Lesson 2 of Insurance: Life, Health, and Disability Insurance Flashcards
1
Q
Why Purchase Life Insurance!
A
- Income replacement in the event of the death of the family’s primary wage earner.
- Income for readjustment period after the death of a loved one.
- Financial support for dependents or elderly parents of the primary care giver.
- To fund children’s education after the death of the parent and/or guardian.
- Paying off debts such as a mortgage, car or other debts for surviving family.
- Providing income for the surviving spouse.
2
Q
- The Cost of Insurance
- Age or Mortality Cost
A
The Cost of Insurance:
- Age on the x-axis and Premiums on the y-axis.
- As age increases, premiums increase.
Age or Mortality Cost:
- Age x-axis and Mortality Cost y-axis.
- As age increases, mortality costs increase.
3
Q
Approaches to Providing Adequate Protection!
A
The Capital Needs Approach - List
- Income needs, education, retirement funding.
- A list of What Needs to happen:
- Mortgage
- Boat
- Vacation
- Education
The Human Life Value Approach
- Less amount of income earned, less consumed by insured.
Capital Retention
- Not invade the capital, but use it as an income generator.
- In 5 years or 10 years the balance is $5 Million. How much do I need to put in so 5 million is always there.
Income Retention
- Maintain income level.
- Assumption that when my wife dies in 30 years, there is nothing in acccount. On a inflation assumption.
Income Multiplier
- Multiple of income
- Example:
- 10x $50,000
- 10 x 50,000
4
Q
Needs Approach
A
- Evaluates the income replacement and lump-sum needs of survivors in the event of an income producer’s untimely death.
- Any future cash or income need should be discounted using the present value of that future cash flows.
5
Q
Most Common Needs Include
A
- Lump-sum cash needs
- Final expenses
- Debt Repayment
- Education expense needs
- Emergency Expenses needs
- Income needs
- Readjustment period needs
- Dependency period needs
- Spousal life income needs
- This includes a “blackout period,” which begins when social security survivor benefits cease (last child reaches age 16) and ends when the spouse begins receiving social security retirement benefits (age 60 at the earliest).
6
Q
Human Life Value Approach
A
- Uses projected earnings less self-maintenance costs at the basis for measuring the life insurance needs.
- Figuring out PV
-
Important items in calculating the Human Life includes:
- Individual current earnings
- Future Growth Rate of earnings,
- Number of working years remaining
- Cost of self-maintenance
- and the capitalization rate (discount rate.) Less amount of income earned, less consumed by insured.
7
Q
Human Life Value Approach Example
“Dave earns $45,000 after tax this year and his personal expenditures are $8,000 per year. He believes that his salary will grow at 4% per year, his heirs can earn 6% on any investments, and he will work for another 26 years. What is his human life value insurance need?
A
N =26
I = [1+.06) ÷ (1+.04))] - 1 x100 = 1.923%
PMT = $45,000 - 8,000 = $37,000
FV = 0
PV =??
Human Life Value Insurance (PV) = $751,482.34
8
Q
Term Life Insurance
A
- Pure life insurance protection which pays a predetermined sum if the insured dies during a specified period of time.
- Protection ceases at the end of the term useless renewed.
- Premium pattern may be level or increasing on an annual or set period basis.
- Face amount may be level or decreasing.
- Maximum death benefit per premium dollar spent.
- Suitable for temporary needs, young families.
- There is no cash value, savings component or investment component.
- It is very inexpensive at young ages.
- Needs such as education funding paying off debts, or to cover expenses during the grieving process.
- This is the answer most of the time for young clients, especially with children.
9
Q
Term Life Insurance - Provisions
A
- Renewable
- Convertible
- Waiver of Premium
10
Q
Renewable
A
- Most term policies can be renewed without evidence of insurability.
11
Q
Convertible
A
Most term policies have provisions to convert
- to a whole life policy
- without evidence of insurability
- for a particular period of time. (May be less than the full term).
12
Q
Waiver of Premium
A
- If the insured becomes totally disabled,
- the premiums are waived during the period of disability.
13
Q
Term Life Insurance - Limitations
A
- Exponentially increasing premiums for older age entry or renewal.
- Mortality cost of the premium increases each year.
- Most term policies are lapsed without collection by the insured.
- No savings component, cash value, or investment component.
- Term policies may not meet permanent insurance needs.
- Permanent needs would be if the insured required life insurance throughout her lifetime.
14
Q
Term Life Policies!
A
- Annual Renewable Term (ART)
- Long Term
- Decreasing Term
15
Q
Annual Renewable Term (ART)
A
- ART premiums increase annually.
- Every year the policy becomes more expensive.
- There’s no cash value associated with ART.
- Death benefits is fixed at the face amount of the policy.
16
Q
Advantages of ART
A
- Pure death benefit protection that is inexpensive
- Insured receives a maximum death benefit for each dollar in premiums.
- ART can be converted to a permanent policy without proving insurability.
17
Q
Disadvantages of ART
A
- ART may become too costly at older ages.
- There is no savings component
- Premiums increase each year.
18
Q
Level Term
A
- Premiums are level for a period of time such that the insured prepays some of the later.
- More expensive premiums earlier in the policy.
- No cash value associated with a level of term policy.
- Death benefits is fixed at the face amount of the policy.
19
Q
Advantages of Level Term
A
- Premiums remain level, which helps the insured budget a fixed amount each month.
- Results in lower premiums later in the policy.
- Level Term provides a pure death benefit protection that is inexpensive.
- The insured receives a maximum death benefit for each dollar in premiums.
- Can be converted to a permanent policy without proving insurability.
20
Q
Disadvantages of Level
A
- The insured overpays premiums initially.
- There is no savings component.
21
Q
Decreasing Term
A
- Premiums are level for a decreasing term policy.
- Take into account death benefit is declining.
- There’s no cash value associated with a decreasing term policy.
- Death benefit DECREASES over the term of the policy.
- Not very popular, but can be economically reasonable.
22
Q
Appropriate Uses of Term Life Policies!
A
-
Only for temporary needs:
- such as education funding,
- paying off debt, or
- to cover expenses during the grieving process.
-
For decreasing term, the most appropriate use would be to
- payoff a mortgage.
23
Q
Whole Life Insurance of Permanent Life Insurance!
A
- Whole life policies provide lifetime protection if premiums are paid as agreed.
- All whole-life policies pre-fund future higher mortality costs using present value analysis.
- Premium patterns may vary widely from a single premium to level premiums over a fixed term, or level premiums for life.
- Whole life policies have a savings or investment component with earnings accruing on the residual of the premium less the cost for the year plus any previous savings balance.
- ~ Premiums $2,000
- ~ Mortality Cost <$1,200>
- ~ Overhead Profit <$300>
- = Savings Component = $500
- Cash values may be used for loans or may be received if the policy is surrendered.
- The cash surrender value is the cash value less cash surrender charges.
- Cash values usually have a minimum guaranteed rate of interest.
- Participating or non-participating (DIVIDENDS - Included)
Exam Tip:
- If they describe someone who wants guarnatees or doesn’t want chance something to go sideways. Is conservative.
24
Q
Advantages of Whole Life Insurance of Permanent Life Insurance
A
- Whole life policies provide tax-deferred growth of cash value.
- Whole life provides permanent protection until age 120.
25
Disadvantages of Whole Life Insurance of Permanent Life Insurance
- Premiums are expensive and there is no flexibility with the premium payments.
- Cash value grow gradually.
- Insured may not be able to purchase as much protection.
26
**Types of Whole Life Insurance!**
- Ordinary Life
- Limited Pay Life
- Variable Life
- Current Assumption Whole Life (CAWL)
27
Ordinary Life
- Insured pays premium until age **120 or death**
- **Cash value increases to face value** at age 120.
- Death benefit is level throughout the term of the policy.
28
Limited Pay Life
- Premiums are higher than ordinary life
- because the insured only pays premiums until a certain age.
29
Variable Life
- Cash value is invested in stock, bond, and money market mutual funds. (subaccounts)
- An opportunity for higher returns on cash value exists with variable life.
- Death benefit and cash value fluctuate based on investment performance.
- Fixed Premiums
## Footnote
(INFLEXIBLE) PURPOSES ON EXAM NOT FLEXIBLE
30
Current Assumption Whole Life (CAWL)
- The insurer uses new money rates and new mortality rates to establish premiums.
- In the event that interest rates turn out to be too high and premiums too low,
- the insurer reserves the right to adjust the premium once,
- usually at the five-year mark.
31
Lo CAWL
- Is a **low premium** assuming a higher interest rate for crediting.
- Interest-sensitive insurance (Lo CAWL) is designed to create demand due to lower premiums.
