Life Insurance Flashcards
What are the 5 factors that influence risk of an individual dying?
1) age
2) gender
3) personal and family health history
4) smoking habits
5) job and income level
What 2 things is risk of death based on?
1) life expectancy
2) probability of death
In Canada, at birth, what is the life expectancy of males?
79.8 years
In Canada, at birth, what is the life expectancy of females?
83.9 years
What is a mortality table (life table)?
life expectancy and probability of death statistics compiled for each unique & defined group of people in a table
Describe the probability of death for:
a) before age 40?
b) after age 40?
a) before age 40 - low & slowly increases until age 40 (except the first few years of life)
b) after age 40 - increase more & more each year due to age-related problems
What are the 6 financial impacts of death?
1) loss of income
2) loss of caregiver
3) debt repayment
4) income taxes
5) estate creation
6) business impact
How can Death Benefit proceeds from life insurance be used to help?
1) loss of income
2) loss of caregiver
3) debt repayment
4) income taxes
5) estate creation
6) business impact
1) loss of income - minimize financial impact of death on the surviving family
2) loss of caregiver - provide the money to pay for a substitute caregiver
3) debt repayment - repay debts that might otherwise have to be taken from the value of the estate of deceased
4) income taxes - pay the tax liabilities owing on the estate
5) estate creation -
a) pay future education costs of deceased’s children
b) create a legacy (paying an inheritance)
c) give to charity
6) business impact - protect business assets by funding a partnership agreement
What are 4 ways to manage risk?
1) risk avoidance - avoid the situation or circumstance that exposes them to risk
2) risk reduction - when cannot avoid risk, strategy to lessen the risk being exposed to
3) risk retention - individual accepts some or all of the risk (eg. waiting periods or deductibles)
4) risk transfer - when some or all of the risk is transferred from one to another (eg. transfer financial risk from indiv to insurer in exchange of premium payments)
What are the 3 types of Term Insurance?
1) Single Life
2) Joint First-to-Die
3) Joint Last-to-Die
What is the purpose of Joint First-to-Die contract?
provides survivor with capital to use money in any way desired. some insurance companies may offer the survivor the opportunity to continue the same level of coverage on his/her own life under a new policy
What is the purpose of Joint Last-to-Die contract?
useful for estate planning including creating an inheritance for beneficiary and paying estate costs (income tax) - these policies are more commonly used with permanent insurance
What are 3 types of Term policies?
1) Level Term
2) Decreasing Term
3) Increasing Term
Is there tax on Death Benefit paid to beneficiary?
No. Death Benefit is paid tax-free
Why pick a Level Term policy?
- Death Benefit is same as initial face amount
- life insurance needs not expected to change over the term
- policy easy to understand
- cheapest form of life insurance
Why pick a Decreasing Term policy?
- Death Benefit becomes smaller over the life of the policy
- premiums on Decreasing Term are lower than Level Term
- usually offered on a group basis
- policyholder has an obligation (eg. mortgage) that will reduce over a period of time
Why pick an Increasing Term policy?
- Death Benefit grows larger over the length of the policy
- DB increase may be a set dollar amount or percentage of the face amount (total amount of increase may be limited to a maximum DB)
- policyholder expects an obligation to increase in the future (eg. debts or living expenses)
- pay lower premium cost for increasing term vs acquiring additional coverage in the future due to older age
- In Canada, increasing Term is increasingly difficult to find (same effect may be achieved by adding Rider). Increasing Term still offered in USA.
What are the payment options for premiums?
1) monthly
2) quarterly
3) semiannually
4) annually
What is the provincial premium tax on Term insurance?
Premiums are level over the term.
Provinces charge a premium tax on the premium (2-4%) included in the premium cost. Insurance company then pays the provincial government
When premiums are paid monthly, quarterly, or semiannually on Term policies? What is the modal factor used?
Modal factor table is determined by insurance company
Typically, monthly Term modal factor is 0.09
What is mortality cost?
mortality costs approximate the insurance company’s cost of paying out policy death benefits
Term life insurance can either be renewable or non-renewable. True or False?
True.
Non-renewable: expires at the end of the term.
Renewable: right to renew is guaranteed regardless of heath of the life insured
- right to renew is limited to certain age (eg. age 70)
- premiums are higher for renewable than non-renewable
- there may be doubts of future insurability (eg. family health history indicate likelihood of future problems)
Renewable policy guarantees the right to renew the policy at the end of term - does this also guarantee premium rates?
