Questions – Life Insurance General

Can I pay for an insurance policy monthly or annually?

Some plans may offer discounts if you pay the premium on an annual basis.

Is there a waiting period before coverage goes into effect?

Life insurance policies do not have a waiting period. They have contestability periods.These typically apply for fraud.Policies also require an exclusionary period for suicide.

Are there circumstances where benefits are not paid?

Most plans have benefit exceptions where they may deny benefits.If an applicant commits fraud during the application process, an insurance company has the ability to deny a claim.

Does the plan require a physical exam?

Most insurance plans require a physical exam as part of their underwriting process.

What lifestyle factors can impact your life insurance policy before and after the plan goes into effect?

Insurance companies want to know if an applicant engages in activities such as skydiving, flying a small plane, scuba diving or similar activities they might categorize as increasing the probability of early death. They also want to understand if there are lifestyle factors that might translate into a riskier condition. While an insurance company may not disqualify someone who participates in these activities, the company may charge a premium for it or exclude death from the activity as a condition of approval.

What happens if you miss a monthly premium or are late on a payment?

Non-payment of the life insurance premium or a late payment may impact your benefits. In some cases, it can cause a policy to lapse.

Does the life insurance plan have a cash value if you decide to cancel the policy?

As a rule, the answer is ‘no’ for term life insurance policies. For many other plans, there may be a cash value, though surrender charges may consume up a portion of the cash value.

What is the process to change life insurance beneficiaries?

Call your insurance company to identify the proper procedure. It is usually a form you need to complete.It is a policy holder’s right to change the beneficiaries.

What happens with the plan if you decide to move out of state or to another country?

If you relocate to a foreign country that the insurer feels is a significant risk immediately after receiving your policy, you may have a problem.Most life insurance companies specifically ask about intentions to relocate out of the country as part of the application process. If you relocate out of the country years after receiving the policy, your coverage will stay with you (though certain exclusions may apply such as active military.) If you move out of state, your policy will remain in force under the regulations in effect from the state of policy origination.

Under what circumstances can an insurance policy be cancelled?

These conditions are specified in the insurance contract or mandated by the state insurance authority. Read your policy and contact your insurance commission if you have concerns.

Are there situations where the premium may change?

If one buys a guaranteed policy, it guarantees that premiums will not change. Universal life policies can be guaranteed. Almost all whole life policies are guaranteed. Term life may be sold as a guaranteed flat rate for 10 to 30 years. Non-guaranteed policies are most often found in index universal policies, universal policies, and variable life policies.Some policies also guarantee how long the policyholder must pay to have a fully paid up policy for life.Ask your sales representative to explain any conditions under which premiums may change.

Can a family member make premium payments if I am no longer able?

Yes.Your life circumstances may change and you should fully understand how to keep it in good standing should you no longer be able to make premium payments.

Does an insurance company offer a final expense life insurance plan?

Many insurance companies offer small dollar policies that are typically issued later in a person’s life for just this purpose. Shop around.Many of these policies can be found online.

What is the appeals process if benefits are denied?

In insurance policy is a contract between you and the company. The appeals process will stated in the contract. You may also want to consult an attorney.

What is a “guarantee against lapse” or “no-lapse guarantee”?

This ensures that your death benefit remains secure regardless of changes in the policy’s interest-crediting rates or rate of return, charges or cash value. You control for how long this guarantee is in effect — for a few years or the rest of your life.

A minimum premium amount must be paid to keep this guarantee in effect. Generally, the greater your minimum premium, the longer the guarantee. Keep in mind that the timing of premium payments can affect guarantees, especially if premiums are paid after the grace period. Guarantees are based on the insurer’s ability to pay claims.

Will my insurance agent submit my medical information to more than one insurance company?

If an insurance agent is submitting your medical information to a number of different companies, this is an indication that the agent is independent. This may be advantageous if you have health-related issues.

What is a sales illustration and should I get one?

A sales illustration will project the future value of your life insurance policy, based on a wide range of different variables you might be considering. In particular, it will show you which costs and benefits are guaranteed and which ones aren’t. You should always request a sales illustration if one is available before you buy a life insurance policy.

Can I change my mind after I purchase a life insurance policy?

Yes, you can. There is a period of time after you receive the policy called the “free-look” period when you can return it and receive a full refund of any premium paid. The free-look period usually ranges from 10 to 30 days, and a notice must be displayed on the policy’s cover page informing you of this. You should read your policy carefully during the free-look period — if you don’t understand something, be sure to ask for a thorough explanation.

