THE TOOLS AND TECHNIQUES OF LIFE
INSURANCE PLANNING
(4th Edition)
Outline
CHAPTER 1 INTRODUCTION TO LIFE INSURANCE
A. Principal Uses of Life Insurance
B. Advantages
C. Disadvantages
D. Legal Aspects of Life Insurance
E. Tax Aspects of Life Insurance
F. Economic Aspects of Life Insurance
1. Life Insurance As Investment
2. Simplified Life Insurance Financial Mathematics
3. Elements of Life Insurance Premium Pricing and Cash Value Calculations
a. Risk Shifting and Risk Sharing
b. Premiums and Costs
c. Interest Rates
d. Mortality and Morbidity and the Law of Large Numbers
e. Adverse Selection and Moral Hazards
f. Underwriting Process
g. Expenses and Risk Loadings
4. Participating and Nonparticipating Policies
G. Summary Comparison of Policies
H. Where Can I Find Out More About It?
CHAPTER 2 HOW TO ESTIMATE THE INSURANCE NEED
A. Introduction
B. Income Replacement and Family Needs Analysis
1. Rules of Thumb
a. Multiples-of-Salary Method
2. The Income Replacement Approach
a. Human Life Value
b. Basic Assumptions
c. Family Support Ratio
d. Other Adjustments
e. Adjustment for Social Security Survivor Benefits
f. Converting Social Security Survivor Benefits to Present Values
g. Income Replacement Approach – Step by Step
h. Income Replacement as a Multiple of Gross Pay
3. Needs Analysis
a. Insurance Needs Analysis Work Sheet
b. Insurance Needs Analysis Case Study
4. Static Versus Dynamic Analysis
C. Business Insurance Needs Analysis
1. Key Employee Insurance
a. Critique of Ad Hoc Rules of Thumb and Common Key Employee Valuation Approaches