No. Right to renew is guaranteed but new premiums will reflect the age of the life insured at renewal (most policies provide a guaranteed schedule of renewal rates)
Re-entry term is a form of renewable policy. What conditions are reviewed to determine premiums?
Renewal is guaranteed but renewal premium is based on health:
1) if health is better, a lower premium is offered
2) if health deteriorates, the guaranteed renewal rates are higher than those for a renewable policy that doesn’t have re-entry provision
Initial premiums for renewable policy are HIGHER than renewable policy with a re-entry provision. True or False?
True. Life insured doesn’t have to provide evidence of insurability on guaranteed renewal policies there insurance company is taking the risk of continuing coverage to someone whose health may have deteriorated by the time policy is up for renewal
Why pick a convertible Term contract?
- security of knowing Term can be converted to permanent insurance (WL, Term-100, UL)
- can be assured of future death benefit
- can convert without evidence of insurability
- premiums for convertible Term are higher
What is a contestability period?
contestability period is 2 years following issue date of the policy - insurance company can void a policy if it discovers material error made in the application. Material error: an error that would have affected whether the policy would have been issued
** after 2 yrs, a policy can be voided by insurance company only if there was a fraud committed
Does contestability period apply on convertible policies?
No. permanent policy issued after conversion is considered an extension of the initial term policy
What is the suicide exclusion period?
2 yrs following issue date of the original policy. Suicide committed after 2 yr suicide exclusion period will be covered
How to determine original age and attained age of the life insured?
Original age: age of the life insured when policy was first issued
Attained age: age of the life insured on his last, nearest, or next birthday
What is a disadvantage of using Original Age conversion?
a lump sum payment must be made when policy is converted (retroactive conversion) to be in line with what his cost would have been had he chosen permanent policy in the first place. This can be a significant sum
Original age vs Attained age - which of the premiums will be higher after conversion?
Attained age… Original age conversions result in lower premiums for the permanent life insurance
What are the Advantages & Disadvantages of Term Life?
Advantages:
1) low initial costs - more affordable for those who cannot afford permanent insurance
2) premiums are guaranteed over the term
3) renewable and convertible provisions can be used to extend coverage
4) term of coverage can be customized to meet a specific need
Disadvantages:
1) premiums & coverage are not guaranteed beyond the term or renewal period
2) premiums increase as the life insured ages & can become prohibitive
3) coverage is usually not available past a certain age
4) policy is worthless at the end of the term
What 3 situations would be appropriate for Term Insurance?
1) Short-term risks - if there is a possibility that the risk may extend for a longer but not a permanent period of time, then should consider a renewal term policy
2) Decreasing risks - risks that diminish over time (eg. mortgage insurance)
3) Limited cash flow - policyholder may not have enough cash for permanent policy
What are the 3 types of Permanent Insurance?
1) Whole Life
2) Term-100
3) Universal Life
What are the key factors of Whole Life?
1) provides coverage for entire lifetime of the life insured
2) premiums remain level
3) has a set death benefit
4) builds up a cash surrender value (CSV) - can receive payment of CSV minus surrender charges if policy is surrendered prior to death
What are key factors of Term-100?
1) provides coverage for entire lifetime of the life insured
2) has set level premium lower than WL
3) has set death benefit
4) no cash surrender value
5) policy matures at age 100 (ie. premium payments stop at age 100, but life insurance coverage continues)
What are key factors of Universal Life?
1) provides coverage for lifetime of the life insured
2) has 2 parts to the policy - insurance & savings
3) has basic premium and option to deposit more called excess premium which goes into savings component
4) has minimum death benefit w/ option to increase DB
5) savings account offers policyholder different investment options
6) accumulated savings (&investments) are tax sheltered and form part of DB (tax-deferred if funds are withdrawn prior to death)
What is Whole Life insurance?
a form of permanent life insurance - typically guarantees premiums, death benefit, and minimum cash surrender values (CSV)
What is the formula for Mortality Costs?
annual mortality cost = face amt X prob of death
What admin expenses are included in WL policy premiums?
1) marketing expenses
2) salaries & commissions to agents
3) processing applications
4) paying for medical exams
5) paying income taxes
6) investigating claims
7) paying death benefits
What is the formula for Modal Factor?
monthly premium = annual premium X modal factor sample modal factors: semiannually = 0.51 to 0.53 quarterly = 0.26 to 0.30 monthly = 0.087 to 0.09
What are the 3 Premium Options available for payment in WL?
