Taxes, Retirement and other insurance concepts Flashcards
Group Insurance
Group insurance is written on a group of people who have something in common other than the need to obtain insurance (a homogenous group). Most group life insurance is the term. Underwriting is done on the group as a whole rather than on each individual. The average ages, gender, and experience rating of the group are used in calculating the premium. All employees are eligible. No insurability is required. Group members may join in the 30-day open enrollment period without providing evidence of insurability. After the 30 day period, evidence of insurability may be required. The contract is between the insurance company and the employer. The employer is the policy owner and maintains the master policy while the employees receive certificates of coverage.
Contributory Group
Employee contributes to the premiums. 75% of the group must join (avoids adverse selection).
Non-Contributory Group
Employer pays 100% of the premium. 100% of employees must join. Easier to install and administer.
Washington Statutes and Regulations Pertaining to Group Insurance
Employee groups need only have 2 or more persons; 25 persons is the minimum for unions, credit unions, and public employee groups.
If 75% of the group desires dependent coverage, the insurer and employer must make it available.
The maximum amount of life insurance available for family members (of covered employee) including the spouse, shall not be in excess of the amount on the life of the insured employee.
Assignable: Group insurance may be assigned to a spouse, child, parent, or trust only. All rights of ownership may be assigned, e.g., conversion, premium payment, and beneficiary selection. Group life may not be assigned to a financial organization.
Conversion rights: An employee or dependent, who becomes ineligible for the group coverage after being covered for 3 months or longer, has 31 days to convert group coverage to an individual plan offered by the insurer. Employees fired for misconduct are not eligible for conversion. No evidence of insurability is required when converting. The premium is based on attained age. During the 31 day conversion period, the insured is covered by the group policy.
Third Policy Ownership
Third-party ownership is when the policy owner is not the insured, group insurance, or an employer owns a policy on a key employee (insurable interest must be present at the time of application ONLY). The owner of the policy retains all rights of ownership. If the third party insured is an adult, both the insured’s and owner’s written consent is required. third party ownership is commonly used in business insurance.
Human Life Value Approach
This approach in determining how much life insurance a person need analyzes the potential earnings lost when the insured dies. It bases the amount of insurance needed on the current value of the insured’s annual income available to the family up to retirement by looking at the potential earned income minus income taxes and expenses.
Human Life Value
The human life value is the value to others that life has in monetary terms based on the amount it would take to replace the financial support lost when a person dies. This is calculated in the following steps:
Estimate the person’s income potential to retirement.
Subtract the living expenses to determine how much of the income would be used to support dependents.
Discount this figure with a reasonable interest rate to arrive at the current dollar value of the lost income. The goal is to determine the dollar amount which, currently invested at a reasonable interest rate, would produce the lost income.
The dollar value of lost income is the amount of life insurance needed.
Personal Insurance Needs
Takes into account final expenses, such as burial, illness, existing debt, etc., as well as income needs, educational needs, child care (if needed), housing costs, number of survivors (dependents), or money necessary to pay to the estate of the deceased to satisfy estate tax liabilities.
Before a producer makes any recommendation for the purchase or exchange of a life insurance policy or annuity, the insurance producer, or an insurer (when no producer is involved), shall make reasonable efforts to obtain information concerning the consumer’s need for the product being offered, benefit to the consumer or consumer’s family members, financial status; tax status; investment objectives; and other information used or considered to be reasonable in regard to the purchase.
Consumer’s also need to be aware of provisions, such as suicide exclusion, incontestability period, and possible surrender charges
Survivor Protection
The death benefit in a life insurance policy provides funds needed to protect survivors when the insured dies. It provides funds for last illness and funeral expenses, funds to pay off debts as well as funds for survivor income, including money needed for food, clothing, utilities, home and auto maintenance, property taxes, insurance, medical and dental bills, children’s education, etc.
Liquidity
Liquidity refers to financial holdings that can be converted to cash in a timely manner. A life insurance policy with cash value has liquidity. The owner can use the money in the cash value as collateral for a loan at any time or he can withdraw the money. The cash value is held in reserve by the insurer, which is in effect a savings account the policy owner can borrow against or withdraw. The policy owner can also surrender the policy and take the cash value.
Business Insurance Needs - Key Person
A key employee is usually the backbone of any business. The Key Employee may in many cases be the business owner. Premature death of this person can be very costly to the employer of the business, or the business itself. Proper life insurance can offset these costs thereby allowing the business to continue.
Normally, the employer is the owner and the beneficiary of the policy. The key employee is the applicant.
Business Insurance Needs - Buy and Sell (agreement)
A buy and sell agreement is a contract that allows surviving partners of a deceased partner to purchase his or her interest in the company from the deceased partner’s estate. The agreement is funded with the proceeds of a life insurance policy. The policy may also be called partnership life. The two types of Buy and Sell plans are:
Cross-Purchase Plan: Each of the partners purchases a policy on the other partners (e.g., with 4 partners there would be 12 policies).
Entity Purchase Plan: The company buys the policies on each partner or major stockholder.
Executive Bonus Plans (Split Dollar)
Executive bonus plans are used by employers who want to offer a bonus to some valued employees, not to all employees. With this plan, an employee will purchase a permanent life insurance policy insuring his own life. The employer and the employee agree that the employer will either pay the employee a cash bonus to cover the premium cost or pay the premium directly to the insurer. The employer can deduct the bonus or the premium as a business expense.
The plan does not fall into IRS requirements under the Employee Retirement Income Security Act (ERISA) for non-discrimination since it is only for certain employees and does not qualify as a tax-qualified plan. Therefore, the amount paid by the employer is taxable as income to the employee.
Modified Endowment Contract (MEC)
A MEC is any life insurance contract that fails the seven-pay test.
The seven-pay test compares policy premiums to IRS(Internal Revenue Service) allowable premiums in the first 7 years of a policy. The net level premium established by the IRS is based on the insured’s age, the type of policy, and the amount of insurance. If the sum of the policy premiums exceeds the sum of the net level premiums (specified by the IRS) at any time in the first 7 years, the policy fails the 7-pay test.
Taxation penalties are basically the same as for deferred annuities, which would include a 10% penalty for early withdrawal of the deferred interest in the C.V.
Taxation of Life Insurance
Interest accrued on death benefits (during a “settlement option”) is taxable.
Interest accrued in the cash value (C.V.) is tax-deferred. If the C.V. is withdrawn, the deferred interest is taxed as ordinary income. A policy with a C.V. can be exchanged for another C.V. policy without incurring a tax liability if IRS 1035 exchange rules are followed