b. Basic Principles of Key Employee Valuation
c. Key Employee Valuation Method
D. Estate Preservation and Liquidity Needs Analysis
CHAPTER 3 HOW TO DETERMINE THE RIGHT COMPANY
A. Life Insurance Company Due Care
1. Company Rating Services
a. A.M. Best
b. Moody's
c. Fitch Ratings
d. Standard & Poor's
e. Weiss Research
2. Life Insurance Company Due Care Checklist
a. Company Size and Age
b. Company Financial Information
c. Trends
B. Mutual Companies versus Stock Companies
C. Reinsurance
D. Federal and State Laws and Regulation
E. Underwriting
F. Company Service and Fairness to Policyholders
G. Selected References and Sources
H. Questions and Answers
CHAPTER 4 HOW TO DETERMINE THE RIGHT POLICY
A. How to Select the Type of Insurance Product or Product Mix Appropriate for the Client
1. Preferences, Prejudices, and Priorities
2. Amount of Insurance Needed
3. Cash Flow Considerations
4. Duration Of Need Considerations
B. How to Decipher Policy Illustrations or Ledger Statements
1. Surrender Charges
2. Cash Value Projections
3. Policy Loans
4. Dividends
C. How to Compare Policies
1. Traditional Net Cost Method
2. Interest-Adjusted Cost Methods
a. Interest-Adjusted Net Surrender Cost Index
b. Interest-Adjusted Net Payment Cost Index
3. The Equal Outlay Method
4. Cash Accumulation Method
5. Linton Yield Method
6. Belth Method
a. Belth Yearly Rate of Return Method
b. Belth Yearly Price of Protection Method
7. Baldwin Method
8. Policy Comparison Measures Summary
D. Policy Replacement
E. Where to Find Policy Rating Information
CHAPTER 5 LEGAL ASPECTS OF LIFE INSURANCE
A. Introduction
B. Parties to the Contract
C. Requirement of Insurable Interest
D. Legal Form and Contents of the Contract
E. One-Month Grace Period for Premium Payments
F. Incontestable Clause
G. Suicide Clause
H. Misstatement of Age Adjustment Clause
I. Dividend Clause
J. Nonforfeiture Provisions
K. Policy Lapse and Reinstatement Clause
L. Naming and Changing the Beneficiary
M. Modes of Settlement
N. Policy Loans
O. Automatic Premium Loan (APL) Provision
P. Assignments of a Life Insurance Policy
Q. Waiver
R. Estoppel
CHAPTER 6 SPECIAL POLICY PROVISIONS AND RIDERS
A. Introduction
B. Term Riders
C. Limitation Riders
1. War Rider
2. Aviation Rider
3. Hazardous Occupation or Avocation Rider
4. Limited Benefit Period Rider
D. Cost of Living (COL) Riders
E. Accidental Death Benefit (ADB) Riders
F. Waiver-of-Premium Rider
1. Period of Coverage
2. Waiting Period
3. Definition of Total Disability
G. Disability Income Rider (DIR)
H. Additional Purchase Options (Guaranteed Insurability Options)
I. Accelerated Death Benefit (ADB) Riders
1. Events Triggering Early Payout
2. Policies ADB Riders May Be Attached To
3. Income Taxation of Accelerated Death Benefit Payments
J. Automatic Premium Loan Provision
K. Policy Loan Interest Rate
L. Dividend Options
M. Bailout Provisions
N. Change of Plan Provision
O. Change of Insured Provision or Rider
P. Additional Insured Riders
Q. Common Accident Provision (Survivorship Clause)
R. Settlement Options
CHAPTER 7 ADJUSTABLE LIFE
A. What Is It?
1. AL has Features of Universal Life
2. AL has Features of Ordinary Level-Premium Whole Life Insurance
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Exception to the Cost Recovery Rule
3. Caveat: Potential Taxation Under the MEC Rules
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
J. Questions and Answers
CHAPTER 8 ANNUITIES
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
F. Alternatives
G. Where and How to Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
J. Where Can I Find Out More About It?
K. Questions and Answers
CHAPTER 9 CURRENT ASSUMPTION WHOLE LIFE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Exception to the Cost Recovery Rule
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. Expense Charges
2. Mortality Charges
3. Net Investment Yield on Investment Portfolio
4. Interest Crediting Methods
5. How to Navigate Through a Ledger Statement for Current-Assumption Whole Life
6. Ledger Statements Do Not Tell All
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 10 GROUP LIFE INSURANCE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. What Are the Tax Implications?
F. What Are the Requirements?
G. Where Can I Find Out More?
H. Questions and Answers
CHAPTER 11 JOINT LIFE (FIRST-TO-DIE) INSURANCE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Income Taxation
2. Income Taxation of Split Dollar Arrangements
3. Corporate Owned Life Insurance
4. Estate and Gift Taxation
5. Estate Inclusion When Policy Owned By Corporation
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 12 LIMITED PAY WHOLE LIFE INSURANCE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. Non-MEC Policies
2. MEC Policies
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. What to Look for in the Ledger Statements of Whole Life Policies Paying Dividends as Declared
2. Ledger Statements Do Not Tell All
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 13 ORDINARY LEVEL PREMIUM WHOLE LIFE INSURANCE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Taxation of Living Proceeds
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. How To Evaluate the Dividends Paid on Par Policies
2. What to Look for in the Ledger Statement of an Ordinary Life Policy
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 14 SINGLE PREMIUM LIFE INSURANCE
A. What Is It?
1. Types of Single Premium Life Insurance Policies
2. Contract Provisions of Single Premium Life Insurance Policies
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Taxation of Lifetime Distributions and the MEC Rules
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 15 SURVIVORSHIP LIFE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Income Taxation
a. Income Tax Implications in Split Dollar Plans
2. Estate Taxation
a. Estate Inclusion When Policy Owned By Corporation
3. Gift Taxation
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. What is the Composition of the Base Policy?