1) Ongoing premiums - fixed price on an ongoing basis
2) Single premium - paid at once in a lump sum (eg. paid-up policy)
3) Limited payment - premium payment limited to a set number of years or age
What are the 2 types of WL policies?
1) Guaranteed WL
2) Adjustable WL
What is a Guaranteed WL?
guarantees DB and a set premium
What is an Adjustable WL?
- DB and premiums are guaranteed for only a certain period of time
- at the end of the guarantee period, insurance company will recalculate mortality costs projections vs actual and adjust premiums or DB accordingly
- premiums are typically lower in adjustable WL
- Adjustable policies no longer in common use in Canada
What is the difference between Participating WL and Non-Participating WL?
Participating WL - offers policyholder the option of receiving a share of the insurance company’s surplus revenues in the form of a dividend
Non-Participating WL - policyholder doesn’t receive dividends, insurance company keeps surplus revenues as retained earnings
Are dividends guaranteed for Participating WL?
No. policyholders have the potential to share in revenue surpluses but not guaranteed - therefore premiums are higher than Non-Participating WL
What are the 6 dividend options for WL Par-Policy?
1) cash
2) premium reduction
3) accumulation
4) paid-up addition (PUA)
5) term insurance
6) impact on death benefits & cash values
What is Cash dividend option in WL?
- policyholder can choose to receive dividend in cash
What is Premium Reduction dividend option in WL?
- policyholder can choose to apply dividend directly again premium for following year
- also called Premium Offset
- in earlier years, dividend is less than premium. however in later years, dividend may be more than premium - excess can be paid out or allocated to other dividend options
What is Accumulation dividend option in WL?
- dividends will be deposited into a separate accumulation account called “Side Account” & earns interest
- accumulated dividend in side account is invested to provide additional growth
- growth in Side Account is taxable
- value that accumulates in Side Account can increase DB so long as it is not withdrawn first
- value of Side Account is paid to beneficiary along with DB when policyholder dies
What is Paid-Up Addition (PUA) dividend option in WL?
- policyholder can use dividend as a single premium to buy more WL
- each PUA is its own policy with own DB and CSV
- PUA cost is based on attained age
- PUA is also considered a Premium Offset
- PUA can be used to increase DB without evidence of insurability
What is Term Insurance dividend option in WL?
- policyholder can use dividend as a single premium to pay for 1-yr Term insurance
- Term insurance has own DB, which is paid out if death occurs during that year
- Term insurance cost is based on attained age
- Term insurance doesn’t require evidence of insurability
What is Impact of DB & CV dividend option in WL?
- PUA may increase both the CSV and the DB
- accumulation option may increase DB if accumulated dividend have not been withdrawn
- Term insurance may temporarily increase DB (for 1 yr only)
What is a dividend illustration?
dividend illustration is a chart or graph that an agent uses to help policyholders understand how participating policies work and to visualize the dividends & effect on DB and CSV
- should use at least 2 dividend scales to set overall expectations of low vs high outcomes
What are the 4 Non-Forfeiture Benefits of WL?
1) Cash surrender value (CSV)
2) Automatic premium loan (APL)
3) Reduced paid-up insurance (RPU)
4) Extended term insurance (ETI)
Why use Cash Surrender Value (CSV) non-forfeiture?
- CSV taken will be taxable
- use when the need for insurance coverage has changed
- use when ability to pay for insurance has changed
What are surrender charges?
surrender charges are used against policy’s cash value to discourage from cashing out before insurance company can recover expenses
- fee is deducted from CSV before it is paid out
- surrender charges decrease over time and are eventually eliminated
How do policy loans in WL work?
- up to 90% of the CSV is available to policyholder as a policy loan
- loan doesn’t have a specified repayment schedule
- interest is charged on loan and accumulates until loan is repaid
- loan doesn’t appear in credit reports
- when policy is surrendered, CSV minus loan minus unpaid interest
- when life insured dies, DB minus loan minus unpaid interest
Why use Automatic Premium Loans (APL) non-forfeiture?
- APL occurs automatically when premium goes unpaid or policyholder gives permission for the loan
- APL can be taken from CSV once or many times. interest is charged against each loan
- when policy loan limit is 90%-100% of CSV is reached, plus a 30 day grace period, the policy terminates & residual CSV if any, is paid to policyholder
Why use Reduced Paid-Up (RPU) Insurance non-forfeiture?
