7 - 1 Adjustable Life What is it? Flexible premium adjustable death benefit type of permanent cash value insurance Hybrid combination of universal

7 - 1

Adjustable Life

What is it? Flexible premium adjustable death benefit type of permanent cash value insurance

Hybrid combination of universal life (UL) and ordinary level premium participating life insurance

Adjustable life has features of universal life Increase or decrease the premiums

Increase or decrease the face amount

Lengthen or shorten the guaranteed protection period

Lengthen or shorten the premium payment period

Chapter 7Tools & Techniques of Life

Insurance Planning

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Adjustable Life

Adjustable life has features of universal life Increases in face amount require evidence of insurability

Unlike universal life, adjustable life’s policy elements are “bundled” Not explicitly stated in policy statements to the insured

Like traditional participating policies, the pure protection and savings elements are not segregated

Adjustable life has features of ordinary level premium whole life insurance Minimum interest guarantee

Guaranteed maximum mortality charges

Cash values


Insurance Planning

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Adjustable Life

Adjustable life has features of ordinary level premium whole life insurance (cont'd) Nonforfeiture values

Policy loan provisions

Dividend options

A reinstatement period and

Settlement options


Insurance Planning

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Adjustable Life

Adjustable life has features of ordinary level premium whole life insurance (cont'd) Various options or rider available

Waiver of premiums

Guaranteed purchase of insurability

Accidental death benefits and

Cost of living adjustments

Changes are permitted only at specified intervals and only with advance notice to the insurer

Depending on the premium and death benefit level chosen the policy can assume almost any form of term or whole life policy from low premium term to high premium limited payment whole life


Insurance Planning

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Adjustable Life

Adjustable life has features of ordinary level premium whole life insurance (cont'd) Minimum annual premium is typical equivalent to a premium for a five year term

policy

Once a policyowner has selected a given plan of insurance, premiums must be paid as scheduled unless the policyowner gives the insurer notice of his desire to change the plan of insurance

The plan of insurance defines the length of guarantees at any point in time

The cash value is computed based on Premium payments Face amount of coverage The term or duration of coverage


Insurance Planning

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Adjustable Life

When is the use of this tool indicated? When flexibility is desired, guaranteed protection is needed and the forced savings

feature of ordinary level premium whole life insurance is preferred

For the family market To adjust to changes in the insured family, income and lifestyle

For business life insurance needs

Advantages Policyowners discretion in premium payment schedules

Element of forced savings creating a level of savings discipline for the client

Policyowner can change the amount of coverage or the term of the coverage


Insurance Planning

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Adjustable Life

Advantages (cont'd) Cost of living adjustment to the face amount is possible

Cash values may accumulate income tax deferred or income tax free depending on whether gains are distributed during lifetime or at death

Cash values are not subject to the fluctuations in the market value characteristic of longer term municipal bonds or other long term fixed income investments, when market rates change

Policy cash values can be borrowed at low net cost


Insurance Planning

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Adjustable Life

Disadvantages Direct recognition method

Smaller dividends allocated to borrowed cash values

Lifetime distributions or withdrawals of cash values subject to income tax to the extend of any gain in the policy

Surrender of the policy in the first five to ten years might result in considerable loss

Interest on policy loans is generally not tax deductible

Policy changes made by the policyowner may inadvertently cause the policy to be classified as a modified endowment policy


Insurance Planning

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Adjustable Life

Tax implications Adjustable life policies are taxed in the same manner as other types of life insurance

policies

Adjustable life policies are subject to the same income, gift, generation skipping and estate taxation as all other life insurance policies

For non-modified endowment policies that meet the definition of life insurance under IRC 7702

The cash surrender values grow income tax deferred

The policyowner can take withdrawals (up to their basis in the contract) and then policy loans income tax deferred