2. How Much Term Insurance is Included in the Recommended Plan?
3. How is the Policy Affected by the First Death?
4. What Yields or Interest Rates are Assumed?
5. Is the Level of Projected Yields or Interest Rates Reasonable?
6. What is the Sensitivity of the Plan to Changes in Yields or Interest Rates?
7. Do the Illustrations Assume Bonus Credits or Terminal Dividends?
8. Are Mortality Assumptions Realistic?
9. Does the Policy Illustration Use Loans to Finance Any Premium Outlays?
10. Are Assumed Lapse Rates Realistic?
11. What Split Options are Offered?
12. What are the Underwriting Standards?
13. What is the Death Benefit Internal Rate of Return?
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 16 TERM INSURANCE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. Comparing Term Policies
2. What to Look for in Ledger Statements of Yearly Renewable Term
3. Information the Ledger Statements Do Not Provide
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 17 UNIVERSAL LIFE
A. What Is It?
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Exception to the Cost Recovery Rule
3. Caveat: Potential Taxation Under the Modified Endowment Contract Rules
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
I. How Do I Select the Best of Its Type?
1. Expense Charges
2. Mortality Charges
3. Net Investment Yield on Investment Portfolio
4. Interest-Crediting Methods
5. How to Navigate through a Universal Life Ledger Statement
6. What Ledger Statements Do Not Tell
J. Where Can I Find Out More?
CHAPTER 18 VARIABLE AND VARIABLE UNIVERSAL LIFE
A. What Is It?
1. Variable Life
2. Variable Universal Life
B. When is the Use of This Tool Indicated?
C. Advantages
D. Disadvantages
E. Tax Implications
1. General Tax Rules
2. Exception to the Cost Recovery Rule
3. Caveat: Potential Taxation Under the MEC Rules
4. Taxation of Capital Gains on the Underlying Assets
5. Taxation of Transfers Between Investment Funds
F. Alternatives
G. Where and How Do I Get It?
H. What Fees or Other Acquisition Costs Are Involved?
1. Charges to VL Policies
2. Charges to the VL Cash Value Accounts
3. Charges to VUL Policies
I. How Do I Select the Best of Its Type?
1. How to Navigate Through a Variable Life Ledger Statement
2. What Ledger Statements Do Not Tell
J. Where Can I Find Out More?
K. Questions and Answers
CHAPTER 19 MODIFIED ENDOWMENT CONTRACTS
A. Introduction
B. MEC Tax Treatment
C. Technical Definition of a Modified Endowment Contract
D. The Seven-Pay Test
E. Initial Test for Policies Entered into After June 20, 1988
1. Definition of Net Level Premium
2. Contracts With Death Benefits Under $10,000
3. Refund of Excess Premiums
F. Benefit Reductions Within the First Seven Contract Years
1. Distributions Affected
2. Reductions of Benefits Attributable to Nonpayment of Premiums
G. Material Change Rules
1. Changes That Are Not Material
2. Material Change Defined
3. Material Increases In Death Benefits
4. Other Material Changes
5. Seven-Pay Test As Applied To Material Changes
CHAPTER 20 SECTION 1035 EXCHANGES
A. Why an Exchange?
B. Basic Income Tax Implications of an Exchange
C. Partially Tax-Deferred Exchanges
D. Taxable Exchanges
E. Issues Under Sections 7702 and 7702A
F. Mechanics of the Exchange
G. Exchanges Involving Loans
H. Exchanges Involving Qualified Pension or Profit Sharing Plans
I. Fatal Flaw Checklist
J. Alternatives
CHAPTER 21 TAXATION OF BENEFITS
A. Taxation During the Insured’s Lifetime
1. Life Insurance Defined
2. Cash Value Increases
3. Dividends
4. Election to Make Policy Paid-Up
5. National Service Life Insurance
6. Policy Withdrawals
7. Surrender, Redemption or Maturity of a Policy
8. Annuity Taxation
9. Deductibility of Premium Payments
10. Policy Loan Interest
11. Timing of Interest Deduction
12. Taxation of Policyowner or Insured in Business Situations
a. Employer-Owned Contracts
13. Taxation of Policyowner in Creditor Situation
14. Taxation of Policyowner in Alimony Situations
15. Taxation of Advance Premium Deposits
