Tools & Techniques of Life Insurance Planning, 7th Edition

Stephan R. Leimberg

• Publisher: The National Underwriter Company
• Year: 2017
• ISBN:
  9781945424496
• Topic: Negocios y empresa
• Subtopic: Seguros

Life insurance remains one of the cornerstones of financial planning. If you provide life insurance planning to clients, or are looking to expand your business in this key area, this book is a must-have. The expert authors, Stephan R. Leimberg and Keith A. Buck, deliver: » Detailed information about the entire range of life insurance products that can be used by estate and financial planners in a wide variety of circumstances » Planning techniques for retirement income needs, estate and gift tax avoidance, estate liquidity needs, and long-term care planning » Plain-language descriptions of the tax consequences of various life insurance products and strategies that plans can use to minimize tax liabilities » Planning techniques for individuals and businesses, including key personnel policies and buy-sell agreements The 7th Edition includes: » Completely updated tax and accounting information » Expanded coverage of 1035 exchange rules, including partially tax-deferred exchanges » Improved planning techniques for pension maximization and buy-sell agreements » Detailed discussion of annuity types and tax consequences » Newly revised comparisons of permanent life insurance features, including joint life, single premium, and limited pay options » In-depth analysis of life insurance riders » Planning techniques for using life insurance in qualified and nonqualified plans And, as with all the resources in the highly acclaimed Leimberg Library, every area covered in this book is accompanied by the tools, techniques, practice tips, and examples you can use to help your clients successfully navigate complex financial planning issues. Whether you're a newcomer to this area or a seasoned planning professional, this is the one resource that leads you quickly to the life insurance planning answers you need.

INTRODUCTION TO LIFE INSURANCE

CHAPTER 1

INTRODUCTION

Life insurance is a complex amalgamation of legal, tax, and economic elements. Basically, it is a unique wealth creation tool that assures the accumulation of a desired amount of liquid capital at death. Depending on the plan of insurance, it may also create more or less capital for lifetime needs.

Through its unique capital creation feature and tax advantages, life insurance can help people solve a host of personal and business problems. However, insurers offer a wide variety of life insurance policies that are suited to a broad host of financial planning problems. Once an insurance adviser identifies a client’s problems, the adviser must match the appropriate life insurance products to the problems. To do so, the planner must first fully understand the legal, tax, and economic elements of life insurance and the particular features of each type of policy.

This chapter will provide an overview of, as well as an introduction to, the multifaceted aspects of life insurance. Use this chapter to gain and maintain perspective and balance. Because life insurance is not really one product but a multiplicity of products, above all, learn to “MATCH THE PRODUCT WITH THE PROBLEM!”

PRINCIPAL USES OF LIFE INSURANCE

Broadly stated, life insurance is indicated only when there is a NEED.

The following is a checklist of common estate building and estate conservation needs that life insurance can satisfy the following:

• Provide for income needs of surviving dependent family members

• Pay federal and state death taxes and other estate settlement costs

• Pay debts

• Provide for children’s education

• Shift wealth from one generation to another in the most cost effective manner possible

• Meet “special” financial demands of physically or mentally handicapped or learning-disabled children or parents or other dependents with physical or mental limitations

• Benefit a charity

• Relieve survivors of financial management burdens by providing an inexhaustible lifetime annuity

• Create an “instant estate”

The following is a checklist of business insurance needs that life insurance can satisfy:

• Fund a buy-sell agreement

• Finance nonqualified deferred compensation arrangements

• Finance Death Benefit Only (DBO) plans

• Provide a basic level of financial security for families of all employees

• Recruit, retain, retire, and reward key employees

The operative word is NEED. Planners should recommend life insurance only if, and to the extent, a need exists. Thus, financial services professionals must first identify the need and then match the type and amount of the product to that need.

ADVANTAGES

The advantages offered by life insurance vary with the type of policy and the problem to which the policy is applied. These advantages are highlighted in subsequent chapters that describe the particular types of policies and the applications to which they are most suited. However, all types of life insurance policies provide certain favorable features, which are listed below.

1. Life insurance provides a guarantee of large amounts of cash payable immediately at the death of the insured. The amount of the death benefit payable is usually significantly greater than the premiums paid for the policy.

2. Life insurance proceeds are not part of the probate estate. The only way life insurance benefits become part of probate is when they are paid to or for the benefit of the estate of the insured. Therefore, the insurance company can pay death proceeds to the beneficiary without the delay caused by administration of the estate.

3. There will be no public record of the death benefit amount or to whom it is payable.

4. Life insurance policies generally have some protection against creditors of both the policyowner and of the beneficiary. The amount of protection varies from state to state.

5. Life insurance cash values provide instant availability to cash through policy loans. The interest rate (or interest-rate formula) for policy loans is known in advance and is usually lower than the rate applicable to loans from other sources.

6. The death benefit proceeds from a life insurance policy generally are not subject to federal income taxes.

7. The increases in the cash value of a life insurance policy enjoy federal income tax deferral. Interest earned on policy cash values generally is not taxable unless or until the policyowner surrenders the policy for cash.

8. Life insurance proceeds often are exempt from state inheritance taxes.

9. Despite some highly publicized life insurance company insolvencies, the life insurance industry remains unparalleled in safety among the financial intermediaries such as the savings and loan, banking, and mutual fund industries. It is commonly noted that not a single dollar of death claim has been lost or denied because of a life insurance company insolvency or failure.