- an option for coverage without continuing to pay premiums
- use CSV as a single premium to pay for a new WL with smaller face amount
- amount of coverage is determined by CSV and attained age
- no need for evidence of insurability
Why use Extended Term Insurance (ETI) non-forfeiture?
- use CSV as a single premium to pay for new Term policy with same face amount as original WL
- duration of Term is determined by amount of CSV & Attained age
- no need for evidence of insurability
- results in same DB as well as temp insurance coverage
What is Limited Payment WL?
- WL coverage while limiting the premium payment period to a set number of years or specific age
- once premiums are no longer required, the policy is said to endow (to provide, give to)
What are the Advantages & Disadvantages of Whole Life?
Advantages:
1) premiums are guaranteed for life
2) coverage continues for life; regardless of age or health
3) par-policy may result in dividends. can receive in cash, accumulate (side account), paid-up addition (PUA), or 1-yr Term
4) WL builds up cash surrender value (CSV) over time that policyholder may receive if he cancels or surrenders the policy
5) in later years, WL premiums will likely be less than premiums for Term
6) WL may offer non-forfeiture benefits in addition to CSV: APL, RPU, and ETI
7) may obtain policy load against the CSV
8) lower volatility in the returns
Disadvantages:
1) high initial costs
2) policyholder has little or no choice over how the policy reserve is invested
3) par-policy dividends are not guaranteed
4) theory to buy Term & invest the difference may result in better financial outcome (provided the policyholder is disciplined to invest the difference)
5) the way policy reserves are invested/managed is not entirely transparent to the public
Term vs WL: compare Coverage differences
Term:
1) provides coverage for specified period or term
2) coverage is usually not available past a certain age (eg. 75 or 80)
3) used to meet a need of specific duration
WL:
1) provides coverage for life
2) coverage is available for life, regardless of age
3) term cannot be customized to a specific duration, but can be surrendered at any time
Term vs WL: compare Premium differences
Term:
1) premiums generally increase with the age of the life insured
2) premiums will be lower for younger age than for WL
3) premiums eventually become higher when life insured ages than on WL, and may become cost-prohibitive
WL:
1) premiums generally remain constant regardless of age
2) premiums are higher for younger age than for Term
3) premiums remain level; eventually will be lower than premiums for Term
Term vs WL: compare Renewability differences
Term:
1) depending on contract, policy may be non-renewable or need to provide evidence of insurability for renewal
2) some Term are convertible to WL without evidence of insurability
WL:
1) policy never requires renewal & will remain in force even if health declines
Term vs WL: compare Cash Surrender Value (CSV) differences
Term:
1) policy does not build up cash value
2) policy has no value upon expiry or termination
WL:
1) policy never expires & builds up cash surrender value (CSV) over time
2) can receive CSV if policyholder terminates or surrenders policy
Term vs WL: compare Investment differences
Term:
1) no dividends
2) policyholder cannot borrow from policy
WL:
1) par-policy may provide dividends, although not guaranteed
2) policyholder may take out a policy loan against CSV
Term vs WL: compare Benefits differences
Term:
1) no non-forfeiture benefits
2) death benefit amount increase requires evidence of insurability & payment of additional premiums
WL:
1) may provide non-forfeiture benefits, which increase in value the longer the policy is in force
2) DB can increase w/o evidence of insurability & paying additional premiums by using PUA option, or leaving dividends in accumulation account
When to use WL?
1) need for insurance is permanent (eg. purposes that arise @ end of life)
2) policyholder able to afford premiums
3) policyholder willing to pay premiums over entire payment period
4) policyholder wants insurance coverage to increase (eg. keep pace with inflation = par-policy)
5) policyholder doesn’t want investment aspect
What is taxed upon death?
1) investment assets
2) non-principal residences (eg. cottage)
3) business shares of private companies
What is Term-100 (T-100)?
- combines elements of Term and Permanent insurance (life long coverage)
- some policies matures & pay out DB @ age 100 or dies (whichever comes first)
- some policies only pay DB when life insured dies but premiums cease @ age 100
How are premiums for T-100 compared to Term & WL?
T-100 premiums are lower than WL and higher than Term
What is the grace period if premiums are missed on Term, WL, T-100?
Term and T-100: 30 days grace period
WL: can use APL to avoid premium payment lapse
What is LCOI?
Level Cost of Insurance
- apply to T-100
When to use T-100?