How do I compare the costs of different kinds of life insurance?

Comparing life insurance costs requires obtaining quotes from different insurance companies for comparable policies. You can obtain insurance quotes from local insurance agents and brokers, over the telephone or by searching on the Internet. Keep in mind that cost comparisons can get complicated when policies include non-guaranteed features like dividends because there’s no guarantee that an insurer’s past practices with respect to these features will be continued going forward. Also remember that quotes can be meaningless if given prior to medical underwriting.

The most important thing is to make sure you can afford the insurance you buy – not just today, but also in the future because premiums for some types of insurance can change over time. Your personal and financial circumstances can also change, thus affecting your ability to pay premiums in the future. So be sure to ask if a policy’s premiums can change or if they will remain steady over the life of the policy.

How much life insurance coverage do I need?

There are lots of different so-called “rules of thumb” when it comes to how much life insurance you should buy. One of the most common is 10 times your annual income. However, the right amount of life insurance coverage depends on many different factors that are unique to every family. You should talk to your insurance agent about your unique circumstances to come up with the right coverage amount for you and your family.

Can I get a lower premium if my health condition changes later?

If you don’t receive the most favorable health rating when you apply for coverage, you may be able to improve your rating later if your health improves, and thus possibly lower your premium.

Will I be covered if I become disabled?

Your life insurance policy may include an optional benefit called a disability rider that pays your premiums if you become disabled.

Are there other riders I can buy?

Different insurers offer different riders, but the most common riders typically include:

• Accelerated death benefit rider — This will enable you to collect a portion of the death benefit if you become terminally ill and are given a short life expectancy.
• Accidental death benefit rider — This will pay out an extra benefit if your death is caused by an accident.
• Long-term care rider — This will help pay for long-term care expenses if you can’t perform certain “activities of daily living” (or ADLs) such as dressing yourself or using the toilet.
• Critical illness rider — This will pay out a lump sum if you’re diagnosed with a critical illness. The illness must be specified in the policy.

Do beneficiaries pay income tax on death benefits they receive?

Usually not, but there are two possible exceptions: transfers for value and employer-owned life insurance.

Are life insurance premiums tax-deductible?

In most instances, no.

Are taxes due on cash value accumulation?

No. Life insurance cash value accumulates on a tax-deferred basis.

How is life insurance defined for tax purposes?

There are two tests a life insurance policy must meet for tax purposes: the Cash Value Accumulation Test (CVAT) and the Guideline Premium Test (GPT). These tests limit the amount of funding relative to a policy’s death benefit.

Are different types of life insurance policies treated differently for income tax purposes?

Yes. Modified Endowment Contract (MEC) policies don’t receive some of the tax benefits that non-MEC policies do — specifically, with regard to dividend options, withdrawals, partial surrenders and policy loans.

Are taxes paid on policy distributions?

Taxes are only paid on distributions (dividends, withdrawals and partial surrenders) that exceed the amount of the policy owner’s investment in the policy.

Are taxes paid on policy loans?

No, because loans aren’t considered to be distributions from the policy.

How do you calculate a life insurance policy’s cost basis?

Cost basis is how much a policy owner has invested in a policy. Premium payments increase cost basis while distributions decrease cost basis. Note that dividends used to reduce premiums or buy paid-up additions generally do not impact the investment in the policy — only net premiums paid out of pocket increase cost basis.

What are the tax implications of a policy surrender?

The amount of gross surrender proceeds (cash, policy loans and accrued interest) that exceeds the owner’s cost basis is considered taxable income to the policy owner.

Are there tax benefits if a policy is surrendered or lapses and the cost basis is higher than the surrender value or lapsed proceeds?

No, because life insurance is considered to be a personal asset, not an investment, so losses aren’t deductible.

Is policy loan interest deductible?

No.

What are the tax implications if there’s an outstanding loan on a lapsed policy?

Any outstanding loans and accrued interest are considered to be distributed to the policy owner upon lapse. If this amount, plus residual cash value, exceeds the owner’s cost basis, it’s considered taxable income. If there is a large loan balance, the taxable income can be substantial, with no corresponding surrender value.

What are the tax implications if a policy with an outstanding loan is gifted?

If the loan and any unpaid interest exceed the owner’s cost basis, the gift is considered to be a part-sale transaction and the owner is taxed on the portion of the policy sold to the extent of the gain. The policy is also considered to have been transferred for valuable consideration and the beneficiary will be taxed on a portion of the death benefit received.

Are donations of life insurance policies to charitable organizations deductible?

