What Is It?
Permanent Cash Value Life Insurance With Similarities to Whole Life And Universal Life
Current assumption whole life insurance is a type of permanent, cash value life insurance that is a variation of whole life with some similarities to universal life insurance policies. This type of policy provides premiums that are fixed for specified periods and recalculated on predetermined anniversary dates. With some policies, the death benefit is also recast. Current assumption whole life mimics universal life in the manner in which interest is credited and expenses are identified and charged. Current assumption whole life (and individual insurance companies' variations) are sometimes referred to as interest-sensitive whole life, indeterminate premium whole life, or fixed premium universal life.
When Can It Be Used?
You Have a Need for Insurance and a Desire for Fixed Premiums with Potentially Higher Investment Returns
Current assumption whole life insurance is appropriate when you have a need for life insurance and want the discipline imposed by the fixed-premium feature. The fixed-premium feature forces you to make payments and therefore forces you to save, benefitting you through cash value accumulation. In addition to forced savings, current-adjustment whole life policies include the potential to participate in positive investment returns through the payment of a guaranteed return and the potential for excess interest (more about those later).
You Are Willing to Assume Some of the Risk of Adverse Investment or Mortality Experience
In exchange for a potentially higher return on your cash value, you bear some of the investment risk--the risk that the investments have unfavorable returns (and you don't get a higher return). You also bear a portion of the mortality risk--the risk that the insurance company will face a mortality rate higher than expected (which means higher death benefit payouts for the insurance company). Periodically, your policy premiums may be increased or decreased to reflect the mortality experience of the insurance company since the previous determination date.
Strengths
Provides Benefits Common to All Cash Value Insurance
Like all other permanent, cash value policies, a current assumption whole life policy contains the following features:
- Cash value grows tax deferred
- Cash value can be borrowed against
Policy Cash Value Receives Guaranteed Interest Rate
With a current assumption whole life insurance policy, the insurance company manages your cash value and guarantees a minimum return. Even if the insurance company's investments perform poorly, you still receive the guaranteed minimum rate of interest on your cash value. This provides you with a predictable growth rate on your cash value and can be important when you have specific future financial goals, such as supplementing your retirement or paying your child's college tuition.
You Can Participate In Favorable Investment Returns Through Excess Interest Rate (Bonus Money!)
In addition to the guaranteed rate, you may also receive an excess interest rate on your cash value. The excess rate payments allow the insurance company to share favorable investment returns with policyowners and maintain a competitive position in the market. The method of determining excess interest varies by company, and most companies make adjustments to excess interest credits.
Caution: Some companies require a partial forfeiture of excess interest in the event of policy surrender.
Your Premiums Are a Fixed Amount Between Redetermination Dates
When you buy current assumption whole life, your premium payments are adjusted on specific anniversary redetermination dates. Once set, your premium remains fixed until the next redetermination date, making budgeting for your payments easy to plan for between dates. Policy redetermination dates can occur as often as annually, but two- and five-year intervals are also common.
Policy Excess Cash Value May Be Withdrawn
With a current assumption whole life policy, you may have the ability to withdraw excess cash value accumulations without affecting your policy or your death benefit. Generally, you can make tax-free withdrawals up to the amount of your policy basis.
Caution: There may be a surrender fee charged for partial or full policy surrenders.
Tradeoffs
Policy Loans Affect Cash Value
The money you get as repayment for a policy loan comes from the insurance company's general fund. Your cash value account isn't really emptied of the loan amount. On the other hand, a portion of your cash value that is equal to the loan amount is designated as collateral. The real returns on the underlying investment are not credited to the collateral amount. Rather, during the term of the loan, this portion of your cash worth is credited at a policy loan rate. Your cash value growth is impacted during the term of the policy loan since a portion of it is not included in the real investment return.
Caution: There is generally no requirement that your policy loan must be repaid, but for any unpaid loan balance, interest accrues on a compound basis. If the value of your outstanding policy loan plus the accrued interest equals the remaining cash value, the net cash value becomes zero, and the policy terminates.
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Policy Loans Affect Death Benefit
A part of your cash value equal to the loan amount, in the event that there is an outstanding policy loan, is subject to the special loan policy rate rather than the real investment return. The rise in monetary value may be impacted by this. Furthermore, in the event that you pass away with an outstanding policy debt on your account, the insurance company will be the first to get paid back from your death benefit. The policy beneficiary receives the remaining death benefit after the loan is repaid.