1) policyholder requires a fixed amount of coverage for a need that is not expected to increase prior to death
2) policyholder is certain he will never surrender the policy
3) policyholder has no need for investment opportunities provided by Universal Life (UL)
What is Universal Life (UL)?
1) UL combines life insurance with tax-advantaged investing
2) highly flexible type of policy
3) more complicated due to its insurance/investing nature
4) unbundled factors that determine the premium (mortality costs, administrative costs, and investment income)
5) Cash Value in UL = value of the investment account
What is another name of premiums used in contracts & sales literature for UL policies?
Deposits
(“deposits” and not “premiums” are referred due to their role as both an insurance & investment option)
- however, will use “premiums” for consistency
What is the provincial tax rate for premiums on UL?
2%-4%
What are the typical administrative expenses of insurance companies?
1) selling costs (marketing, agent commissions)
2) underwriting & issuing policies
3) costs associated with investigating & paying claims
4) income taxes
Admin costs are higher for UL, Term, WL, or T-100?
UL admin costs are higher than the others due to the complexity of the policy
What factors are flexible (changeable) in a UL policy?
1) timing and amount of premiums
2) face amount (face amount & DB amounts paid out can be different)
3) life or lives insured
What does the minimum premium amount pay for in a UL?
- to keep the policy in force until age 100:
1) mortality costs
2) admin costs
3) premium tax
Which policy has a premium minimum requirement & maximum limit?
Universal Life
UL flexibility permits lump sum deposits and higher regular deposits to be made as desired. True or False?
True
When can insufficient account value result from in a UL?
1) minimum funding
2) withdrawals from policy
3) few or no deposits to account
4) low or negative investment returns
What is the formula for UL Modal Factor?
1 divide number of pmts per year (eg. 1/12 = 0.0833)
What is the UL Modal Factor for monthly, semiannually, and annually?
1) monthly = 1/12 = 0.0833
2) semiannually = 1/2 = 0.50
3) annually = 1/1 = annual premium
UL: Increased face amounts lead to increased mortality charges. True or False?
True.
changes to the face amount impact the cash value in the policy a mortality costs are directly linked to the face amount
The ability to substitute one life insured for another is unique to UL. True or False?
True.
- substitute person must provide evidence of insurability
What are the 4 components that affect the mortality costing method in a UL?
1) net amount at risk (NAAR)
2) mortality cost based on yearly renewable term (YRT)
3) mortality cost based on level cost of insurance (LCOI)
4) mortality deduction is guaranteed or adjustable
What is the insurance company’s risk in any policy?
risk is the amount that must be paid as the death benefit
What is the formula for the net amount at risk (NAAR) in UL?
NAAR = death benefit - investment account value
What are 2 ways policyholder can choose to apply risk of death to the NAAR on UL?
1) YRT (yearly renewable term) - one-year term insurance that renews at the end of the year for UL
2) LCOI (level cost of insurance) - remains constant & spread evenly over the duration of the policy
What is the formula for Mortality Cost?
Mortality Cost = NAAR X COI / 1000
COI (cost of insurance) under YRT is lower in earlier years than LCOI. True or False?
True
When to use YRT vs LCOI for UL?
YRT - if policyholder qualifies for low term rates & wants more of deposits to be invested in early years of policy
LCOI - mortality cost is lower in later years than YRT which will help preserve cash value (lower investment value)
Which is correct?
A) can switch from YRT to LCOI
B) can switch from LCOI to YRT
A
What are the 4 death benefit options for UL?
1) Level Death Benefit
2) Level Death Benefit plus Account Value
3) Level Death Benefit plus cumulative premiums
4) Indexed Death Benefit
What are 2 forms of Level Death Benefit offered to UL?
1) DB equal to face amount
2) DB equal to account value when account is worth more than face amount
- investment account grows as NAAR decreases - this option is the least expensive
When is it suitable to choose a Level DB plus Account Value for UL?
- if policyholder can deposit large premiums in excess of minimum premium required
- NAAR is level over duration of policy while DB increases
- mortality deductions will be greater & investment account will grow at a slower pace than Level DB
When is it suitable to choose a Level DB plus Cumulative Premiums for UL?
- typically most expense option
NAAR = face amount + cumulative premiums - account value - this option reduces NAAR quickly, allows investment account to grow at faster pace
- most suitable for policyholders who plan on maximizing premiums
- insures premiums are not forfeited by policyholder
*if investment account exceeds face amt plus cumulative premiums, insurance company keeps excess amount
When is it suitable to choose an Indexed Death Benefit for UL?