The death benefit is payable on an income tax free basis


Insurance Planning

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Adjustable Life

Tax implications (cont'd) Adjustable life policies are taxed in the same manner as other types of life insurance

policies

Adjustable life policies are subject to the same income, gift, generation skipping and estate taxation as all other life insurance policies

For non-modified endowment policies that meet the definition of life insurance under IRC 7702

The cash surrender values grow income tax deferred

The policyowner can take withdrawals (up to their basis in the contract) and then policy loans income tax deferred

The death benefit is payable on an income tax free basis


Insurance Planning

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Adjustable Life

Tax implications (cont'd) Cost recovery rule (FIFO)

Only after the policyowners investment are fully recovered (via withdrawals) are additional amounts received treated as taxable interest or gain in the policy

Exception to the cost recovery rule Withdrawals within the first 15 years coupled with a reduction in death benefits

If such distributions take place, they will generally be fully or partially taxable to the extent of gain on the policy

The taxable amount depends on when the withdrawal is made Within the first five years – Stringent and complex tests apply. Potentially a larger

portion or perhaps all of any withdrawal will be taxable if there is gain in the policy

Fifth to fifteenth years – A mathematical test applies. frequently only a portion or none of the withdrawal will be taxable


Insurance Planning

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Adjustable Life

Tax implications (cont'd) Caveat: Potential taxation under the MEC rules

Distributions under the contract are taxed under the interest first rule rather than the cost recovery rule.

In addition, these distributions are subject to a 10% penalty if they occur before the policyowner reaches age 59 1/2, dies or becomes disabled

Distributions under the contract means partial surrenders, policy loans, loans secured by the policy, loans used to pay premiums and dividends taken is cash

Changes in premiums or death benefits may inadvertently cause an adjustable life policy to become a MEC in basically three ways

Increase in premiums push cumulative premiums above amount permitted under the “seven pay test”

A reduction in the death benefit causes a re-computation of the seven pay premium, which is applied retroactively


Insurance Planning

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Adjustable Life

Tax implications (cont'd) Changes in premiums or death benefits may inadvertently cause an adjustable life

policy to become a MEC in basically three ways (cont'd) A “material” increase in the death benefit at any time triggers a new seven pay test

MEC status can be voided if excess premiums are returned to the policyowner within 60 days after the end of the contract year in which the excess occurs

Alternatives to adjustable life (AL) Universal life

AL provides somewhat less flexibility to adjust premiums and death benefits than UL policies

AL policy elements are bundled whereas UL policy elements are “unbundled”

AL has more restrictive withdrawal rules than UL


Insurance Planning

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Adjustable Life

Alternatives to adjustable life (AL) (cont'd) Universal life (cont'd)

UL offers two death benefit options Option I – level total death benefits and Option II – Level insurance benefit plus cash value

AL only offers the traditional level total death benefit

AL offers more certainty regarding cash value accumulations than UL

AL dividends give the policyowner more options as to how to use or apply the favorable experience of the company that UL policies

The requirement to pay the scheduled premiums under the AL policy provides a forced savings feature that is absent with UL


Insurance Planning

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Adjustable Life

Alternatives to adjustable life (AL) (cont'd) Pre-programmed combinations of differing life insurance policies

Where and how do I get it? Very few companies continue to develop, distribute and market true adjustable life

policies

What are the fees and other acquisition costs are involved Most adjustable life policies have no explicit surrender charges

Many will pay a terminal dividend when surrendered

Costs of administration is higher

Expense charges and mortality charges tend to be somewhat higher for these policies


Insurance Planning

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Adjustable Life

How do I select the best of it’s type? Key considerations

Policy loan provisions

Policy loan interest rate

Does the company use a direct recognition method

Dividend interest rate current crediting rate

Financial stability and strength of the life insurance company

What are the adjustment provisions

What are the guaranteed insurability options

Quality of service provided by the life insurance company


Insurance Planning

Documents

7 - 1 Adjustable Life What is it? Flexible premium adjustable death benefit type of permanent cash value insurance Hybrid combination of universal