Yes, but with provisions. Interested readers are advised to see the article ‘Life Insurance – Even Giving it Away Can be Complicated’ in the Life Insurance section of this website for additional information. This is an area you are advised to consult a tax advisor if this is under consideration.

What are the tax implications if the insured survives to the policy’s maturity date?

Withdrawals of policy values up to the owner’s cost basis can be made without any tax implications. Meanwhile, loans can be taken for amounts that exceed the cost basis, and mature policies surrendered for maturity value are taxed like any other surrender.

What is a Modified Endowment Contract (MEC) and how are MEC distributions taxed?

A MEC is a special type of insurance policy that doesn’t receive some of the tax benefits that non-MEC policies do. MEC policies are generally taxable as a distribution of earnings to the extent of the gain. Collateral assignments and loan pledges are treated as distributions. Note that an additional 10% penalty applies to premature distributions of income, unless the policy owner is 59½ years old or older or is disabled.

Do MEC policy values grow tax-deferred?

Yes, assuming that policy values aren’t borrowed or withdrawn.

Are MEC death benefits taxable?

No, with two possible exceptions: transfers for value and employer-owned life insurance.

What is a 1035 exchange?

This enables policy owners to exchange one life insurance policy for a different policy (or a long-term care policy or annuity contract) without recognizing a gain or loss. To qualify for a 1035 exchange, an annuity contract can be exchanged for a different annuity contract or long-term care policy, and a long-term care policy can be exchanged for another long-term care policy. Also, the insured and the policy owner must be the

same in both the old and new policies, so policy ownership can’t be changed. Annuities cannot be converted to life insurance via a 1035 exchange due to taxation differences.

What if there is an outstanding loan on the policy being exchanged?

Some insurers will allow an outstanding loan to be carried over to the new policy, in which case there is no taxable loan payoff. If the loan is paid off instead, either the gain in the policy or the amount paid off is taxable, whichever is less.

Are there any special rules for survivorship policies when it comes to 1035 exchanges?

Since the insured individual(s) must be the same for an exchange to qualify for Section 1035 treatment, a policy on the life of a single insured individual can’t be exchanged for a policy on the life of two different insured individuals, and vice versa. With a second to die policy, once the first insured individual dies, the policy can be exchanged for a new policy on the surviving individual’s life.

If the transfer-for-value rule has been violated, can this be fixed after the fact?

This can be fixed with a subsequent transfer within one of the exceptions in order to clear the previous transfer for value.

What are the tax implications if an employee’s spouse is the beneficiary of a life insurance policy owned by an employer?

The employer will receive the death benefit income-tax free and then transfer the death benefit to the spouse, which is considered a taxable benefit. A written agreement should be in place to ensure that the employer receives a deduction for the payment to the spouse.

What is underwriting?

This is the process followed by insurance companies in determining who they will insure and how much they’ll charge for coverage. Among the factors considered are your age, gender, health status and habits, family health history, and whether or not you participate in dangerous hobbies or work in a hazardous occupation.

You will provide all this information to the insurer on your insurance application and health questionnaire. In addition, the insurer will require that you undergo a health examination, as well as agree to the preparation of a Medical Information Bureau (MIB) report and the request of information from your doctors.

There are various levels of underwriting — including full underwriting, simplified underwriting and guaranteed issue — that will impact your premium. Be sure to ask which type of underwriting will be used for your policy, what kinds of medical information you’ll have to provide, and what type of health examination you’ll have to undergo.

What happens to the cash value in the policy when I pass away?

This is a very important question to ask for policies that build cash internally. This includes all life insurance policies other than term.When a policy holder dies, his beneficiaries receive the death benefit. Unless a rider has been added to the policy to convert excess cash to death benefit, the insurance company keeps the excess cash value.

Whole life policies offer a Paid-Up Additions rider that converts excess cash to small insurance policies. These riders add to the cash value of the policy and the death benefit.

People purchase index universal life, universal life, and variable life policies for the express purpose of growing cash values faster than whole life policies.To the extent they are successful, policy holders must either have a rider that adds the excess cash value to the death benefit or withdraw the excess cash value from the policy. Failure to purchase the rider or withdraw the cash will result in the loss of the excess cash to the insurance company upon death.

Should I question whether an insurance company has increased the mortality charges on any of their policies in the last ten years?

An increase in the cost of insurance in a policy is a red flag about the company and the policy type. It most often means that the company was losing money on the policy.They increased the cost of insurance to compensate for the investment losses they were experiencing. This was most likely to occur on non-guaranteed Universal Life policies issued when interest rates were much higher.