32
Hi CAWL
- Assumes a lower interest rate that is currently being credited
- resulting in a **higher premium** with the possibility of a one-time downward adjustment at year five.
33
Whole Life Insurance CFP Exam Tip
**The Blanket of Guarantees**
- Guaranteed Premiums
- Guaranteed Death Benefit
- Guaranteed Cash Accumulation.
34
**Appropriate Uses of Whole Life Insurance!**
- **Anyone with lifetime and permanent needs.**
- Income
- Retirement Funding
- Estate Tax
- **Estate planning purposes to provide liquidity to pay transfer taxes.**
- Provide liquidity at death to pay taxes,
- provide income during the grieving process, or
- payoff debts.
- Insured has a need for investment like performance/returns.
- Suitable for income, retirement funding, and estate tax.
- Have a savings or investment component. .
35
**Individual Life Insurance Policies!**
## Footnote
Multiple Insureds
- First-to-Die
- Second or Last-to-Die
36
First to die
- Provides death benefits when the first insured dies.
- The first-to-die life expectancy is less than either single life expectancy.
- All else being equal this is the **more expensive form** of individual insurance.
37
Second or last to die (AKA Survivorship Life)
- provides death benefits when the second or last insured dies.
- Second to die **life expectancy is greater than either individual life expectancy**.
- Second-to-die policy is **appropriate to pay for estate taxes and provide liquidity.**
- This is the most common form.
38
**Dividend Options!**
- Nonparticipating
- Participating
- Dividend options
39
Nonparticipating
- Whole life policy does not pay dividends.
40
Participating
- Whole life participating policy will pay dividends.
41
Dividend Options
(Not reported on 1900-DIV statement)
(Not dividends reported on a 1900-DIV statement, are insurance dividends).
- Cash
- Accumulate at Interest
- Reduce Premiums
- Paid-up Additions
- One-Year term
**Exam Tip:**
- Remember that dividends are a CRAP-0
42
Cash
- Client receive money and can use it or invest as they wish
43
Accumulate at Interest
- The company invests the dividends and they are tax-free up to the client's basis in the policy.
- Interest paid on the dividends is **taxable**.
44
Reduce Premiums
- Decrease the out-of-pocket expense for premiums.
45
Paid-up Additions
- Purchases additional insurance each year for insured regardless of health or occupation.
- Increase in Death Benefit
- Most Popular for Whole Life
- Once they do the paid up additions they remain on the policy.
46
One-year Term
- Adds term insurance each year to the policy face amount equal to the cash value of the policy.
**Exam Tip:**
- Also known as the 5th dividend option on the CFP EXAM.
## Footnote
Once they do the paid up additions they remain on the policy.
47
**Settlement Options for Life Insurance!**
- **Lump Sum Payment**
- **Interest Only**
- **Annuity Payments from Life Insurance**
- Fixed Amount
- Life Income
- Fixed Period
- Life Income with Period Criteria
- Joint and Last Survivor Income
48
**Lump Sum Payment**
- Pay the lump sum directly in the form of a check to the beneficiary.
## Footnote
When someone dies, beneficiary will take it out as a lump sum. 99.9% of the time.
49
**Interest Only**
- Receive periodic payments of interest on the policy proceeds.
50
**Annuity Payments from Life Insurance**
- Fixed Amount
- Life Income
- Fixed Period
- Life Income with Period Criteria
- Joint and Last Survivor Income
51
Fixed Amount
- The beneficiary will receive fixed payments until the proceeds are depleted.
52
Life Income
- The life income option converts the death benefits into an annuity contract for the life of the beneficiary.
53
Fixed Period
- Instead of receiving an annuity payment over the lifetime of the beneficiary, the death benefit proceeds may be used to purchase an annuity certain, which is an annuity that will make payments for a specified number of periods (usually years).
- In financial planning engagements, using a fixed-period annuity payout may be preferential to the life income method when the beneficiary:
- Needs additional cash flow for a fixed period of time, such as until retirement age (when distributions from retirement accounts will begin).
- Suspects that he or she will have a shorter-than-average life expectancy and would like to preserve some of the death benefit value for a successor beneficiary if the primary beneficiary dies before the term expires.
54
Life Income with Period Criteria
- This method combines the benefits of the life income method with the benefits of the fixed-price method.
- This approach transforms the death benefit into a life annuity contract based on the age and health of the beneficiary, yet promises to make a specified number of payments under the contract.
55
Joint and Last Survivor Income
- With a joint and last survivor income settlement option, annuity payments are made over the joint lives of two individuals.
- When one of the joint annuitants dies, the survivor will receive a reduced payment for the rest of his or her life.
56
**Life Insurance Nonforfeiture Options!**
- After the policy develops a nonforfeiture value, the policy may be surrendered and the surrender value may be.
- Taken in cash
- Used as a single premium to purchase a paid-up life insurance policy.
- Used to buy extended-term insurance.
- **Subtopics:**
- Cash surrender value
- Reduced paid-up insurance
- Extended Term Insurance
- Accelerated Death Benefits
57
Cash Surrender Value
- Insured receives the accumulated cash value when terminating the life insurance policy.
- The cash surrender value is the cash value less surrender charges.
58
Reduced Paid-up Insurance
- Insured receives the cash value in the form of a paid-up policy with a smaller face amount.
59
Extended Term Insurance
- The insured receives the cash value in the form of a paid-up term policy for a specific duration, with the same face amount as the original policy.
60
Accelerated Death Benefits
- If an insured becomes terminally ill, the insured may take an accelerated death benefit.
- Accelerated death benefits may be in the form of a lump sum or monthly income.
- Any payments are deducted from the policy's face value.
- Life expectancy must be 24 months or less.
- Income from an accelerated death benefit is not taxable to the insured.
- There are no restrictions on what the accelerated death benefit can be used for:
- Medical care,
- home health care,
- nursing home,
- trip around the world, or
- a new car.
61
**Universal Life Insurance!**
- Is a Permanent Policy
- **Types of Universal Life Insurance**
- Universal Life A (Universal Life Option 1)
- Universal Life A (Universal Life Option 2)
- Non Direct Recognition Program
- Direct Recognition Program
- **Insured may adjust:** (FLEXIBILITY)
- Premiums paid,
- face value of the policy, and
- cash value.
- Insured does **not direct the investment portion** of the cash value.
- **Cash value can be used to actually pay the policy premiums.**
- NAR = Net Amount at Risk
- Is **Unbundled**
**EXAMPLE:**
- Bill pays his premium of $1,500 which is added to the cash value of his policy of $10,000. His new cash value is $11,500. The insurance company then reduces his cash value to reflect the portion of his premium to cover the mortality costs, administrative expenses, and insurer profit. This portion of the premium is $1,000, so the ending cash value is $10,500.
- If Bill preferred he could just use the original cash value of $10,000 to pay his entire premium.
## Footnote
UNIVERSAL LIFE FLEXIBLE
HAS 0 GUARANTEES
62
Universal Life A (Universal Life Option 1)
- **A flexible premium, adjustable death benefit**, and unbundled (profit, cash) life insurance contract.
- If the **cash value gets high enough, the death benefit will increase.**
- Normally, the amount of insurance purchased declines as the cash value rises, keeping the total death benefit level.
- The beneficiary receives the cash value or death benefit.
- Cheaper Option Between A and B.
**EXAMPLE:**
- Tiffany purchases a universal life insurance policy with a face amount of $1,000,000 and a cash value of $100,000. Death Benefit would be $1M.
63
Universal Life B (Universal Life Option 2)
- Same as Universal A except that death benefits vary directly with the cash values.
- Universal B is more expensive than Universal A because the death benefit is equal to a specified amount of insurance plus the cash value, and the total death benefit will typically rise.
- The beneficiary receives the cash value or death benefit.
- More expensive option.
**EXAMPLE:**
- Tiffany purchases a universal life insurance policy with a face amount of $1,000,000 and a cash value of $100,000. The death benefit would be $1,100,000.
64
Variable Universal Life
- **A product with investment options such as**
- stock,
- bond, and
- money market mutual funds.
- There is **no minimum guaranteed rate of return** or interest.
- **Cash value is invested in a separate account**, not the insurer's general account.
- Insured direct investments of the cash value into stock, bond, and MM mutual funds. Has to be allowed from insurance company.
- Cash value is not guaranteed but in the event of an insurance company failure, the separate account will be treated as an asset of the insurance company.
- Variable Premiums
## Footnote
All Same Flexibility as Universal Life but more FLEXIBILITY.
Variable is Sub Accounts.
Individual gets to Choose with Investment Options.
More Risk but they can get more return.
65
Advantages + Disadvantages of Universal Life Insurance
**Advantages:**
- The policy owner determines the frequency and amount of each premium.