16. Taxation of Accelerated Death Benefits
17. Sale of a Life Insurance Policy
18. Corporate Distribution of Policy
B. Taxation At and After the Insured’s Death
1. Implications of Meeting Definition
2. Proceeds Payable at Insured's Death
3. Proceeds Payable at a Date Later Than Death
4. Payments Taken in Installments
5. Life Income Option Elected
6. Fixed Period Option Elected
7. Fixed Amount Option Elected
8. Interest Only Option Elected
9. Exception for Government Life Insurance
10. Exception to the General Rule for Transfer for Value
11. Exception Where Proceeds Considered Compensation or Dividends
12. Exception Where Policy Owned by Qualified Retirement Plan
CHAPTER 22 THE TRANSFER FOR VALUE RULE
A. Introduction
B. The Rule Defined
C. The Requirement of Transfer
D. The Requirement of Consideration
E. Exceptions to the Rule
1. Exception 1: The Transferor's Basis
2. Exception 2: Transfers to the Insured
3. Exception 3: Transfers to a Partner of the Insured
4. Exception 4: Transfers to a Partnership in Which the Insured is a Partner
5. Exception 5: Transfers to a Corporation in Which the Insured is a Shareholder or Officer
6. Summary of Safe Harbors
F. Typical Personal Life Insurance Planning Problems
G. Transfer for Value Problems in Buy-Sell Planning
1. The “Uninsurable Shareholder” Trap
2. The “Switch From Stock Redemption To Cross Purchase” Trap
3. The “Gift of Policies By Corporation Double Trouble” Trap
4. The “Purchase By Insured Followed By Gift” Trap
5. The “Sale by Estate” Trap
6. The Sale by a Trust Trap
7. The “Policy Saving Trust” Trap
8. The “Group Funded Cross Purchase Buy-Sell” Tax Trap
9. The “Endorsement Type Split Dollar” Tax Trap
10. The “Perhaps Not So Safe Gift” Tax Trap
H. Transfer for Value Problems in Employee Benefit Planning
I. Summary
CHAPTER 23 ESTATE TAXATION OF LIFE INSURANCE
A. An Overview
B. Life Insurance Defined
C. Insurance Owned on the Life of Another (IRC Section 2033)
D. Incident of Ownership Within Three Years of Death (IRC Section 2035)
E. Proceeds Payable to or for Benefit of Insured’s Estate (IRC Section 2042(1))
F. Insurance Receivable By Beneficiaries Other Than Insured’s Estate (IRC Section 2042(2))
G. Inclusion of Life Insurance in Retirement Plans (IRC Section 2039)
H. Estate Tax Marital Deduction (IRC Section 2056)
I. Estate Tax Charitable Deduction (IRC Section 2055)
J. Apportionment Rules: Who Pays the Estate Tax on Insurance Proceeds?
CHAPTER 24 GIFT TAXATION OF LIFE INSURANCE
A. Why a Gift of Life Insurance?
B. The Four Questions
C. Outright Gifts of Policies
D. Three Party Situations
E. Payment of Premiums on Behalf of Another
F. Gift Through Settlement Option
G. How Is the Gift Valued?
H. Collection of Gift Tax
CHAPTER 25 LIFE INSURANCE AND THE GENERATION-SKIPPING TRANSFER TAX
A. Reverse QTIP Election
B. GSTT and Irrevocable Life Insurance Trusts
CHAPTER 26 ACCELERATED DEATH BENEFITS AND VIATICAL SETTLEMENTS
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. Advantages
D. Disadvantages
1. Reduced Total Payout
2. Eligibility for Governmental Assistance Programs
E. What Are the Requirements?
1. Types of Life Insurance Policies
2. Limitations on Payments to Chronically Ill Individuals
3. Additional Rules
F. How Do I Select the Best of Its Type?
G. Tax Implications
1. Income Taxation of Accelerated Death Benefits or Viatical Settlements
2. Unanswered Questions
3. Transfer for Value Rule
H. Ethics
I. Alternatives
J. Questions and Answers
CHAPTER 27 BUY-SELL AGREEMENTS
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. What Are the Requirements?
D. How Is It Done – An Example
E. What Are the Tax Implications?
F. Questions and Answers
CHAPTER 28 CHARITABLE USES OF LIFE INSURANCE
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. What Are the Requirements?
D. How Is It Done – An Example
E. What Are the Tax Implications?
F. Questions and Answers
1. Value and Form of Gift
CHAPTER 29 DEATH BENEFIT ONLY (DBO) PLAN
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. What Are the Advantages?