- face amount increases each year by inflation rate
- Canada’s inflation rate is approx 2%
- policies index inflation rate to either:
A) Consumer Price Index (CPI)
B) policyholders choice of indexation rate (1% to 8%) - if account value is greater than indexed DB, insurance company keeps excess
- NAAR & mortality deductions increase over time
- this option is suitable for policyholders who desire to protect an end-of-life risk that is expected to increase over time
What are the 4 features that make UL policy unique from other life insurance?
1) net premiums
2) tax deferral
3) investment choices
4) impact of return on policy viability
When can a child be covered under Family Coverage Rider & Child Coverage Rider?
1) at age 15 days after birth
2) at adoption
What is the formula for misstatement of age adjustment?
premium charged/correct premium = correct rate X face amount = adjusted amt of insurance
What are the 4 steps of Capital Retention (capital needs approach)?
1) Assets - Final Expenses = Cash needs
2) Continuing income - Continuing expenses = Income needs
3) Income needs/Interest rate = Capitalized value
4) Capitalized value +/- Cash needs* = Insurance needs
* ADD cash needs if a negative sum; SUBTRACT cash needs if a positive sum
(eg. Assets=$5k; Final expenses=$10k; Continuing income=$40k; Continuing expenses=$50k; interest rate=4%
i) $5k-$10k= -$5k Cash needs
ii) $40k-$50k= $10k Income needs
iii) $10k/4%=$250k Capitalized value
iv) $250k+$5k=$255k Insurance needs
What is the formula for Impact of Inflation?
Inflation adjusted rate of return = (Rate of return - Inflation)/(1 + inflation)
eg. investment return=5%; inflation=2%
Inflation adjusted RoR=(5%-2%)/(1.02) = 2.94%
What is the formula for Impact of Tax?
After-tax rate of return = Rate of return X (1 - Tax rate)
eg. investment return=5%; avg Tax rat=25%
After-tax RoR = 5% X (1 - 25%) = 3.75%
What is the formula for Impact of Inflation & Tax?
Inflation adjusted after-tax rate of return = (Rate of return X (1 - Tax rate) - inflation) / (1 + inflation)
eg. investment return=5%; avg tax rate=25%; inflation=2%
Inflation adjusted after-tax RoR = (5% X (1 - 25%) - 2%) / (1 + 2%) = 1.71%
What is the formula for ACB (Adjusted Cost Basis)?
1) Before Dec 2/82
2) On or after Dec 2/82
1) Before Dec 2/82
Premiums - dividends = ACB
2) On or after Dec 2/82
Premiums - NCPI - dividends = ACB
*NCPI (Net Cost of Pure Insurance)
What is the formula for taxation of CSV (Cash Surrender Value)?
1) Before Dec 2/82
2) On or after Dec 2/82
1) Before Dec 2/82
CSV - (premiums - dividends) = taxable gain
2) On or after Dec 2/82
CSV - (premiums - NCPI - dividends) = taxable gain
What is the maximum amount allowed for policy loan?
90% of CSV
What is the formula for tax on policy loan?
loan - ACB = taxable portion of loan
What is the formula for Present Value?
Present Value (PV) = Future value (FV) / (1 + interest rate [i])^n
eg. FV=$50k; interest rate=3.1%; n=3 yrs
PV = $50k / (1 + 0.031)^3
PV = $50k / (1.031 x 1.031 x 1.031)
PV = ~$45,620
What is the formula for Future Value?
Future value (FV) = Present Value (PV) X (1 + interest rate [i])^n
eg. PV=$50k; interest rate=3.1%; n=3 yrs
FV = $50k X (1 + 0.031)^3
FV = $50k X (1.031 x 1.031 x 1.031)
FV = ~$54,800
What is the formula for tax on investment interest income?
Interest income X MTR = tax on interest income
eg. earned interest=$1000; MTR 26%
$1000 X 26% = $260 tax
What is the formula for Capital Gains Tax?
market value of capital property - cost of capital property = capital gain x 50% = taxable gain portion X MTR = Capital Gains Tax
eg. sell price=$6500; cost=$500; MTR=26%
$6500 - $500 = $6000 x 50% = $3000 X 26% = $780 Capital Gains Tax
What is the formula for Capital Drawdown Method?
(monthly expense x 12) x num of yrs for coverage
What is LCGE?