- The death benefit may increase.
**Disadvantages:**
- The death benefit may decrease.
66
Non-Direct Recognition Program
**A non-direct recognition approach**
- does not adjust the dividends paid on a policy
- where there is an outstanding loan against the cash value of a policy.
67
Direct Recognition Program
The direct recognition approach, **dividends are reduced** by any outstanding loan against the policy.
68
Feature Comparison of Common Life Insurance Policies
- The Use part is most important for the exam.
## Footnote
Cash Value can be replaced with investments.
69
Termination Options (Slides)
## Footnote
Also on a previous slide.
**Example to use:**
- Policy is for $100,000
- Cash Value $30,000
- Whole Life Policy
- Paying $1,000 do not want to pay anymore.
After the policy develops a **nonforfeiture value**, the policy may be surrendered and the **surrender value may be**
- **Taken in cash**
- **Used as a single premium to purchase a paid-up life insurance policy.**
- Reduced Paid Up Quote: $60,000 is Death Benefit.
- No More Premiums paid is advantage.
- **Used to buy extended term insurance.**
- Give extended Term 16 Years.
- Death Benefit stays at $100,000
- If I die in 15 Years my wife gets $100,000
- If I die in 16 years and 1 week my wife gets nothing
70
Business Use of Insurance (Slides)
Buy Sell Agreements Funded With Life Insurance
**Cross Purchase:**
- Pros:
- Increase in surviving partner's basis
- Cons:
- Lots of policies = N * (N-1)
- N is owners
- Cost Variances
- Study Tips:
- Recommended for 2-3 owners.
**Entity Purchase:**
- Pros:
- Company Pays
- Much fewer policies needed
- Cons:
- Does NOT increase surviving partner's basis.
- Study Tips:
- Recommended for 8-9 owners.
**Key Person Insurance**
- Designed to protect a business upon the loss of key employee
- Premiums are not a deductible business expense
- Death proceeds are received tax-free
71
**Life Insurance Policy Provisions!**
- Grace Period
- Misstatement of Gender or Age
- Suicide
- Disability Waiver of Premium
- Incontestability
72
Grace Period
- Typically lasts 31-61 days after the premium due date in which policy remains in force.
- If insured dies during grace period, the insurer assumes the insured would have renewed.
- The insurer will pay the death benefit and deduct the premium.
73
Misstatement of Gender or Age
- Younger persons and women pay less for life insurance
- Misstatement of age on an application will not void the contract
- The death benefit will be paid, but reduced by what premiums would have been if age was accurately stated.
74
Incontestability
- States that once the policy has been in force for a period of time (typically two years),
- the insurer may not cancel the policy if they later discover a material misrepresentation omission or concealment.
75
**EXAM QUESTION Misstatement of Gender or Age**
Cindy, who is actually 45, has been lying about her age for the last 15-20 years and tells Connor, the insurance agent, that she is 30. She has a driver's license to support age of 30. She buys a $1M term life policy paying premiums of $1 per thousand. Age 45 premiums are $2.50 per thousand. Cindy dies in the first year. Which is correct?
a) Beneficiaries collect $0 but get the premiums back because Cindy died.
b) Beneficiaries collect $1M as long as her death was accidental.
c) Beneficiaries collect $40,000, which is the policy value with premiums adjusted for actual age.
d) The policy is voidable for up to two years by the insurance company for fraud.
Answer: C
The face is adjusted for the correct premiums. Cindy is paying (1,0000,000 ÷1,000) x 1.
She should be paying 2.50 per 1,000, so the face is adjusted to $400,000.
(1,000÷2.50) x 1,000 = 400,000.
76
Suicide
- Coverage is excluded if **suicide is committed within one or two years** of purchasing the policy.
- If suicide is committed within the exclusion period, **premiums are returned.**
77
Disability Waiver of Provisions
**Whole Life:**
- The insurer will waive all premiums after disability
**Universal and Variable Universal:**
- Insurer will waive the charges related to mortality and administration OR waive the entire premium.
78
**Assignment!**
The policy owner assigns rights to life insurance contract to someone else.
- Absolute Assignment
- Collateral Assignment
79
Absolute Assignment
- The owners transfer all policy ownership rights, typically the result of divorce.
80
Collateral Assignments
- Collateral assignments are used for collateral on debt, which only assigns limited ownership rights.
- The assignment automatically terminates when the debt is satisfied.
- Most participating **whole-life policies use DIRECT RECOGNITION,** which reduces dividends and interest for the portion of the cash value used as collateral for loans.
81
**Group Life Insurance!**
- Group Term Insurance
- Group Whole Life Insurance
82
Group Term Insurance
- Group term is the most **common form of insurance offered by employers**.
- Premiums for the **first $50,000 in coverage are tax-free.**
- Premiums paid by **employers are tax deductibles.**
- Premiums paid by the **employee are with after-tax dollars.**
- **Income must be imputed based on the coverage in excess of $50,000**.
83
**EXAMPLE of Group Term Insurance**
Tyrella has a $75,000 group term life insurance policy that is provided by her employer at no cost to her. Base on Tyrella's age, her policy has a table 1 rate of $.0.23 per unit. Since the policy exceeds the $50,000 in coverage the employer can provide tax-free, Tyrella will have taxable income reported for the amount over $50,000. It will be calculated as follows:
$75,000 - $50,000 = $25,000 worth of coverage that will be taxable.
$25,000 divided by $1,000 - 25 units of coverage
25 x 0.23 = $5.75 multiplied by 12 months in the year = $69 worth of taxable income will be added to her W-2 for this year.
84
Group Whole Life Insurance
- Allows employees to accumulate savings for retirement through the **cash value of a policy.**
- If there are **premiums paid by the employer, they are taxable income to the employee.**
- Employer allows **premiums savings from the group rate to pass to the employee.**
85
**Life Annuity Contracts!**
- Periodic payment to an individual that continues for a fixed period or the duration of a designated life or lives.
- Provides protection from outliving your assets.
- Superannuation
- Commonly used to fund retirement.
- Not appropriate if you want to leave assets to your heirs.
- Life or Pure Life
- Not a hedge against inflation. (must be a variable annuity)
86
**Types of Annuities!**
- Immediate Annuity
- Deferred Annuity
- Flexible Premiums Deferred Annuity (FPDA)
- Single Premiums Deferred Annuity (SPDA)
- Fixed Annuity
- Variable Annuity
- Equity Indexed Annuity
87
Immediate Annuity
- Payments to annuitants begin immediately and
- are purchased with one single lump sum.
88
Deferred Annuity
- Payments to annuitants begin at some future date.
- A deferred annuity is usually in the form of a retirement annuity that accumulates interest until retirement age.
- A deferred annuity can be purchased either in a lump sum or periodic installment premiums.
89
Flexible Premiums Deferred Annuity (FPDA)
- Allows insured to vary the premiums paid.
- Retirement income is a function of total premiums paid.
90
Single Premiums Deferred Annuity (SPDA)
- SPDA is a **SINGLE** lump sum payment of premium.
- Earnings accumulate tax-free until distributed.
- Proceeds from a life insurance policy can be used to purchase a single premium annuity.
91
Fixed Annuity
- Annuity accumulates a fixed interest rate **over a period of time.**
- A fixed annuity provides the owner with more security than a variable annuity contract.
92
Variable Annuity
- Owner may invest in stock or bond mutual funds that are held in "sub-accounts."
- Stock or bond mutual funds.
- There is no guarantee of a return on investment.
- The owner accepts more investment risk with a variable annuity.
- A variable annuity is appropriate if the client wants to **keep pace with inflation.**
93
Equity Indexed Annuity
- Form of fixed annuity **linked to an index. (S&P500)**
- Provides some participation to index performance.
- Usually **limits the downside risk** of an index.
Form of Fixed annuity
Limits Downside risk of index
Index Term
Participation Rate
Cap Rate
Floor Crediting rate
Indexing Method
94
Form of Fixed annuity
- It is linked to an index
- Immediate: Benefit is linked to the index
- Deferred: Credited interest rate is linked to index.
- Index is most often the S&P500
95
Limits Downside risk of index
- Example: minimum value of 90% of premiums + guaranteed interest - withdrawals.
- Offers modest upside potential
- Indexing method and participation rate are critical.
- Guaranteed minimum interest rate (low).
96
Index Term
- Typically ranges from 1-10 years.
- Interest is credited at the end of the term.
97
Participation Rule
- Percentage of index increases that affect credited interest.
- If participation rate is 70% and the index rises 10%, credited interest = 7%
- May vary from term to term or could be guaranteed.
98
Cap rate (not in all annuities)
- Maximum rate of credited interest
99
Floor Crediting Rate (not in all annuities)
- Typically 0% - no losses allocated to the contract.
