Chapter 5
How are Dividends taxed in life insurance policy?
1. if they are paid to the policy owner, they are not taxed, as long as they do not exceed the premiums paid on the policy 2. If dividends are left with the insurance company to accumulate interest, the accumulated interest is taxable as ordinary income 3. if dividends are used to buy paid up additional insurance, they are generally not taxable
What is a primary beneficiary?
Also refereed to as the designated recipient, is the person named by the applicant to receive the proceeds upon the insured's death. most commonly a spouse
What is the gross premium?
An expense factor is added to the net level premium to derive the gross premium, which is what the policy owner will have to pay.
What is an interest factor?
As a consideration in determining premiums has to do with the assumption that the company's investments will earn a certain average rate of interest and that this earned interest will be used to offset costs.
What is the morality factor?
Considers the average number of deaths that will occur each year in each age group as a basis for predicting at what age individuals are likely to die
What is a revocable beneficiary?
Is so designated, the policy owner may change the beneficiary without the beneficiary's knowledge or consent
What happens if no primary or contingent beneficiary survives?
Proceeds are paid to the insured's estate.
Are endowment proceeds taxable?
Proceeds paid in a lump sum at maturity are taxable only if the proceeds are more than the cost of the policy. 1. Installment proceeds are paid and tax in the same way as other kinds of life contract- interest portion is taxable
What is Cash Value?
Refers to the excess (over the amount needed for insurance) paid into the policy in early years. 1. These funds belong to the policy owner. 2. They are available for policy loans but must be repaid to avoid lowering the proceeds.
What is net level premium?
The net single premium is converted into annual payments, or net annual level premiums, incorporating adjustments to the single premium due to the fact that these annual premiums will accumulate less interest over the life of the policy.
What is the exception to the tax treatment of the accelerated death benefit?
The exclusion does not apply to any amount paid to a person (other than the insured) who has an insurable interest in the life of the insured because the insured: 1. is a direction, office, or employee of the person or 2. has a financial interest in the person's busines
What happens if the primary beneficiary has died before the insured has?
The proceeds will go to he contingent beneficiary (a tertiary beneficiary may also be named)
If the policy classified as a MEC how are proceeds taxed?
The same like non MECs
What is a Viatical Settlement Provider?
a person who regularly engages in the business of buying or taking assignment of life insurance contracts on the lives of insured individuals who are terminally or chronically ill and who meets the requirements of Section 101 (g)(2)(B) of Internal Revenue code.
What is the substandard risk individual?
an individual who represents an increased risk because of one of the factors such as age, sex, health, occupation, hobbies, habits. 1. Insurer may reject such an applicant or adjust the premium to reflect the risk
How are premiums calculated?
premiums are expressed as annual cost per $1,000 of face amount
What is the Lien System?
under this method, a policy is issued at standard rates with a lien against the policy that reduces the amount of insurance if the insured dies from a listed cause.
What is the rate up in age?
under this method, the applicant is rated at an older age than actual, resulting in higher premium.
What is the fixed amount option for receiving the death benefit?
1. A specified amount is paid out regularly at specified intervals until the proceeds are used up
When evaluating individual applications, what other factors should be taken into account?
1. Age - the older, the higher the risk 2. Sex- Women on average live longer 3. Health- applicants in poor health= greater risk 4. Occupation, hobbies and habits- hazardous activities increase risk.
What is a irrevocable beneficiary?
if so designated, the beneficiary cannot be changed without the consent of the beneficiary
Are premiums tax deductible?
no
What are possible beneficiaries?
1. Individual- most common beneficiary 2. Businesses 3. Trusts- managed for the benefit of their beneficiaries 4. Estates 5. Charities 6. Classes (my children )
What are the options for receiving the death benefit from a life insurance policy?
1. Lump Sum 2. Fixed Amount 3. Life income 4. Interest Only
What does the mortality table indicates?
1. The average number of years remaining for a group of the same age (life expectation) 2. The average number of deaths for a group in given years (probability of death)
What is the lump sum option for receiving the death benefit?
1. The proceeds are paid in a single lump sum on the insured's death - default method 2. Interest earned on the face value during this interim is also paid to the beneficiaries
What happens if the death benefit proceeds are included in the estate of the deceased?
1. it is likely they will be subject to federal and state estate and inheritance tax
What is Per Stirpes?
1. means by the roots 2. If the named beneficiary dies before the insured, the benefits that were due the beneficiary will be passed to the beneficiary's child or children in equal shares (most used today)
What must the trustee or the escrow agent do on receiving acknowledgement of the transfer
1. must transfer the proceeds to the Viator within three days of receipt, failure to do so renders the contract null.