Lifetime Capital Gains Exemption
What is a consideration when replacing policy that was issued before Dec 2/82?
Policies issued prior to Dec 2/82 will have extra tax advantages that are not available on new policies
What family dynamics are important for assessing the client’s situation?
1) minor children & their needs
2) lifestyle risks
3) occupation factors eg. current income
4) financial situation eg. current liabilities, funeral expenses
Which is the best option if policyholder needs money but doesn’t want to be obligated to make repayments and minimize income tax impact?
1) surrender policy
2) withdraw from accumulating fund
3) take out policy loan
4) take out bank loan
3) take out policy loan
- bank loan would result in regular repayment of at least interest cost
- withdrawal policy gain is higher than policy loan
[section 7.5]
What are important factors to check on when a client changes employment?
1) income replacement need eg. same salary, then no replacement need
2) group insurance coverage adequate?
What are capital gains on assets when one spouse dies before the other?
None. Transfer of assets between spouses occur outside tax implications
Why would client not receive a CSV amount if he decides to surrender the policy within 3 years for non participating WL?
- surrender charges are levied against cash value to discourage from cashing in policy before insurance company can recover admin expenses
- a fee is charged to surrender the policy, deducted from CSV before it’s paid out
- surrender charges decrease over time & are eventually eliminated
- for WL, illustration of the guaranteed CSV will show $0 for the first 3-10 years before beginning to increase gradually
What would be paid out when a client cancels a WL policy?
CSV + prorated portion of premium refunded
What are 4 important things about an applicant that the insurance company pays attention to?
1) ability to pay premiums
2) named insurable interest
3) justification for the amount of coverage
4) history of insurance applications
What 4 things does the application request details about to assure applicant can afford premiums?
1) occupation
2) employer
3) income from all sources
4) net worth
What are the 6 types of lifestyle questions on insurance applications?
1) hobbies, interests, sports participation
2) travel (past & future plans)
3) smoking habits
4) alcohol & drug use
5) driving history
6) criminal charges & convictions
What are 2 possible outcomes if discovered that applicant lied about smoking habits?
Insurance company may:
1) void the policy & refund premiums paid
2) adjust premiums or DB to reflect what is accurate give the smoking habit
What are the 4 requirements to meet for TIA (Temporary Insurance Agreement?
1) completion of application
2) minimum of one month’s premium
3) a negative (“no”) answer to a short list of health questions on TIA application
4) life insured within approved age range (ie. age 15 days to 70)
Until what age of minor children will be covered on policies as a dependent?
age 18 or if enrolled in FT post secondary, age 22 or 23
What is a buy-sell agreement?
- a buy-sell agreement specifies that either the corporation or other shareholders/partners to buy a deceased owner’s interest in a company
1) owner may not leave the interest to an heir when buy-sell agreement exists
2) share redemption plan is used if the corporation will buy the shares
3) a cross-purchase agreement is used if another shareholder/partner will buy the shares
What are 4 main common investment assets?
1) corporate shares
2) bonds
3) rental real estate
4) funds; segregated, mutual, exchange-traded
*may be held in registered (RRSP) or non-registered accounts
Is there tax liability on registered accounts that roll over to spouse?
No
Is there tax liability on non-registered accounts that roll over to spouse?
No, if joint ownership on account - may roll over to spouse with no tax liability
What are the 3 main tax liabilities that can arise upon death?
1) income earned in year of death
2) capital gains on property inherited by someone other than spouse
3) probate tax on property passed on through the will (except AB & QC)
Under a cross-purchase agreement, who would be the owner and beneficiary?
each business owner buys insurance policy on the other owner(s)
beneficiary = policyholder of each policy
In a Key Employee insurance that has a split-dollar arrangement, how would the coverage be divided?
- business would own the Face Amount portion, therefor pay premiums similar to Term insurance
- employee would own the Cash Value portion, therefore pay balance of premiums
What are the 4 limitations of group plans?
1) limited amount of coverage
2) lack of control for group members
3) policyholder (company) might discontinue the plan
4) premiums upon conversion under personal policy are not guaranteed
What is the one-time lump sum DB amount for deceased on CPP (Canada Pension Plan)?
$2,500
What is the max monthly amount of survivor’s pension benefit?