100
Indexing Method
- Annual Reset - Ratcheting Method
- High Watermark Approach
- Point-to-Point Method
101
Annual Reset - Ratcheting Method
- Index-linked rate calculated each year (beginning vs end of year)
- Interest added each year and protected from future decreases
- Generally has a lower participation rate & may use averaging over time.
102
High Watermark Approach
- Compares the highest anniversary index to the initial index.
- Beneficial if the index declined near the end.
- Interested is only credited at the end.
- May have a lower participation rate or use a cap rate.
103
Point-to-point method
- Compares index at the end of term (typically 6-7 years) to the beginning of term, paying interest at the end of the term.
- May have a higher participation rate.
104
**Timing of Annuity Payments!**
- Pure Life Annuity
- Life Annuity with Guaranteed Minimum Payments
- Installment Refund Annuity
- Joint and Survivor Annuity
105
Pure Life Annuity
- Payments are made to the annuitant over his lifetime.
- Payments stop at the death of the annuitant.
- The primary risk is receiving one payment, and then dying.
- AKA Life Only
- This is the MAX INCOME.
- MAXIMIZING
106
Life Annuity with Guaranteed Minimum Payments (Period Certain)
- Payments continue for a **minimum term** and payments are payable to the annuitant's beneficiary if death occurs prior to the expiration of the minimum term
- Or until the death of the annuitant if the annuitant's lifetime exceeds the minimum term.
- The payout is **less** under this method than a pure life annuity.
**EXAMPLE:**
- Pure life Annuity, Age 62, $250,000 basis: $1,200/month paid out.
- Guaranteed Minimum for 20 Years, Age 62, $250,000 basis: $900/month paid out.
107
Installment Refund Annuity
- Payments continue for a minimum term or
- Until death of annuitant with cash refund option.
- If total payments to the annuitant are less than the premiums paid for the policy at the owner's death, the policy will pay the difference between premiums paid and what has already been paid out.
**EXAMPLE:**
- Sam paid $250,000 for his annuity. He received $175,000 in payments prior to his death. Under the installment refund annuity, his beneficiary would receive $75,000 ($250,000 - $175,000).
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Joint and Survivor Refund Authority
- An annuity is paid over the lifetime of two annuitants, usually a husband and wife.
- Payments are **lower** than a Pure Life Annuity.
- Payments continue until death of second annuitant.
109
**Practice Question**
Frank is 68 years old and has invested assets of $500,000. Frank's family has a history of living beyong 100 years. Frank is concerned about maximizing his retirement income and making sure he doesn't outlive his retirement assets. Which insurance product would you recommend?
a) Installment refund annuity
b) Pure life Annuity
c) Whole Life Insurance
d) Life Annuity with guaranteed minimum payments
Answer: B
"Maximizing"
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**Taxation of Life Insurance!**
- **Death benefits are generally excludable from taxable income.**
- Exception is the transfer for value rule, discussed later.
- **Dividends** earned on cash surrender value are **not taxable until withdrawn.**
- **Cash value is not taxable if withdrawn at death.**
- **Loans** against life insurance **are tax-free**.
- The exception is if the contract is a Modified Endowment Contract (MEC).
- If a contract is deemed an MEC any loans or withdrawals will be treated using the LIFO method. (How a policy becomes an MEC is defined in the next section of this text.)
- Exchanges for one life insurance policy to another or for an annuity, do not create a taxable event.
- Exchanging an annuity for life insurance creates a taxable event.
- If one owns a life insurance policy on his or her own life, or if the proceeds of the policy are made available to the executor of his or her estate,
- the death benefit will be included in the owner/insured's gross estate, and may be subject to estate tax.
111
**Taxation of Benefits Received During Life!**
- Dividends
- Withdrawals
- Surrender Policy Prior to Death
- Transfer of Policy for Value
- For Surrender and For Sales to Unrelated PArties (3 Examples)
- Premiums
- Taxation of Installment Option for Life Insurance Proceeds or Annuity Payments
- Taxation of VIatical Settlements and Accelerated Settlements
112
**Dividends**
- Dividends are **not taxable** and are considered a **return of basis** (or premiums).
- If **dividends exceed premiums**, then the **dividend is taxable.**
113
**Withdrawals**
**If a MEC**
- Taxed on a LIFO Basis (INTEREST FIRST)
- MECs are subject to a 10% penalty if withdrawn before age 59.5
- A policy is an MEC if it fails the 7 Pay Test.
- A contract fails the 7 Pay Test if the cumulative premiums paid exceed the premiums due for the time period being considered.
- Taxed as ordinary income until cash value equals accumulated premiums.
- If the contract is deemed an MEC, the withdrawals or loans are taxed on a LIFO basis.
- MEC status only affects loans, not the taxation of proceeds at death.
- Taxed as ordinary income until CV = accumulated premiums.
- If the client does not intend to take a withdrawal or loan, then creating an MEC is of no consequence.
- Single Premium Payment is a MEC
**NOT a MEC:** (Regular Life Insurance Policy)
- Withdrawals are considered a return of principal until the basis has been distributed, then taxed as ordinary income.
- Taxed on a FIFO basis. (basis first).
- Loans are not taxable.
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MEC's
(Modified Endowment Contract)
- Since most of the abusive uses of life insurance involve situations where all of the premium is paid in the first few years of the contract's existence, a policy that has its premium payments front-loaded will not be eligible to receive the tax benefits traditionally associated with life insurance.
- In particular, if the owner of the policy attempts to borrow from the policy cash value, the loan will be considered a taxable distribution to the policy holder to the extent of any gain in the contract.
- The death benefit received by the beneficiary will continue to be income tax free to the extent that the policy has not been transferred.
115
Traditional Life Insurance & MEC
116
EXAMPLE of a Withdrawl
- Patrick purchased a single premium life insurance policy on his life 10 years ago for $100,000. The current value of the policy is $275,000. Patrick needs some cash to put a down payment on a vacation home, so he borrows $50,000 from the policy.
- The gain inherent in the policy is $175,000 ($275,000 - $100,000), and, therefore, the $50,000 Loan will be treated as a 100% taxable distribution to Patrick.
- If Patrick dies next year, the beneficiary of the policy will receive the net death benefit free of federal income tax.
117
**Surrender Policy Prior to Death**
The insured may surrender a policy prior to death and take cash value as:
- Lump Sum
- Interest Only
- Installment Payments
118
Lump Sum
The amount above premiums paid is ordinary income.
119
Interest Only
Interest is taxable as ordinary income.
120
Installment Payments
- Portion is a return of principal and interest.
- The interest portion is taxed as ordinary income.
121
**Transfer of Policy for Value**
Death benefits are **taxable** to the transferee to the extent **proceeds exceed the basis.**
**Exceptions to Transfer-for-value Rule:**
- Transferred to the insured.
- Transferred to a business partner of the insured.
- Transferred to a partnership of the insured.
- Transferred to a corporation in which the insured is a shareholder or officer.
- Transfer that results in carryover basis from TRANSFEROR to transferee.
**In the event that the owner of the life insurance policy transferred the policy for value, he will experience varying treatment of the proceeds received depending on health:**
- Terminally or chronically ill - Tax Free Receipt
- Not Terminally or chronically ill (life settlement) -
- tax free return of basis,
- ordinary income on cash surrender value over basis, and
- capital gains on the remainder.
## Footnote
Exceptions part is FLashcard worthy.
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Example of Transfer Policy for Value
Robin owns a life insurance policy with a cash value of $50,000. Robin transfers the policy to the following persons with the associated tax consequences:
**To an accounting firm in which she is a partner.**
- Exception to transfer-for-value rule - No Tax
**To her ex-husband as part of a divorce settlement.**
- No tax because she did not receive payment for the policy.
**Example:**
- Jim's daughter owns a policy on Jim and transfers the policy to Jim.
- Gifting Life Insurance that has a basis. (cash value).
- Mike forms a partnership and transfers a life insurance policy to the partnership.
123
For Surrender and For Sales to Unrelated Parties (3 Examples)
- Surrender and Sale of a Cash Value Policy to an unrelated party and
- sale of a term policy to an unrelated party.
124
Example 1
- Cash value life insurance - surrendered
- Entered year 1, January 1
- Cash surrender value (CSV) in year 8: $78,000
- Cost of insurance charges: $10,000
- Premiums paid to date: $64,000
- Tax consequences OI = $14,000 (CSV - Premiums = OI)
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Example 2
Cash value life insurance sold (using the same data as above) to a related party.
- Sale Price: $80,000
- Sold June 15th of year 8 of the policy
- Tax consequences are OI = $14,000 and $2,000 capital gains.