What is the life income with period certain option for life income?
makes installment payments for the lifetime of the primary beneficiary and to the end of certain period even if the beneficiary has died (10 years certain, 15 years certain)
What is assumed about interest in regard to annual premiums ?
1. Assumed that premiums are paid in full at the beginning of the year. 2. The company must be conservative in guaranteeing any interest rate in its policies 3. The higher the assumed rate of interest, the lower will be the premium charged to policy holders.
What is the Fixed Period option for receiving the death benefit?
1. Equal installments are paid out over a specified number of months or years 2. The size of the payment is a function of the amount of proceeds, the overall period of time,the frequency of payments and the guaranteed interest rate being applied to the declining balance
Why would proceeds be included in a deceased estate for tax purposes?
1. If the policy was owned by the deceased at death, or the deceased had "incidents of ownership" within three years of death. 2. If the beneficiary is legally required to use the proceeds to pay debts or taxes of the estate.
What are some of the exceptions to the exempt from income taxation rule of proceeds?
1. In mos cases, death proceeds are exempt from federal income taxation when paid in a lump sum. 2. If proceeds are paid out in periodic installments, the interest portion of these proceeds is taxable as ordinary income
What is the Net Single Premium
1. It is the amount that, combined with interest, will be sufficient to fund the future death benefit. 2. If a life insurance policy were to be paid up in one single premium payment, this is the amount that would be required. 3. The amount is, in general terms, the mortality cost minus assumed interest.
What are the primary factors that are used to determine the basic premium for life insurance?
1. Mortality (Most significant) 2. Interest 3. Expense
By the date of application a Viatical Settlement provider must disclose what?
1. Possible alternatives to the Viatical Settlement contracts 2. The fact that proceeds may be taxable and that assistance should be sought from a personal tax advisor. 3. The fact that the settlement could be subject to the claims of creditors. 4. The fact that the recipients' eligibility for Medicaid or other government benefits might be adversely affected and that advice should be obtained from the appropriate agencies. 5. The policyowner's right to rescind the contract within 15 or 30 days of execution. 6. The name, business address, and telephone number of the independent third-party escrow agent, and the fact that the viator may inspect or receive copies of the relevant escrow or trust agreements or documents.
What is the Interest only option for receiving the death benefit?
1. The proceeds remain with the insurer, who pays interest in installments to the beneficiary 2. This option is useful as a way of providing income to contingent beneficiaries such as children, after the primary beneficiary such as a parent has died 3. The contract may provide the beneficiary with withdrawal rights
What is the Life Income option for receiving the death benefit?
1. This is a form of life annuity 2. Payments are made with reference to life contingencies 3. The amount of each installment is based on the type of life income chosen, the rate of interest, the gender of the beneficiary, and the beneficiary's age when the income begins.
What is the section 1035 say about exchanges?
1. it allows an ordinary life contract to be exchanges tax free for another life contract, an endowment, or an annuity. 2. An endowment may be exchanged tax free for another 3. an annuity may be exchanged tax free for another annuity
What is the Spendthrift clause?
1. it denies the beneficiary any right to change the time of payment or amount of installments or to borrow or assign any of the proceeds from a life policy 2. it also prevents the proceeds from being attached by creditors of the beneficiary 3. the clause may be attached as a rider or in the form of an endorsement
What is Per capita?
1. means by the head 2. only named and living beneficiaries will receive the policy's proceeds.
Can a beneficiary be changed?
1. the policy owner has the right to change the beneficiary by naming a new beneficiary 2. Unless the beneficiary was designated as irrevocable, then the policy owner must obtain permission from the beneficiary to make a change.
What are some of the exceptions to the non-deductible rule of premiums?
1.Premiums that a person paid for life insurance in an alimony agreement or for a policy that is owned by and paid to a charity. 2. Premiums an employer pays in the form of a bonus to an employee. 3.Premiums an employer pays as part of a pension plan.
What is the flat extra premiums?
A permanent fixed charge is added per $1,000 of coverage, based on extra deaths per thousand. May be removed later ( this might be suitable in a situation where the risk is greatest during the early policy years)
If the policy classified as a MEC how are dividends taxed?
Distributions from a MEC are taxed on a last in first out basis to the extent of gain and are subject to a 10 percent penalty unless the distribution is made after 59.5 or death, disability or annuitization occurs
Are life insurance proceeds tax exempt?
Generally they are exempt from income taxation, even when they exceed the cost of the insurance.
What can be said of premiums in regard to MEC?
If a policy becomes a MEC, it is "tainted" for as long as it exists and the classification carries over to any policy that is issued in exchange for the MEC. A Sec. 1035 exchange is a material change for MEC purposes and causes retesting. Cash values that are transferred from the existing policy will not count as premium. If the policy fails the material change test, it will be classified as a MEC.