A) under age 65
B) age 65+
C) age 65+ with own CPP
A) under age 65 = $614.62 (2018 amount)
B) age 65+ = $680.50 (2018 amount)
C) age 65+ combine with own CPP = $1,134.17 (2018 amount)
*person’s estate/family must apply for these benefits; they are not paid automatically
How is the QPP different from CPP benefit?
Same as CPP except:
1) DB is paid for actual funeral expenses (max. $2,500)
2) surviving spouse younger than age 45 w/ dependent children receive a different sum as survivor’s pension
What are 5 types of lifestyle choices that affect probability of death?
1) smoking
2) substance abuse
3) bad driving habits
4) frequent travel (especially to certain countries)
5) hazardous avocations
What is a CDA (Capital Dividend Account?
*only available to corporations when a DB is paid
- a notional account (virtual)
- non-taxable portion of capital gains
- life insurance death benefit (company owns, which will pay estate in exchange for shares)
Eg. XYZ Inc owns and is beneficiary of $1m
ACB = $300k
gains that flow into CDA account = $1m - $300k = $700k
$700k can then be paid to shareholder tax-free
What is the taxation on Investment Income for Non-Registered Accounts (after tax dollars)?
Income Type —-> Taxation in Non-Registered Accounts
1) Interest ———> 100% inclusion. taxed at MTR
2) Dividend ——> preferential tax treatment via dividend tax credit
3) Capital Gains -> 50% is taxable and @ MTR
What is the taxation on Investment Income for Registered Accounts (pre-tax dollars)?
Type of Tax Benefit —————–> Examples of accounts
1) Tax deferral on principal & income earned in the account —————————> RRSP, RRIF, LIF, LRIF, RPP
2) Tax deferral on income only –> RESP, RDSP
3) No tax on income —————–> TFSA
Capital gains get a preferential tax treatment in that you need to include only 50% of the gain in your total income.
In Capital Loss, what 4 factors apply?
Capital Loss:
1) adjust against capital gains in the same year
2) go back 3 calendar years
3) carry forward losses indefinitely
4) at death, capital losses applied against all income sources
Cottage FMV=$400k ACB=$100k
When owner dies and want to pass cottage to son, what is the ACB value the son will absorb?
Son will absorb FMV $400k of the cottage as his ACB value
- deceased will need to treat cottage as disposition when passing to family member, therefore pay MTR on capital gain
- no children roll-over
Cottage FMV=$400k ACB=$100k
When owner dies and want to pass cottage to spouse, what is the ACB value the spouse will absorb?
there will be spousal roll-over.
spouse will absorb same ACB of $100k
What are 5 areas for Tax Exemptions in Canada?
1) capital gains on principal residence
2) LCGE (Lifetime Capitals Gains Exemption) for qualified small business or farm or fishing property
3) Life insurance DB
4) TFSA
5) windfall gains (eg. lottery winnings, casino winnings, etc)
What 3 things an Estate is subject to?
1) Probate (proof of last will, taxed @ 1.5% of estate value)
2) Capital Gains Tax
3) Creditors - payback loans
After tax and creditors, estate will be distributed based what 2 ways?
1) Testate - with a will (one you make yourself)
2) Intestate - without a will (province makes for you)
If you name the beneficiary as your estate, what proceeds will be subject to taxation & creditors?
Proceeds from:
1) Life insurance
2) RRSP, RRIF, RRP
3) TFSA
What are 3 ways to bypass the Estate for assets?
1) property held joint-tenancy with right of survivorship
2) spousal rollover
3) name a beneficiary (not estate) will bypass Estate & Creditors - life insurance, RRSP, RRIF, RPP, TFSA
What is the modal premiums for:
A) WL/T100/Term
B) UL
Monthly premium = annual premium X modal factor
A) monthly modal premium (annual premium X 0.09)
B) no modal premium (annual premium/12)
When there is a partial surrender on a policy, what do you need to prorate to calculate policy gain?
prorate ACB
Prorated ACB = (Amt withdrawn/cash value) X ACB
Policy gain = withdrawal - prorated ACB
What is the formula to determine amount to withdraw from policy in order to end up with after-tax amount to pay for xxxxxx?
(x - (x/CV X
What is Testamentary trust?
a trust that is created on the day a person dies.
prior to 2016: testamentary trusts were taxed at federal rate of individual
2016+: limited to 36 months for estates, after which will be at top marginal rate
what is Inter Vivo Trust?
created during an individual’s lifetime, taxed at highest MTR 33%
What is a REIT (Real Estate Income Trusts)?
real estate property for the benefit of unit holders