Following is the breakdown:
- Basis is determined by $64,000 in premiums (Revenue Ruling 2020-05)
- $80,000 sale price - $64,000 basis = $16,000
- Of the $16,000 gain, $14,000 is OI (as in example 1) and the remaining $2,000 is capital gain.
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Example 3
15-year term insurance policy (15-year level) sold to an unrelated party
- Premium paid: $500/month
- Sold June 15th of year 8 of the policy
- Premiums paid $45,000
- Sold for $20,000
- Sale price - premium paid = loss/gain. $20,000 - $45,000 = -$25,000.
- The taxpayer cannot take the loss unless it is incurred for trade or business, or a transaction entered into for profit.
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Premiums
- Premiums paid by the insured are not tax deductible by the insured.
- **Group life**
- insurance premiums paid by an employer **ARE DEDUCTIBLE** by the employer.
- Premiums paid by the employer are taxable income to the employee.
- The first $50,000 of coverage is NOT taxable to an employee.
- An employee must impute taxable income for benefits in excess of $50,000.
- The imputed income is a function of age and amount of benefits per $1,000 in excess coverage.
- **For Key Employee and split-dollar:**
- Insurance premiums paid by an employer are not deductible by the employer.
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Example of Premiums
- Frank, age 40 earns $75,000 per year and has a group term life insurance through his employer equal to twice his salary. How much income needs to be imputed?
- Based on Table 1 for IRC Section 79 the monthly cost for excess coverage is $0.10 per $1,000 in excess coverage, therefore:
- ~$75,000 x 2=$150,000 Death Benefit
- ~$150,000 - $50,000 exclusion = $100,000 in excess coverage
- ~(100,000÷1,000) x 0.10 x 12 = $120 imputed income
- Pay an additional $120 of income on taxes.
- Frank salary is $100,000. His employer provides 2x salary in group coverage. The cost is $.12/month for $1,000 in coverage. How much income must Frank imputer.
- ~$100,000 x 2 = $200,000 Amount of Insurance.
- ~$200,000 - $50,000 = $150,000 taxable income.
- $150,000 ÷ $1,000 = (150 x $.12) x12 = $216 imputed income.
- Pay additional $216 of taxes on income.
## Footnote
Exclusion is $50,000. Thats the max.
129
Exam Tip
**Keep the deductibility of premiums straight.**
- Premiums are not deductible for the insured, but
- premiums are deductible by the employer for group life insurance and
- those premiums are taxable income to the employee.
130
Taxation of Installment Option for Life Insurance Proceeds or Annuity Payment
- **The taxable income is calculated using the exclusion/inclusion ratio:**
- Monthly payments x 12 x life expectancy = Total payments
- (Basis ÷Total Payments) = Exclusion Ratio
- (Exclusion Ratio x Monthly Payments) = Amount Excluded from Monthly Income
- Any payments **received beyond the life expectancy are 100% included in taxable income.**
- In other words, after recovering your entire basis the remainder is all taxable.
- Any basis not recovered before the death of the annuitant is deductible on his final return as a miscellaneous itemized deduction NOT subject to 2%.
- Life insurance death benefits paid as an annuities retain the exclusion ratio while the death benefit is being paid out.
- For example, Fred has a life insurance annuity that was projected to pay 200 monthly payments. He is about to receive is 2015 monthly payment. The payments after the 200th payment will be fully taxable to Fred. The exclusion ratio will apply until the value of the death benefit has been paid out.
- The beneficiary of an annuity from a life insurance settlement is not permitted to recover any basis left at death.
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Example of Taxation of Installment Option for Life Insurance Proceeds or Annuity Payment
- Peter, age 62 had paid $500,000 into an annuity over his lifetime. He has decided to begin receiving a lifetime annuity since he has now retired. He will receive $4,000 per month for the remainder of his life, which is expected to be 20 more years. How much of the installment payments are taxable and how much is excluded from taxable income?
- **Exclusion Ratio:**
- (4,000 x 12 x 20) = 960,000 total expected payments
- 500,000 ÷ 960,000 = 52% exclusion ratio
- 52% of each payment excluded from each payment
- $4,000 x .52 = $2,080 return of basis or income excluded from gross income.
- $4,000 x .48 = $1,920 taxable as ordinary income.
## Footnote
If the question was asking Peter received his first annuity payment on October 1, what amount of ordinary oncome is taxable for the year you would do $1,920 x 3.
If he lives more then 20 years that next payment he recieves will be 100% taxable.
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**EXAM QUESTION**
Just prior to the payout period the amount of money that is available in the contract as principal paid over the life of the annuity is determined at $200,000. The total annuity is currently valued at $360,000. The annuity payment is calculated at $24,000 per year. Our client wants us to retire at age 65. The IRS Tables Multiplier from the IRS Table for age 65 is 15 (remaining life expectancy). What amount of the annuitant's payment will be excluded from tax?
a) 1,111.11 until the principal amount has been exhausted.
b) 888.89 for the life of the annuitant.
c) 1,111.11 for the life of the annuitant.
d) 888.89 until the principal amount has been exhausted
a) 1,111.11 until the principal amount has been exhausted.
Divide the figure of paid in principal (200,000) by the figure of current cash in the annuity (360,000)
200,000 ÷ 360,000
=55.6%
The exclusion percentage is then applied to each monthly payment.
$2,000 x 55.6% = $1,111.11 (of each payment is tax excluded)
The exclusion applies only until the principal is returned...after that all payments are fully taxable.
133
**Taxation of Viatical Settlements and Accelerated Benefits**
- Life insurance companies may allow insured who are terminally ill or chonically ill to **receive an accelerated death benefit.**
- The insured sells or surrenders **life insurance contract** for a payment that is less than death benefit but
- greater than cash value.
- Proceeds are typically used to pay for the medical care of the insured.
- Terminally ill is a person who is expected to die within 24 months.
- **Proceeds are NOT subject to income taxes to the insured.**
- **Purchaser incurs tax liability** to extent the proceeds of the policy exceed the purchase price.
- FV > Purchase Price of Policy
- Chronically ill:
- Certified by a licensed healthcare provider as being unable to perform, without assistance, at least two Activities of Daily Living (ADL).
- **ADL's are:**
- (1) eating
- (2) toileting
- (3) transferring
- (4) bathing
- (5) dressing
- (6) continence
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**EXAM QUESTION OF Taxation of Viatical Settlements and Accelerated Benefits**
Walter is terminally ill and has a 20-year level term life insurance policy with a face value of $500,000. Walter has paid $15,000 in premiums over the last 10 years. Walter sells the term policy to a company that specializes in Viatical settlements. Walter sells the policy for $400,000. What is the tax impact to Walter and the Viatical settlement company at Walter's death?
a) Walter has taxable income of $385,000, company has taxbale income of $100,000.
b) Walter has taxable income of $400,000, company has taxable income of $100,000.
c) Walter has taxable income of $0, company has taxable income of $100,000.
d) Walter has taxable income of $0, company has taxable income of $500,000.
Answer: C
There is no taxable event to Walter and the Viatical settlement company has taxable income to the extent the policy proceeds exceed the amount paid for the policy.
Policy Proceeds > Amt paid for Policy
$500,000 - $400,000.
135
**Policy Taxation Summary Chart**
136
**Taxation of Annuities FIFO and LIFO!**
**For withdrawals prior to the start of the annuities:**
- Before 1982 annuities, a FIFO method was used for withdrawals such that withdrawals up to the owner's basis are not taxable but rather are treated as a return of capital.
- For annuity contracts purchased after 1982, the withdrawal rule was LIFO
- which means that withdraws are taxed to the extent of the earnings before capital (basis) is returned.
- **Annuities after 1982 and premature withdraws, the withdrawal receives LIFO tax treatment. Any annuity prior to 1982 receives FIFO tax treatment.**
- Exchanging one annuity for another does not create a taxable event (1035 exchange).
- Exchanging one annuity contract for a life insurance contract creates a taxable event.
137
Taxation of Annuities Exchanging Annuities
- In order to qualify for this favorable tax treatment, the existing policy must be exchanged directly for the new policy.
- The following chart outlines the exchange treatment for life insurance and annuities:
**Scenario 1**
- FROM: Life Insurance
- TO: Life Insurance
- IS: No Tax
**Scenario 2**
- FROM: Life Insurance
- TO: Annuity
- IS: No Tax
**Scenario 3**
- FROM: Annuity
- TO: Life Insurance
- IS: Taxable Event
**Scenario 4**
- FROM: Annuity
- TO: Annuity
- IS: No Tax
138
**EXAM QUESTION Taxation of Annuities Exchanging Annuities**
Mary Pat, ags 62, has an annuity worth $100,000. Thirty-five years ago she purchased the annuity with $15,000. Today, she has a need for additional life insurance on her husband, Brad Which of the following is the most appropriate strategy to provide Mary Pat with additional life insurance on her husband using her annuity?