D. What Are the Disadvantages?
E. What Are the Requirements?
F. How Is It Done – An Example
G. What Are the Tax Implications?
H. What Are the ERISA Implications?
I. Questions and Answers
CHAPTER 30 IRREVOCABLE LIFE INSURANCE TRUSTS
A. Why a Gift of Life Insurance?
B. Advantages of Ownership of Life Insurance by 3rd Party
C. Disadvantages of 3rd Party Ownership of Life Insurance
D. Why Make a Gift of Life Insurance to an Irrevocable Life Insurance Trust?
E. Disadvantages to Ownership of Life Insurance by an Irrevocable Trust
F. Irrevocable Trust – What It Is and How It Works
G. Mechanics
H. Selection of a Trustee
I. Reducing or Eliminating Gift Taxes on Policy Transfers and Premium Payments Through Crummey Powers
J. Gift, Estate, and Income Tax Problems Related to Crummey Powers
K. Reducing or Eliminating Gift Taxes on Premium Payments Through Methods Other Than Crummey Powers
L. What the Attorney Should Consider in Drafting
M. How to Avoid the Transfers Within Three Years of Death Rule
N. Structuring the Trust for “What Ifs”
O. Allocation of the Federal Estate Tax
P. Income Tax Implications
Q. How to Handle Last to Die (Survivorship) Insurance in an Irrevocable Trust
R. How to Handle Group Term Life Insurance in an Irrevocable Trust
S. Community Property Issues
CHAPTER 31 KEY EMPLOYEE LIFE INSURANCE
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. What Are the Requirements?
D. How Is It Done – An Example
E. What Are the Tax Implications?
F. Questions and Answers
CHAPTER 32 LIFE INSURANCE IN QUALIFIED PLANS
A. What Is It?
B. When Is the Use of This Technique Indicated?
C. Advantages
D. Disadvantages
E. How Is It Done – An Example
F. What Are the Tax Implications?
G. Questions and Answers
CHAPTER 33 NONQUALIFIED DEFERRED COMPENSATION
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. Advantages
D. Disadvantages
E. What Are the Requirements?
F. How Is It Done – An Example
G. What Are the Tax Implications?
H. Questions and Answers
CHAPTER 34 PENSION MAXIMIZATION
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. Advantages
D. Disadvantages
E. What Are the Requirements?
F. How Is It Done – An Example
G. What Are the Tax Implications?
H. Questions and Answers
CHAPTER 35 REVOCABLE LIFE INSURANCE TRUSTS
A. What Is a Trust?
B. Living Trust Defined
C. What Is a Revocable Life Insurance Trust?
D. Why Should a Client Set Up a Trust?
E. Advantages of a Revocable Life Insurance Trust
F. Disadvantages of a Revocable Trust
G. Role of the Trust Document
H. What Is the Job of the Trustee?
I. Who Can Be the Beneficiaries of a Trust?
J. Selection of a Trustee
K. Estate Tax Implications
L. Gift Tax Implications
M. Income Tax Implications
N. Creditor Implications
O. Coordinating the Revocable Trust With the Overall Estate Plan
CHAPTER 36 SECTION 162 PLANS
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. What Are the Requirements?
D. How Is It Done – An Example
E. What Are the Tax Implications?
F. Questions and Answers
CHAPTER 37 SPLIT DOLLAR LIFE INSURANCE
A. What Is It?
B. When Is the Use of Such a Device Indicated?
C. Types of Split-Dollar Plans
1. Classic Split-Dollar
2. Equity Split-Dollar
3. Reverse Split-Dollar
D. What Are the Requirements?
E. How Is It Done – An Example
F. What Are the Tax Implications?
1. Treatment under Regulations
a. Economic Benefit Treatment
b. Loan Treatment
c.. Effective Date of Regulations
2. Split Dollar Prior to Regulations
a. Notice 2002-8
b. Notice 2001-10
c. Value of Economic Benefit
3. Private Split-Dollar Plans
4. Estate and Gift Tax Issues
G. Planning Concepts
1. Endorsement Plans
2. Collateral-Assignment Plans
H. Questions and Answers
APPENDIX A TAX TABLES
A. Income Tax
B. Gift and Estate Tax
C. Unified Credit
APPENDIX B ACCOUNTING FOR LIFE INSURANCE
A. Introduction
B. Financial Reporting
C. Accounting Basics
D. Accounting Rules Specifically Affecting Life Insurance
1. Examples of Accounting Journal Entries
2. Alternative Methods
E. Summary
F. Where Can I Find Out More About It?