Policy Will Lapse If Premium Isn't Paid
There is no premium flexibility with current assumption whole life. You are not allowed to change your premium amount or skip payments. If you don't pay your premium, your current assumption whole life policy will lapse.
Tip: Some people like the concept of forced payments because it results in steady cash value growth.
Policy Surrender in Early Years Can Be Expensive
If you decide to surrender (cancel) your policy during the first 5 to 10 years, you could face a substantial loss. Most current assumption whole life policies assess surrender charges instead of front-load fees to recover initial policy expenses and commissions. The surrender charges tend to decrease in amount and may not apply after 10 or 15 years into the policy.
How to Do It
Determine Your Life Insurance Need and Overall Financial Goals
It's important to determine how much insurance you need before purchasing life insurance. Your current age and income, your marital status, the number of incomes in your household, the number of dependents, your long-term financial goals, the amount of debt you have outstanding, any assets you now own, and your level of outstanding debt are all criteria that determine whether you require insurance. Your insurance need evaluation should take your planning horizon, overall financial, estate, and tax planning goals into account.
Tip: Consult your financial advisor concerning your need for insurance. Some of the calculations can be complicated.
Complete the Insurance Application and Name Your Beneficiary
The insurance company has to receive a completed application form before it can issue your policy. In addition to the general health questions on the application, the process may involve a physical examination, which is typically covered by insurance. The beneficiary designation, which names the person or people who will receive the insurance proceeds upon your death, is an essential component of the application. You can modify the beneficiary designation by adding or deleting a beneficiary or altering the percentages that are distributed as proceeds, unless you select an irreversible beneficiary designation.
Buy the Policy and Pay Your Premium
Knowing how much insurance and what kind of policy is best for your specific circumstances is all well and good. However, your objective will remain unfulfilled if you choose not to purchase the policy! Further, putting off insurance won't benefit your pocketbook because insurance costs rise with age. Delaying also runs the danger of negatively altering your health. Put differently, it is not a guarantee that your current state of health and insurance status will persist into the future. If your health deteriorates, your insurer may raise your rates or declare you uninsurable.
Review Your Insurance Need Periodically
Your requirement for life insurance may vary as time goes on and as life events happen. You should therefore evaluate your life insurance policy on a regular basis. Generally speaking, you ought to evaluate your coverage every three years. Important life milestones like buying a house, having a child or adopting one, or changing your marital status are also good reasons to check your coverage. You can avoid the error of not obtaining adequate life insurance, which you would be unable to correct after your death, by regularly assessing your insurance needs.
Tax Considerations
Income Tax
Premium Payments Not Deductible
Life insurance premium payments are not tax-deductible expenses.
Policy Loan Proceeds Generally Not Taxable
The money you receive when you take out a loan against your life insurance policy is not taxable income (unless the policy is categorized as a modified endowment contract, or MEC). This regulation is applicable even if the loan exceeds the whole amount of premiums you have paid (unless the insurance is a MEC).
Example(s): You possess a non-MEC life insurance policy with a $20,000 cash value. $14,000. That is your basis under the policy. You choose to pay for your daughter's college education by taking out a policy loan. As per the conditions mentioned in your insurance, you can borrow up to 90% of the cash value of the policy, or $18,000 ($20,000 x.90). Even if the loan is greater than your basis, you are not currently taxed on the loan amount.
Caution: If you cancel your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus accrued but unpaid interest).
Policy Loan Interest Not Deductible
Interest you pay on a policy loan generally is not a tax-deductible expense (under certain circumstances, interest on loans used for business or investment purposes may be deductible).
Policy Cancellation May Be Taxable
The gain on your policy is liable to federal income tax if you cancel (surrender) it for cash. The difference between the debt forgiveness and net cash value amounts and your policy base is the gain on a canceled policy.
Caution: You may be subject to surrender charges. Check your policy.
Caution: During the first few years of the insurance, fees and expenses are typically assessed against the policy. Therefore, policy surrenders made in the initial few years of the policy might not yield much in the way of cash.
Caution: If you surrender your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus accrued but unpaid interest).