A) Annuitize the annuity and purchase life insurance on Brad.
B) Surrender the annuity and purchase life insurance.
C) Exchange the annuity for a post-1987 annuity, then exchange it for a life insurance policy,
D) Exchange the annuity for a life insurance policy.
Answer: A
Annuities canot be exchanged for a life insurance policy on a tax-free basis. The best choice is to just annuitize the annuity and use the income to purchase additional life insurance.
139
**Health Insurance!**
Traditional medical expense insurance is divided into four major classes.
- Hospital expense
- Surgical expense
- Physician's expense
- Major Medical
140
Hospital Expense
- Covers expenses associated with hospitalization such as room and board charges, but it
- does not cover physician's fees.
141
Surgical Expense
- Covers surgeon fees whether in a hospital or outside of a hospital.
142
Physicians expense
- Covers all nonsurgical physician expenses.
143
Major Medical
- Covers hospitalization, physician and surgeon fees, physical therapy, and prescription drugs.
- For health plans issued after September 2010, the lifetime limits cap on new health policies has been eliminated.
- **Eye exams and dental care are excluded from coverage.**
- Usually, an 80/20 coinsurance clause where the insurer pays 80% of expenses above the deductible and the insured pays 20% of expenses above the deductible.
- Each family member must satisfy a deductible with typically **a maximum of 3 deductibles per family.**
- The coinsurance portion also applies to each family member.
- Specifics on these points will vary, but there are common requirements.
- The ACA put in place a max out of pocket for all new plans.
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Steps to Solve Max Out of Pocket
Also Called Stop Loss Limit
- Insured Pays deductible First
- Insured pays coinsurance percentage to max out of pocket.
- After paying coinsurance percentage of the maximum out of pocket amount, insurer pays 100%.
Add Deductible back to insured amount if less than max out of pocket.
145
**Health Insurance!**
- Group Hospitalization and Major Medical
- Patient Protection and Affordable Care Act (PPACA)
146
**Group Hospitalization and Major Medical**
- Insured only pays the **out of pocket.**
- All policies should now use the out-of-pocket approach per the Affordable Care Act.
147
**EXAM QUESTION Group Hospitalization and Major Medical**
John has a group medical policy with the following provisions: A $250 deductible, 80/20 coinsurance, and a maximum out-of-pocket limit of $1,000, after which the insurance company pays 100%. John is injured in a biking accident and incurs $6,250 in medical expenses. How much will John have to pay?
A) $1,000
B) $1,250
C) $1,450
D) $8,000
A
Loss: $6,250
Deductible: <$250>
Covered Loss: $6,000
Coinsurance: ($6,000 x .20) limit is $1,000 including deductible because it is a group plan with a maximum out-of-pocket limit.
148
**Sample Question**
Let's assume that covered expense charges were $5,250 for an insured with a $250 deductible and an 80/20 coinsurance with a $1,500 max out-of-pocket. The payments would be divided between the insurer and the insured how?
a) Insured pays $1,500; Insurer pays $3,750
b) Insured pays $4,000; Insurer pays $1,250
c) Insured pays $1,250; Insurer pays $4,000
d) Insured pays $2,750; Insurer pays $2,500
Insured Pays:
Deductible: $250
Coinsurance: $5,000 x.2 = $1,000
Total = $1,250
The Insurer Pays:
Deductible: $0
Coinsurance: $5,000 x.8 = $4,000
NOTE: The insured's share was under the MOOP, so it did not apply.
149
**Patient Protection and Affordable Care Act (PPACA)**
## Footnote
Has not been seen on the CFP Exam. Probbaly not gonna test the plan categories. Plan what we need to know is how much it covers.
- Requires most U.S. citizens and legal residents to have health insurance.
- **Those without coverage pay a tax penalty** (PENALTY NO LONGER EXISTS)
- of the greater of $695 per year up to a maximum of three times that amount ($2,085) per family OR
- 2.5% of household income above the filing threshold, whichever is greater.
- Note: The tax penalty for non-compliance will be zero for months beginning after December 31, 2018.
- Create Exchanges through which individuals and small businesses can purchase coverage, with premium and cost-sharing credits available to individuals/families with income between 133-400% of the federal poverty line.
- **EMPLOYER REQUIREMENTS:**
- Assesses employers with **50** or more full-time employees that do not offer coverage a fee of $4,320 per full-time employee, excluding the first 30 employees from the assessment.
- Requires employers with more than 200 employees to automatically enroll employees into health insurance plans offered by the employer.
- Employees may opt out of coverage.
- Exempts employers with up to 50 full-time employees from the above penalty.
- **Creates FOUR BENEFIT CATEGORIES of plans that must provide essential benefits plus a separate catastrophic plan to be offered through the Exchange, and in the individual and small group markets:**
- Bronze plan represents minimum allowable coverage and covers 60% of the benefit costs of the plan, with an out-of-pocket limit equal to the Health Savings Account (HSA) limit.
- Silver plan covers 70% of the benefit costs of the plan, with the HSA out-of-pocket limits;
- Gold plan covers 80% of the benefit costs of the plan, with the HSA out-of-pocket limits;
- Platinum plan covers 90% of the benefit costs of the plan, with the HSA out-of-pocket limits;
- Catastrophic plan available to those up to age 30 or to those who are exempt from the mandate to purchase coverage and provides catastrophic coverage only with the coverage level set at the HSA law levels except that prevention benefits and coverage for three primary care visits would be exempt from the deductible. This plan is only available in the individual market.
- **Requires guarantee issue and renewability** (with no pre-existing condition clauses) and
- allows rating variation based only on
- age,
- premium rating area,
- family composition, and
- tobacco use.
- Provides dependent coverage for children **up to age 26** for all individual and group policies.
- **Prohibits lifetime limits (2010) and annual limits** (2014) on the dollar value of coverage.
- Provide essential benefits per Health & Human Services Department.
- Existing employer plans that exceed minimum coverage are not affected.
## Footnote
They also got rid of the pre-existing condition.
150
**Health Maintenance Organizations (HMOs)!**
- Delivers comprehensive health care in return for a periodic payment (premium).
- Care is managed **by a primary care physician** (gatekeeper) who determines what care is received.
- The primary disadvantage is that there is **no coverage "outside" of the HMO.**
- Structural Models
- **Cheaper then PPO**.
151
Structural Models
Three structural models that HMOs follow:
- Staff Model
- Group Model
- Individual Practice Association
152
Staff Model
- The HMO is a **corporation**, and
- medical staff members are employees of the HMO.
153
Group Model
- This structure is sometimes known as the **network model** where
- the HMO contracts with groups of medical providers to care for insured plan subscribers.
154
Individual Practice Association
- This HMO model is made up of physicians who have their **own office locations** but
- contract out to the HMO on a fee-for-service basis.
155
**Prefered Provider Organizations (PPOs)!**
- **Network of health care providers** with whom an employer or insurance company contracts.
- The provider offers a discount on services.
- The insured receives a high rate of **reimbursement when using providers within the organization.**
- Insured **may seek care elsewhere, but will suffer a penalty** in the form of increased deductibles and coinsurance.
- A PPO preserves an employee's option to **choose a provider outside of the network.**
156
Comparing HMOs and PPOs
157
**Managed Care (Primary Care Physician - PCP)!**
- Insured accesses care via a primary care physician who provides services or refers to a specialist.
- Physicians need approval to perform certain procedures and it may reduce a patient's option for care if not approved.
- The consumer pays a small copayment or other deductibles.
- Healthcare providers agree to accept compensation provided under the plan.
158
**Health Savings Account!**
- **HSAs have replaced MSAs** (no new MSAs).
- HSAs provide employees and individuals seeking health care a **tax deduction for amounts contributed to their accounts** as well as the use of the money and earnings tax-free for qualifying medical expenses.
- The **employer and the employee, or both may make a contribution** to a HSA.
- To be eligible for an **HSA the individual must have medical insurance under a high-deductible health plan** (HDHP).
159
Rules that disqualify eligibility for HSA
- Individuals are not eligible if they are covered in any way by a non-HDHP.
- General purpose HRAs and health FSAs count as other health insurance coverage and can disqualify a taxpayer from using an HSA.
- HRAs are Health Reimbursement Accounts provided by an employer as a fringe benefit for disqualified medical expense requirements.
- Medicare participation disqualifies coverage.
- Individuals who may be claimed as a dependent on another's return are also disqualified.
**EXAMPLE:**
- Ed and Roberta have two children. Their eldest son Tom is a full-time college student who lives at home and works part-time.
