Policy loan provisions - speak to how the cash value of a policy may be loaned to the owner. 6) Beneficiary designations, Survivorship clauses, simultaneous death provisions.
Three methods used to determine clients' life insurance needs p.99
1) Human-life value approach • Determine the client's annual income. • Subtract client's expenses -including income tax. • Determine the number of years the client will work (work-life expectancy / WLE); multiply income less expenses by WLE - factor in expected income growth rate to get the Future Value Family's Share of Earn- ings (FSE). • Then determine the present value by factoring in the anticipated inflation rate. 2) Needs approach The needs approach looks at the amount of cash that one's family needs at death. Specifically this approach looks at the survivors' ability to pay off final expenses, to eliminate debt, to meet financial goals, and to the survivors' future income needs. In this approach, the readjustment period, the dependency period, and the blackout period come into consideration. 3) Capitalized-earnings approach concerned with having a pool of capital from which income can be derived without eroding the principal. This method employees the following four steps: • Determine the amount of capital available for income production. • Determine the annual income need. • Multiply the capital amount by the expected rate of return, and subtract that amount from the annual income need - this amount is called the annual income shortfall. • Divide the shortfall by the expected rate of return, the result of which is the amount of death benefit necessary.
Three options available with whole life insurance p.114-118 OSL
1) Ordinary (or straight) whole life - which requires the owner to pay a specified premium 2) Single-premium policy, which requires one lump-sum payment • A form of Modified Endowment Contract (MEC), which has a different tax attributes that regular life insurance policies 3) Limited pay policies are also available - premium on a limited pay policy will be greater than the premium on an ordinary (straight) life policy since the lifetime premium payments are being front-loaded over the payment period
Six types of whole life insurance
1) Single premium 2) continuous premium (whole life) 3) limited-pay policy 4) universal life, 5) variable life 6) variable universal life
What is the structure and purpose of a cross-purchase buy-sell agreement? p.139
A cross-purchase buy-sell agreement is an arrangement between individuals who agree to purchase the business interest of a deceased owner. Unlike an entity-type agreement, which involves the business itself, a cross-purchase agreement only involves the owners of the business. To fund a cross-purchase buy-sell agreement with life insurance, each party to the agreement purchases a life insurance policy on the life of all of the other parties to the agreement so that the death benefit is sufficient to purchase the interest of any deceased owner. If there are only two parties, this is relatively straightforward - each party purchases one policy on the life of the other. When more than two owners are involved, however, things can get complicated, and as the number of owners grows, so does the complexity of the arrangement and the number of life insurance policies that must be purchased.
What are the tax differences between entity and cross-purchase buy-sell agreements?
If an entity buy-sell agreement is used, and the surviving owners plan on selling their business interests after the death of the first owner but prior to their own deaths, the entity buy-sell agreement will increase their taxable gains upon sale of their interests. One of the advantages to a cross-purchase agreement is the ability to increase the surviving owners basis in his or her share of the business entity. When life insurance death benefits are received (on a tax-free basis) and are used to purchase the business interest of a deceased owner, each surviving owner's share of the business increases, but so does his or her basis in the business entity. Basis represents that portion of the sale proceeds that are not subject to income tax, so a higher basis results in a higher after-tax benefit for the taxpayer. This benefit is not available with entity buy-sell agreements and is often the reason that clients and planners prefer cross-purchase arrangements.
Why are beneficiaries not taxed on life insurance proceeds?
Non-taxation of death benefits encourages the procurement of life insurance.
What are the various needs for insurance on the person in general, and life insurance in particular?
Premature death, catastrophic illness, disability, and the need for long-term care are reasons for life insurance. Financial planners recognize two fundamental needs for the monies generated by a life insurance policy: replacing income and preserving assets.
How do term and whole life insurance differ, and what are the advantages/disadvantages of each?
Term insurance is only payable if the insured dies within the designated number of years, or term, of the con- tract. Whole life insurance provides protection for the insured's entire life. Adv of Term Life: because it is temporary pure death protection, tends to be quite affordable in the early years of the policy. Disadv of Term Life: Perhaps the most notable limitation of term insurance is the increasing premiums on the basis of age. This makes term insurance impractical for many older people. Term insurance should never be viewed as a form of lifetime protection because it generally may not be renewed after age 65 or 70. Adv of Whole Life: Unlike term insurance, which exists solely for the purpose of providing death protection, whole life policies may be purchased as a low-risk investment. Unlike term life in which premiums increase with age, whole life policies are based on a level premium throughout the duration of the payment period. Because of the savings feature attached to whole life, many consumers are more attracted to it than term life. Disadv of Whole Life: the problem of inadequate coverage exists when people can afford only a certain amount of whole life when they really need to purchase more to cover their families needs.
Viatical settlement p.135
sale of a life insurance policy to a third party that does not trigger a taxable event because the insured/owner/seller is either terminally or chronically ill.
What are the five types of annuities that are settlement options from life insurance?
• Fixed amount annuity. • Life income annuity. • Fixed period annuity. • Life income with period certain annuity. • Joint and last survivor annuity.
What are the six component needs that make up the needs approach to the amount of life insurance needed?
• Income during the readjustment period. • Estate clearance fund or a comparable means to liquidate assets. • Life income to widow(er). • Educational funds for dependents. • Emergency funds. • Retirement funds.