DISADVANTAGES

1. Life insurance is not available to persons in extremely poor health (although almost all individuals in poor health can obtain insurance).

2. Life insurance is an extremely complex product that is hard to evaluate and compare. The time required to gather policy information, decipher it, and compare it with other policies discourages purchasers from engaging in comparison shopping.

3. The cost of coverage reduces the amount of funds available for current consumption or investment.

LEGAL ASPECTS OF LIFE INSURANCE

Legally, life insurance is a contract, governed principally by state law. A life insurance contract promises to pay a specified amount of money to a designated beneficiary when the insured person dies. The contract is between the insurance company and the policyowner, who pays premiums in exchange for the promised death (and other) benefits. Frequently the policyowner is the person insured, but someone other than the insured may own the policy.

In return for its promise to pay death and other benefits under the contract, the insurance company charges a premium to provide adequate funds to pay death benefits when they come due and to cover insurance company expenses and profits. (Ultimately, though, the death benefit paid by the insurer on any given policy may significantly exceed the total of the premium(s) paid by the policyowner.)

Although state laws vary, life insurance contracts are issued with a number of standard provisions. In the typical policy, these provisions:

1. spell out who the parties to the contract are;

2. explain the need for an insurable interest by the policyowner in the life of the insured;

3. describe the legal form and contents of the contract;

4. describe the insured’s rights to name and change the beneficiary;

5. limit the insurer’s right to contest or challenge the validity of the contract after (usually) two years, even if the policyowner made a material or fraudulent misrepresentation in acquiring the policy;

6. provide a one-month grace period for the payment of premiums;

7. limit the insurer’s obligation to pay death benefits if the insured commits suicide within (usually) two years of policy issue;

8. provide for an adjustment in the death benefit in the event the insured’s age is misstated;

9. describe how the policyowner may apply or use dividends, if the policy is participating;

10. assure minimum cash values in the event of lapse or termination of the policy and provide certain standard options as to how the policyowner may receive these “nonforfeiture” values;

11. explain the policyowner’s right to reinstate and the procedures for reinstating the policy in the event of lapse;

12. provide a number of alternative settlement options that beneficiaries may elect when receiving death proceeds from the insurer;

13. explain the policyowner’s right to borrow cash values, and spell out the conditions and terms of such loans, including the method of determining the interest rate;

14. give the policyowner the right to automatically have policy loans pay premiums if premiums are not paid by the end of the grace period; and

15. explain the policyowner’s right to assign the policy to another person or entity.

Each of these legal provisions is discussed in detail in Chapter 5, “Legal Aspects of Life Insurance”.

Additionally, in order for a contract to qualify as life insurance for income and other tax purposes it must exhibit risk-shifting and risk-sharing and it must meet the Internal Revenue Code’s definition of life insurance, as provided in Code Section 7702. Code Section 7702 limits the amount of cash value relative to the face amount of coverage.

If the cash value were allowed to be too high relative to the face amount of coverage, there would be: first, insufficient risk shifting and second, an incentive to shelter otherwise taxable investment income in life insurance products. Increases in the cash values inside a contract that fails to meet the standards of Code Section 7702 are taxable to the policyowner as earned, rather than being tax deferred, as in qualifying life insurance contracts.

TAX ASPECTS OF LIFE INSURANCE

1. In general, the tax law does not permit policyowners to deduct premium payments on life insurance policies. Notable exceptions are for premium payments for group life insurance provided by an employer for employees and for “bonus” payments to employees for payment of premiums under Code Section 162 plans.

2. Dividends received by the policyowner generally are not subject to federal income taxation. Dividends are not usually taxable income until the aggregate of dividends paid exceeds the aggregate of premiums paid by the policyowner.

3. Cash value increases in a life insurance policy, attributable to investment income, are not usually taxable income as long as the policy remains in force. Cash value buildup in a life insurance policy generally enjoys an indefinite deferral from taxation while it remains in force and an exemption from taxation if the policy terminates in a death claim. However, if the policy is surrendered for cash, gain on the policy is subject to federal income taxation. Gain on a surrendered policy is the amount by which the net cash value payable plus any policy loan forgiven exceed the owner’s basis in the policy. Basis in the policy equals the premiums actually paid in cash less policyowner dividends and withdrawals recovered tax free, if any.

4. Withdrawals of cash values, when permitted, usually are taxed on a First-In, First-Out (FIFO) basis, or under what is called the cost-recovery rule. Specifically, a withdrawal is considered to be a nontaxable recovery of cost basis or premiums until the policyowner’s entire cost basis has been withdrawn. Only then are additional withdrawals treated as taxable distributions of interest or gain in the policy.

5. A withdrawal of cash values within the first fifteen policy years may be taxed on a Last-In, First-Out basis (LIFO), or under what is called the interest-first rule, if a reduction in the face amount of coverage accompanies the withdrawal. Specifically, in these cases a withdrawal will be taxable to the extent of gain in the policy. The excess is then treated as a nontaxable recovery of basis in the policy.

6. Distributions or withdrawals under the contract at any time before death from policies that are classified as Modified Endowment Contracts (MECs) are taxed under the in...