- Although he is a dependent for tax purposes, Ed does not claim him as a dependent.
- Tim is ineligible for an HSA since he MAY be claimed. Regardless of whether he IS actually claimed.
160
HDHP Premiums
- HDHP Premiums are lower because the deductible is much higher than with traditional policies.
- $1,000 catch-up contribution for those **55 AND OLDER**
**EXAM TIP**
- Remember that the catch-up contribution for HSAs is for those **55 and older**, not the typical 50 and over we see for IRA catch-up contributions.
161
Are contributions deductible for HSA
**They are...**
- For the employee who contributes,
- For the employer who contributes, and
- For any eligible family members who receive contributions on their behalf.
- Janet makes a contribution to an HSA for her non-dependent parents, who are 52 and 59. The maximum that Janet may contribute is $8,750 = (7,750+1,000) since the 59-year-old is eligible for catch-up contributions. Also, Janet's parents are allowed the tax deduction on their return, not Janet.
162
HSA More
- There is no requirement for individuals with an HSA to use those funds for qualified medical expenses in the current year,
- allowing high-income individuals the ability to save on a tax-deferred basis for medical expenses in retirement.
- Distributions for qualified medical expenses (those expenses qualifying as medical expenses for purposes of the itemized deduction) are **tax-free.**
- Note that over-the-counter treatments were added to the approved list in 2019 but must contain medicine (pain relievers, cold treatments, sinus medication, etc.) or items for menstrual care.
- MSAs were only permitted for the self-employed and employees of small business (less than 50 employees).
163
Health Insurance premiums are not permitted as qualified medical expenses unless the premiums are for:
- Distributions are permitted as qualified medical expenses (those expenses qualifying as medical expenses for purposes of the itemized deduction) **are tax free:**
- Long-term care insurance premiums
- COBRA premiums
- Health care coverage while receiving unemployment compensation under federal or state law.
- Medicare and other health care coverage (not including Medigap policies) if you were 65 or older.
- Dental (including orthodontics) and vision care.
- Note: Cosmetic surgery costs are not qualified expenses.
- Distributions for **non-qualified medical expenses** are subject to income tax and a **20% tax penalty** if taken **before age 65.**
Distributions for non-qualified medical expenses are subject to income tax only at 65 or older.
**EXAM TIP:**
- Remember that the penalty for non-qualified medical expense distributions ends at 65, not 59.5 like the rules for qualified plans and IRAs.
- The distribution rules are the same as for HSAs discussed above.
164
**Health Insurance Provisions!**
Individual health insurance policies have provisions regarding the insurance company's right to continue or discontinue the policy.
- Noncancellable policies
- Guaranteed Renewable Policy
165
Noncancellable policies
- These policies are **continuous** and guarantee an insured the right to renew until a specific age or stated number of years.
- The insurer **cannot raise premiums** and cannot cancel the policy.
166
Guaranteed renewable policy
- The **right to renew is guaranteed** until a specific age or stated number of years.
- The insurance company **cannot cancel the policy,**
- but **they can raise the premiums as long as the premiums are raised for an entire group** or class of policyholders.
- All policies must now be **guaranteed renewable under provisions of the PPACA**.
167
**Group Health Insurance!**
- Employer-provided health insurance is **not taxable income to the employee.**
- The coordination of Benefits clause **prohibits the insured from collecting more than 100% of actual expenses** incurred.
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**Health Insurance Portability and Accountability Act (HIPPA)!**
- HIPPA was enacted to **protect worker's ability to obtain health insurance** when
- changing jobs,
- being laid off, or
- retiring.
- HIPPA allows individuals to obtain coverage without restrictions on preexisting conditions if switching from one group plan to another group plan.
- HIPPA does not apply if switching from a group to an individual or individual to an individual plan.
- There is a 12-month exclusion window (18 months for late enrollments) for new employees, which is reduced for each month of "creditable coverage" before enrolling.
- Late enrollment is defined as any enrollment other than the first period in which the individual is eligible to enroll.
- "Creditable coverage" is any health coverage held immediately prior to applying in the new plan and after any significant break (63 or more days in coverage).
- The PPACA no longer allows the imposition of pre-existing donations clauses.
**EXAM TIP:**
- Although the Affordable Care Act prevents policies from containing preexisting condition clauses for policies issued after September 2010, we are still advising students to be familiar with HIPPA rules in the event the topic appears on exams.
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Strategies to utilize in the event of medical coverage changes (Pre-ACA)
- Switch Jobs within 62 days
- Switch Jobs with an Unknown Time Frame
- Retire
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Switch Jobs within 62 days
Switch Jobs with an Unknown Time Frame
Retire
- Utilize HIPPA, coverage begins with no, or a limited, preexisting condition time-frame.
- Utilize COBRA to extend coverage and minimize the "break" period. Utilize HIPPA to obtain a new policy.
- Utilize Medicare if eligible or COBRA.
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**Consolidated Omnibus Budget Reconciliation Act (COBRA)!**
- COBRA is an extension of group health insurance with the same coverage.
- An **employer may charge 2% for administrative expenses.** (Total expense to the employee is 102% of actual insurance cost.)
- Employer Pays $900 Employee Pays $100
- COBRA: Employer does not pay anything you and you paid $1,000 + 2% = $1,020.
- The Premiums are 2%
- Applies to loss of coverage for the covered employee, employee's spouse, and/or dependent children.
- **To be eligible for COBRA, group coverage must terminate because:**
- Covered employee dies.
- Employee is voluntarily or involuntarily terminated.
- Hours are reduced from full-time to part-time.
- Covered employee separates from spouse.
- A dependent child is no longer eligible for coverage (age, married, left school).
- COBRA only applies to employers who offer a group health plan and have at least 20 employees. Therefore, an employer with **fewer than 20 employees is not required to offer COBRA.**
- Note: Both full-time and part-time employees count towards the 20, but **part-time employees count as a fraction of employees** based upon their hours worked. Most likely you will only be given only a court of full-time employees on the CFP Exam.
- The Fair Labor Standard Act (FLSA) does not define full-time employment or part-time employment. This is a matter generally to be determined by the employer.
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EXAMPLE of COBRA
- Ginny's Bait & Tackle has 15 full-time employees and 10 part-time employees. The requirement for full-time is 40 hours per week and part-time employees average 25 hours per week. Ginny's B&T must provide COBRA since they have more than 20 employees 15 full-time plus (10 employees x 25 hours) ÷ 40 (full-time hours) = 6.25 additional employees equivalent.
- Charlie has worked with his company for 32 years and has been a participant in the employer's group health plan for all those years. Charlie was laid off, along with all his coworkers, due to the employer's bankruptcy. Is Charlie eligible for COBRA continuation benefits?
- ANSWER: If there is no longer a health plan, there is no coverage available.
## Footnote
In the lecture they said 2 PT = 1 PT.
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COBRA continuation coverage may be terminated before the designated terms end in:
1. The employer terminates its health plan for all employees as a result of the company going out of business.
2. The employee beneficiary fails to make premium payments, or
3. If the employee becomes covered under any other plan providing medical care.
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MORE COBRA
- A qualified beneficiary for COBRA is generally any individual covered by a group health plan on the day before a qualifying event who is either an employee, the employee's spouse, or an employee's dependent child.
- The employer must have a group health plan and continue that group health plan in order for beneficiaries to receive COBRA.
- The employer must offer coverage for a specified period of time based on the following qualifying events:
- 18 months for a reduction in hours or normal termination.
- 36 months for death
- 36 months for divorce
- 36 months for Medicare eligibility.
- 36 months for loss of dependency status by children of employees.
- Up to **29 months if an employee meets Social Security definition of disabled**.
- An employee terminated due to "gross misconduct" is not eligible for COBRA.
- Employees have **60 days to make a COBRA decision.**
**Memorize the 18 months for a reductio in hours or normal termination (can be voluntary or involuntary termination) and that all others are 36 months. Except for SS durability. If the CFP board test any other event than a reduction in hours or normal termination it is 36.**
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**Long-Term Care Options!**
- Medicaid
- Medicare
- Continuing Care Retirement Communities
- Private Long-Term Care Policy
- Long-Term Care Insurance Partnership Program
- Long-Term Care - Tax Benefits
- Disability Income Insurance
- Definitions of Disability
- Benefit Period
- Elimination Period
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**Medicaid**
- Available to the **nation's poor**.
- Benefits can be paid by the government at either the state or federal levels or a combination of the two.
- Eligibility is determined based on a person's assets.
- ACA expanded Medicaid coverage.
- Individuals entering a **nursing home can apply for Medicaid** and are eligible for Medicaid assistance **once assets are spent down** (subject to state limit).
- There may be a penalty period based on the amount of assets gifted in the five years (60 months) prior to entering the nursing home.
