102-4 Life Insurance (Individuals) - Part 2 Flashcards Preview

CFP 2 - Risk, Insurance, Emp. Benefits > 102-4 Life Insurance (Individuals) - Part 2 > Flashcards

Flashcards in 102-4 Life Insurance (Individuals) - Part 2 Deck (22)
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Universal life insurance

Gives policyowners the ability to adjust the premiums, death benefit, and cash values to meet their financial goals

Nature of policy: insurance contract
Investment of cash value: assets of insurance company
Rate of return: guaranteed minimum IR
Licenses of seller: life agent only
Sold by: computer-generated illustration
Client risk tolerance: generally low risk


Universal Life Death Benefit Options

Option A (aka level death benefit option) pays a level death benefit
-the net amount at risk (NAR) in the policy is defined as the difference between the cash value and the death benefit

Option B (aka the increasing death benefit option) provides an increasing death benefit, which is the NAR plus the existing cash value


Variable life insurance

The policyowner directs the investment of the policy’s cash values among variable subaccounts (aka separate accounts) and bears all investment risk

Considered to be a security and a life insurance product


Variable universal life (VUL) Insurance

Combines the policyowner investment direction element of variable life with the flexible premium, cash value, and death benefit elements of universal life

The attributes include an increasing or decreasing death benefit and a flexible premium payout schedule

Nature of policy: insurance contract & security
Investment of cash value: subaccounts chosen by owner
Rate of return: no guaranteed minimum
Licenses of seller: life agent and securities license
Sold by: computer-generated illustration and prospectus
Client risk tolerance: moderate to high risk


Adjustable life insurance

As the years pass, the policyowner may elect to increase or reduce (adjust) the death benefit, change the premium amount, or both


Survivorship (2nd-to-die) life insurance

Not so much a type of insurance as a time of payment of the policy’s benefits

The most common use of this type of policy is to provide liquidity to pay the estate taxes due on the death of the 2nd spouse


First-to-die life insurance

Commonly used in a buy-sell or business continuation agreement to provide liquidity for one business owner to buy out the family of the 2nd owner


Replacement policy rules

The replacing insurance company must provide a 30-day free look or preview of the new policy to the purchaser, with the right to obtain a full refund if the purchase is subsequently canceled

The company that issued the original policy must be notified in writing about the proposed replacement


Types of values used in life insurance policy illustrations

1. Guaranteed values:
-those for which the insurer bears the risk, such as the IR on permanent life insurance policies w/ guaranteed cash value

2. Nonguaranteed values:
-those for which the risk is borne by the policyowner, such as investment returns under a variable life insurance policy


Comparing the cost of life insurance policies

1. Traditional net cost method:
-based calculations on projected premiums, dividends, and cash values over a selected term
-weakness: does not consider the time value of money

2. Interest-adjusted methods:
-surrender cost method
-net payment method
^each accounts for the time value of money

3. IRR on yield method
-used to determine the IRR on the cash value of a permanent policy that is held for a particular term


Taxation of life insurance rules: annual cash value increase

Not subject to current income taxation


Taxation of life insurance rules: premiums

Generally, premium payments for individual life insurance (whether the owner is an individual or a corporation) are not income tax deductible


Taxation of life insurance rules: dividends

Dividends distributed from a participating life insurance policy and not taxable

They are considered to be a return of premium that reduces the policyowner’s basis in the policy

If the amount of dividends distributed exceeds the premiums paid to date, the excess amount of dividends is taxable as ordinary income to the policyowner


Taxation of life insurance rules: withdrawals or loans

In a regular life insurance policy, withdrawals receive first in, first out (FIFO) income tax treatments

Partial withdrawals of the cash value up to basis, as well as loans taken from the policy are tax-free so long as the policy is not classified as a MEC


Taxation of life insurance rules: Modified Endowment Contracts (MECs)

Subject to LIFO characterization for the life of the policy w/ a 10% tax penalty for withdrawals of loans (excluding the basis or the amount of premiums paid into the policy) made before the owner attains age 59.5

MECs are life insurance policies in which premiums paid within the first 7 years of a new policy or within 7 years of a material change to an existing policy exceed specified amounts under the Internal Revenue Code

“Seven-pay test”

Once a MEC, always a MEC


Taxation of life insurance rules: transfer-for-value

When an existing life insurance policy is transferred for valuable consideration and the insurance proceeds from the death benefit are includable in the gross income of the transferee to the extent that the proceeds exceed the sales price plus the basis, meaning that the income tax exclusion of the death benefit is lost


5 instances when transfer of life insurance policy will not result in loss of exclusion treatment

Transfers to:
1. The insured
2. Partner of the insured
3. Partnership where the insured is a partner
4. Corporation in which the insured is an officer or shareholder
5. Transferee whose basis in the policy is determined by reference to the transferor’s basis


Viatical Settlement

The sale of a life insurance policy by a terminally ill person to an investor or investment group

Typically, the insured receives a lump-sum payment ranging from 50-80% of the policy’s face value

Amount subject to taxation = cash surrender value (CSV) - investment in the contract


Tax treatment for a nonviatical sale of a life insurance policy

When sold to an unrelated person who will not suffer an economic loss at the death of the insured, it’s possible for part of the gain mon the sale to receive capital gain treatment when it exceeds the cash surrender value of the policy


Taxation of life insurance benefits at death of insured

1. Lump-sum payment
-lump-sum death benefits received as a result of the insured’s death are excludable from the income of the recipient

2. Interest-only payment
-fully taxable as ordinary income

3. Installment or annuity payments
-both taxable, non-taxable

4. Estate tax
-included in the descendent gross estate for federal estate tax purposes of the descendent had any incidents of ownership in the policy at the time of death


Accelerated death benefit for life insurance

Source of funds for either a terminally ill or chronically ill individual

Policy rider

Common amount paid 50% of the face amount


Taxation of life insurance benefits during lifetime equations

Investment in contract = premiums paid - dividends received - outstanding loans or withdrawals

Basis in contract = premiums paid - dividends received - outstanding loans or withdrawals - cost of insurance

Gain at surrender = cash surrender value (CSV) - investment in contract

Gain at sale = sales price - basis