Policy Lapse May Be Taxable
If you allow your policy to lapse, you could be subject to income tax even if you don't receive any cash from the policy. A policy lapse can occur when you stop paying premiums and don't have cash values available that can be used to pay the premiums. If you have an outstanding policy loan, it is possible you could be subject to tax on the amount of the loan plus any accrued but unpaid interest.
Death Benefits Generally Not Subject to Federal Income Tax
Policy death benefits are generally not subject to federal income tax. One notable exception is when the policy has been sold or otherwise transferred for valuable consideration by one policyowner to another, subjecting it to the transfer-for-value rule.
Gift and Estate Tax
Policy Proceeds Not Considered Gift to Beneficiary
When the proceeds of your life insurance policy are paid to a beneficiary, they are not treated as a gift for gift tax purposes. However, the insurance proceeds are generally included in your gross estate and will be subject to estate tax if they are included in your estate.
Policy Premium Payments Generally Not Subject To Gift Tax
If you own a life insurance policy with someone else named as the beneficiary, any premium payments you make to that person are not taxable as gifts under gift tax laws. On the other hand, premium payments made by someone else on a policy you own are regarded as a gift to you and can be liable to gift tax. Generally speaking, policy premiums are exempt from federal annual gift tax.
Policy Proceeds Included In Estate Value in Most Cases
The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate or executor. Incidents of ownership include (but are not limited to) the right to change the beneficiary, take out policy loans, or surrender the policy for cash.
Policy Proceeds Often Exempt From State Inheritance Tax
In many states, life insurance proceeds are exempt from state inheritance taxes. Consult your state's laws regarding tax treatment of life insurance proceeds.
Questions & Answers
If You Are Covered Under A Group Life Insurance Policy Through Your Employer, Do You Still Need A Personal Policy?
Indeed, you ought to obtain insurance of your own in addition to the group benefits offered by your workplace. It's likely that your current employer's policy is not portable, which means that your life insurance will not follow you if you quit the company. Throughout their careers, people frequently change professions several times. What will you have for coverage once you retire, even if you intend to work at your current employment until then (if it lasts that long)? Having your personal insurance coverage in addition to any offered by your company is the best method to ensure that your family will be taken care of in the event of your death. Although conversion coverage might exist, it might come at a high cost and provide just a restricted amount of coverage. Furthermore, it might not satisfy all of your wants for coverage.
Can Your Spouse Own A Policy on Your Life And Name Your Child As Beneficiary?
Though it shouldn't be done, this can be done. The death benefit may be liable to gift tax in situations when there is a "unholy trinity" or "Bermuda triangle" between the insured, the policyowner, and the beneficiary.
Can You Name Your Spouse As The Beneficiary on Your Life Insurance Policy If He Or She Is Not A U.S. Citizen?
You can, but there could be estate tax consequences. When your spouse isn't a U.S. citizen and is the beneficiary on your life insurance policy, the death benefit isn't protected by the unlimited marital deduction.
Should You Buy Life Insurance on Your Children?
Purchasing life insurance for your children makes sense in certain situations, but you shouldn't do so until the family's breadwinner(s) and any non-wage earning spouse who is helping to care for the children have the right amounts of coverage in place.
Should You Buy Term Insurance or Cash Value Life Insurance?
It is dependent on your unique situation. The first thing to figure out is not what kind of life insurance to get, but rather how much and for how long. You can go to the financial element after you have provided a quantitative response to the insurance query. It's possible that you require so much coverage that lower-premium term insurance is the only reasonably priced option to obtain it. Once you have determined that you can afford the necessary coverage under either policy type, you should analyze the financial implications of your decision, taking into account things like your tax bracket and the potential rate of return on other assets with comparable risk.
With Cash Value Life Insurance, Does Your Beneficiary Get The Death Benefit Plus The Cash Value Amount?
Maybe. Check the policy. Many cash value policies are written in such a way that the beneficiary receives only the face amount of the policy at death. The cash value is applied to partially pay off the death benefit. There are policies that will pay the beneficiary the face amount plus the cash value, but the premiums tend to be higher. Don't just assume that your policy will pay both amounts--check the policy and/or ask your agent.
Should You "Invest" In Insurance?
It generally isn't a good idea to buy insurance unless you need it. If you want to invest money, many options are available. When you need insurance, there are policy types available that can serve the dual purpose of insurance protection and cash value investments. The bottom line is, don't buy insurance because you are looking for an investment; buy insurance because you need the protection.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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