- Any gifted assets (direct or to trusts) will be assessed in the formula.
- If the nursing home costs $5,000 a month, and $15,000 was gifted in the prior 5 years, the penalty period would be 3 months of no Medicaid coverage once assets were spent down.
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**Medicaid Example**
Margret is 87 years old and has been a widow for 2 years. Her daughter is unable to provide the level of care Margret needs. Margret enters a nursing home today. She currently has countable assets of $80,000. The nursing home costs $8,000 a month. Margret gifted $20,000 to her daughter just before her husband died and another $20,000 the year after he died.
Margret applies for Medicaid when she entered the nursing home. How long before Margret is eligible for Medicaid payment of the nursing home care?
15 months
Margret's current assets of $80,000 will cover 10 months of care at $8,000 a month (80,000 / 8,000 = 10 months). The look back of 60 months reveals $40,000 in gifts. This is calculated toward the penalty period of 5 months (40,000 / 8,000 = 5). After 15 months, Medicaid will begin covering Margret's nursing home.
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**Medicare**
- Medicare benefits are **available to those eligible for Social Security.**
- Benefits under Medicare are extremely restrictive.
- Medicare only pays
- if the **patient is capable of realizing an improvement** in his or her condition.
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**Continuing Care Retirement Communities**
A CCRC is a retirement community that offers several levels of health care on-site.
- Independent Living
- Assisted Living
- Memory Lane
- Skilled Nursing and Rehabilitation
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**Private Long-Term Care Policy**
**Provides coverage for nursing home stays** and other types of care not covered by health insurance.
**Seven Types of Coverage:**
1. Skilled Nursing
2. Intermediate Nursing
3. Custodial Care
4. Home Health Care
5. Assisted Living
6. Adult Day Care
7. Hospice Care
- **Eligibility for benefits under a private long-care policy:**
- Suffer from substantial cognitive impairment. Behavior threatens own/others health and safety.
- Chronically Ill - Unable to perform 2 of 6 ADLs for at least 90 days.
- **Activities of Daily Living include:**
1. Eating,
2. bathing,
3. dressing,
4. transferring from bed to chair,
5. using the toilet, and
6. continence.
**EXAM TIP:**
- Walking is NOT a current ADL.
**EXAM TIP:**
- BED To Chair
- Substantial cognitive impairment - behavior threatens own/other's health and safety.
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Seven Types of Coverage:
1. Skilled Nursing
2. Intermediate Nursing
3. Custodial Care
4. Home Health Care
5. Assisted Living
6. Adult Day Care
7. Hospice Care
1. Traditional nursing home, physician ordered.
2. Occasional nursing care, physician ordered.
3. Assistance with eating, dressing, bathing, etc.
4. In-home nursing or necessary assistance.
5. Apartment style living with healthcare services.
6. Daily assistance while a spouse or family member works.
7. For terminally ill, at home, hospital, or nursing facility.
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**Long-Term Care Insurance Partnership Program**
- Program establishes eligibility rules for a partnership **between Individual LTC Insurance and Medicaid**.
- Individuals use an LTC policy to pay the first portion of Long-Term Care and then qualify for Medicaid without the spend-down requirement.
- A partnership-qualified policy included an "asset disregard" for Medicaid to the extent of the total amount of benefits received under the long-term care policy.
- For example,
- if the long-term policy provides $200,000 of lifetime benefits, the individuals will be able to shelter $200,000 from the Medicaid spend-down requirement.
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**Long-Term Care - Tax Benefits**
- **Premiums are tax deductibles and limited based upon the age of the insured.**
- Benefits are tax-free as long as a policy is **"qualified."** A qualified policy has the following provisions:
- A person is expected to need care for at least 90 days.
- Unable to perform 2 or more activities of daily living.
- OR a person suffers substantial cognitive impairment.
- **Premiums are tax deductible and benefits are tax-free as long as policy is "qualified."**
- A long-term care policy
- does not contain a surrender value,
- is limited to qualified long-term care services,
- uses dividends to reduce future premiums or increase benefits,
- meets consumer protection laws and
- does not pay expenses covered under Medicare.
- **Age of insured: >70**
- Maximum Deduction (2023): **$5,960**
**NOTE:**
- Just know that a portion of LTC premiums are tax deductible **subject to medical deduction of 7.5% of AGI.**
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**Disability Income Insurance**
- Provides income to the insured in the event the insured is unable to work because of illness or injury.
- **Policy Issues:**
- Coverage (sickness and accident).
- Term (to retirement or no death).
- Elimination Period (0 to 180 days).
- Taxability of Benefits (depends on payor).
- Amount of benefits (60 to 70%).
- Definition of Disability (own occupation, etc.)
- Residual Benefit
- Probation Period
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**Definitions of Disability**
- Any Occupation
- Modified Any Occupation
- Own Occupation
- Split Definition
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Any Occupation
- Considered disabled if the insured cannot perform the duties of **"Any Occupation."**
- This definition provides for the least expensive premium.
- $
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Modified Any Occupation
- Considered disabled if unable to perform duties of gainful occupation they're reasonably fitted by
- education,
- experience,
- training, and
- prior economic status.
- $$
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Own Occupation
- Considered disabled if the insured cannot perform the duties of his "Own Occupation."
- **More expensive**, ideal for specialized, high-paying fields.
- Surgeons
- $$$
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Split Definition
- Begins with own occupation, and moves into a modified any occupation after
- a year or two under its own occupational definition.
- $$$
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**Benefit Period**
**Short Term:**
- Coverage is for two years or less.
**Long Term:**
- Coverage is until normal retirement age, death, or for a specific period of time.
## Footnote
Tie to retirement age for Disability Insurance.
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**Elimination Period**
- Amount of **time until benefits begin.**
- During the elimination period, typically the **premium is waived**.
- The elimination period **serves as a deductible.**
- Shorter the Period the More Expensive.
- **Exam Tip**
- Tie Elimination Period to their Emergency Fund.
- Do not want client to choose a 6 month elimination period with a 3 month emergency fund.
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**Waiver of Premium**
If disability is for a short period of time.
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**Taxation of Benefits**
- If EMPLOYEE pays the premium with AFTER TAX dollars.
- If EMPLOYER PAYS the premium.
- If EMPLOYEE pays a premium with PRE-TAX dollars (cafeteria plan).
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If EMPLOYEE pays the premium with AFTER TAX dollars.
If EMPLOYER PAYS the premium.
If EMPLOYEE pays a premium with PRE-TAX dollars (cafeteria plan).
**If EMPLOYEE pays the premium with AFTER TAX dollars.**
- Premiums are not deductible.
- Benefits ARE Tax-Free.
**If EMPLOYER PAYS the premium.**
- Premiums ARE deductible to the employer.
- Benefits to Employees ARE TAXED.
**If EMPLOYEE pays a premium with PRE-TAX dollars (cafeteria plan).**
- Benefits to employees ARE TAXED.
| Seeds and Harvest. Tax on the seed which is first example.
## Footnote
Benchmark 60-70% of income.
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**Disability Insurance Characteristic!**
- Cost of Living Rider
- Residual Benefits
- Integration with Social Security
- Probation Period
196
Cost of Living Rider
- Benefits received will adjust for inflation, which maintains the insured's purchasing power.
197
Residual Benefit
- If the insured goes back to work at less pay, then the policy will pay the difference between current income and income prior to disability.
198
Integrating with Social Security
- Any disability benefits received by Social Security will **reduce the amount of disability benefits** paid by the insurer.
199
Probation Period
- Is the time the insured must wait after the policy is issued,
- before the specified conditions are covered (typically 15-30 days after inception).
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EXAMPLE of Disability Insurance Characteristics
Brian was a neurosurgeon making $30,000 per month prior to becoming disabled. As a result of his disability, he was no longer able to perform surgery but was able to work in hospital administration making $8,000 per month, resulting in a reduction of income of 73.33%. His residual benefit clause calls for a $15,000 monthly benefit. Brian's disability insurance contract will pay 73.33% of $15,000 or $11,000. Thus, giving him an income of $19,000 (11,000 + 8,000) per month.
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**Health & Disability Insurance Policy Provisions!**
- Grace Period
- Reinstatement
- Guaranteed Renewable
- Noncancellable
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Grace Period
- Period **beyond the due date of the premium**.
- Coverage remains if the premium is paid during the grace period.
203
Reinstatement
- What needs to occur if policy lapses.
204
Guaranteed Renewable
- The **insurer is required to renew**, but
- **may increase premiums** if increased on the entire group.
- Renewal is up to the insured.
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Noncancellable
- **Insurers must renew** and
- **cannot raise premiums**.
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Summary Charts of Taxation of Insurance Products