What is Pure Life option for life income?
Makes installment payments for the lifetime of the primary beneficiary, with no guaranteed refund of principal
What must the settlement provider do upon receiving the transfer document?
Must immediately pay the entire proceeds of the settlement into an escrow or trust account.
What is an expense factor?
Operating expenses such as personnel supplies, rent and building maintenance, and local state, and federal taxes must be paid out of premium revenues. 1. As expense factor is computed and included in the premium rates for life insurance.
What is the Refund life option for life income?
Provides payment in the form of a cash refund or installment refund annuity
What is Section 101 of the Internal Revenue Code?
Provides that the proceeds of a life insurance policy maturing as a death claim, subject to the exceptions stated in the law, are not subject to income tax when paid.
What is Reserve?
Refers to the amount required by state insurance laws to be set aside to ensure that future claims can be paid. For example, if policy has a $100,000 death benefit with an annual net premium of $900 and the policyowner is actuarially expected to live 40 years, using an assumed interest rate of 4 % the reserve would be: 20,820 (present value of $100,000 paid 40 years from now at 4%) - 17,813 (present value of 40 annual payments of $900 at 4%) ---------- 3,007 (reserve liability)
What are the extra percentage tables?
The standard premium is multiplied by a percentage to increase the premium rate, based on the assumption that the number of deaths per thousand will increase for those with the additional risk factors.
Are accelerated death benefit include tax or not?
They are excluded from income if the insured is terminally or chronically ill. 1. They are excludable up to a limit; this limit applies to the total of the accelerated death benefits and any periodic payment received from long term care insurance contracts
What can be said about exchanges in regard to MECs?
When a policy owner exchanges an existing life insurance policy in accordance with IRC Sec. 1035, no gain is attributed on the exchange. The adjusted basis of the old policy is carried over to the new one. Only the newly added premium is measured for MEC status.
Can the Viator rescind the Viatical settlement?
Yes, he can 30 days from the date the contract is executed or 15 days from the receipt of the Viatical Settlement proceeds, whichever is less
What is a Viator?
a life insurance policy owner who enters into a Viatical settlement contract with a Viatical settlement provider
What is a Viaticated policy?
a life insurance policy, or a certificate under a group policy, which is the subject of a Viatical settlement contract.
What is a Viatical Settlement provider?
a person who effectuates a Viatical settlement contract. Excludes- 1. Certain licensed institutions that take life insurance as collateral for a loan 2. Certain qualified investors- insurers providing accelerated benefits
What is a chronically ill individual?
a person who has been certified by a licensed health care practitioner within the previous 12 months as unable to perform certain basic activities for 90 days or who requires substantial supervision sue to sever cognitive impairment
What is a Terminally ill individual?
a person who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of certification.
What is a Viatical settlement broker?
a person who offers or attempts to negotiate Vitatical settlement contracts between a Viator resident in this state and one or more Viatical settlement providers
What is a Viatical settlement contract?
a written agreement between a Viatical settlement provider and a Viator. 1. Establishes terms under which the settlement provider will compensate the policy owner in return for the assignment or other transfer of the policy or its death benefit to the Viatical settlement provider
What is a Contingent beneficiary?
aka secondary beneficiary, is the person named to receive the proceeds in case the primary beneficiary has died before the insured. most common is the children
T/F there is no need for a witnessed document before entering into a Viatical settlement
false, the settlement provider must obtain a witnessed document in which the person consents to the contract and acknowledged that he or she has entered into the Viatical settlement
How is life insurance Surrenderance taxed?
if a life insurance policy is surrendered for cash, any proceeds in excess of the cost of the policy are included in income 1. The cost= the total of premiums paid for the life insurance policy, less any refunded premiums, rebates, dividends, or underpaid loans that were not included in income.
What is a Viatical Settlement?
is an arrangement whereby a life insurance policy owner who has a catastrophic or life threatening illness or condition assigns or transfer the policy or its death benefits to another in return for immediate compensation that is less than the expected death benefit of the insurance policy
What is the Uniform Simultaneous death act?
it covers such situations and stipulates that the insured died last unless there is sufficient evidence to show otherwise.
What is the common disaster clause?
it stipulates that in the case of a common accident or disaster where the insured and the beneficiary both die, the insured is presumed to have survived the beneficiary. (without this clause proceeds might be taxed in both estates)
What is a joint and survivorship option for life income?
makes installment payments as long as the second insured of a joint policy survives
What is Level Premium Funding?
refers to the funding method by which the insured pays more than the insurance requires in the early years of a policy 1. The excess of the yearly years is used to help fund the additional cost of mortality in the later years of the policy, enabling the policy owner to pay a level premium throughout. 2. Interest helps keep the premium level down
