Chapter 6: Life Insurance Premiums Proceeds and Beneficiaries
KEYWORDS: LIFE INSURANCE PREMIUMS, PROCEEDS, AND BENEFICIARIES
Prior to reading the chapter, please review the following keywords. An understanding of their basic definitions will improve comprehension of the chapter content.
Accelerated Benefit (Option) Rider: This rider allows the insured to receive a portion of the death benefit prior to death if the insured has a terminal illness that’s certified by a physician and is expected to die within one to two years.
Beneficiary: This is the person (or entity) who’s designated in a life insurance policy to receive the death proceeds.
Cash Value: This is the equity or savings element of whole life insurance policies.
Class Designation: This is a beneficiary group designation (e.g., all of a person’s children), opposed to specifying one or more beneficiaries by name.
Common Disaster Provision: This is a provision of the Uniform Simultaneous Death Act, which ensures a policy owner that death benefits will be paid to the contingent beneficiary if both the insured and the primary beneficiary die within a short period of time of one another. It also states that the primary beneficiary must outlive the insured by a specified period in order to receive the proceeds.
Contingent (Secondary) Beneficiary: This is the beneficiary who’s second in line to receive death benefit proceeds if the primary beneficiary dies before the insured.
Earned Premium: This is the amount of premium that’s paid by the policy owner for policy coverage or insurance protection up to a specific point.
Expense Factor: Also referred to as the loading charge, this is a measure of what it costs an insurance company to continue to operate.
Excess Interest: In life insurance, this provision means that the cash value will increase faster than the guaranteed rate if the insurer earns a greater return than the guaranteed rate.
Fixed Amount Installment Option: This option pays a fixed death benefit in specified installment amounts until the principal and interest are exhausted.
Fixed/Level Premium: This is a concept which averages what the total single premium would be for a policy over periodic payments. More periodic payments = higher total premium.
Fixed Period or Period Certain Option: This payment option pays the death benefit proceeds in equal installments over a set number of years. The dollar amount of each installment is dependent on the total number of installments.
Graded Premium: This premium funding option is characterized by a lower premium in the early years of the contract, with premiums increasing annually for an introductory period. After the introductory period, the premium increases to an amount that’s higher than what the initial level premium would have been. Thereafter, it remains fixed or constant for the life of the policy.
Gross (Annual) Premium: An insurer’s gross premium consists of the net premium for insurance PLUS commissions, operating and miscellaneous expenses, and dividends.
Interest Factor: This is the calculation for determining the amount of interest an insurance company can expect to earn from investing insurance premiums.
Interest Only Option: This is a death settlement option in which the insurance company holds the death benefit for a period and pays only the interest that’s earned to the named beneficiary. A minimum rate of interest is guaranteed, and the interest must be paid at least annually.
Irrevocable Beneficiary: This is a beneficiary that cannot be changed by the policy owner without the written consent of the beneficiary.
Joint and Survivor Option: This is a settlement option which guarantees that benefits will be paid on a life-long basis to two or more people. This option may include a period certain, and the amount payable is based on the ages of the beneficiaries.
Life Income Option: This is a death benefit settlement option which provides the beneficiary with an income that she cannot outlive. Installment payments are guaranteed for as long as the recipient is alive. The amount of each installment is based on the recipient’s life expectancy and the amount of principal.
Life Settlement: This is an agreement in which a policy owner sells or transfers ownership in all or part of a life insurance policy to a third party for compensation that’s less than the expected death benefit of the policy.
Lump-Sum Option: This is a death settlement option in which the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump-sum option is considered the automatic (or “default”) option for most life insurance contracts.
Modified Premium: This is a premium funding option which is characterized by an initial premium that’s lower than it should be during an introductory period (typically the first three to five years). After this period, the premium will increase to an amount that’s greater than what the initial level premium would have been and then remain level or constant for the life of the policy.
Morbidity Rate: This rate demonstrates the incidence and extent of disability that may be expected from a given group of people.
Mortality Rate: This rate is the measure of the number of deaths (in general or due to a specific cause) in some population, scaled to the size of that population, per unit time.
Net Payment Cost Index: This is a formula that’s used to determine the actual cost of a policy for a policy owner. It helps the consumer compare costs of death protection between policies that will be held for 10 to 20 years.
Net (Single) Premium: This is a premium calculation that’s used to calculate an insurer’s policy reserves factoring in interest and mortality.
Per Capita (By the Head): This form evenly distributes benefits among all named living beneficiaries (i.e., all living children).
Per Stirpes (By the Bloodline): This form evenly distributes benefits among an insured’s beneficiaries according to the family line, branch, or root (i.e., children and grandchildren).
Premium Mode: This is the frequency in which a policy owner elects to pay premiums.
Primary Beneficiary: This is the first beneficiary in line to receive benefit proceeds upon the death of an insured.
Policy Proceeds: This is the amount actually paid as a death, surrender, or maturity benefit. In the case of a death benefit, it includes the face value, plus any earned dividends, less any outstanding loans and interest. In the case of a surrender benefit, the amount includes any cash value, minus surrender charges, outstanding loans, and interest. In the case of maturity, the benefit amount includes the cash value, less any outstanding loans and interest.
Reserves: This is the money an insurer sets aside (as required by the state’s insurance laws) to pay future claims.
Revocable Beneficiary: This is a beneficiary that the policy owner may change at any time without notifying or getting permission from the beneficiary.
Settlement Options: These are optional modes of settlement that are provided by most life insurance policies. Options include lump-sum cash, interest only, fixed-period, fixed-amount, and life income.
Single Premium Funding: This is a policy funding option in which the policy owner pays a single premium that provides protection for life as a paid-up policy.
Spendthrift Clause: This clause prevents creditors from obtaining any portion of policy proceeds upon an insured’s death. Additionally, the clause can be selected by the policy owner to prevent a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period.
Surrender Cost Index: This is a cost comparison calculation formula which is used to determine the average cost-per-thousand for a policy that’s surrendered for its cash value. It aids in cost comparisons if the policy owner plans to surrender the policy for its cash value in 10 or 20 years.
Tertiary Beneficiary: This is the third beneficiary in line to receive death benefit proceeds. The tertiary beneficiary will only receive the death benefit if both the primary and contingent beneficiaries die before the insured.
Underwriting Department: This is the department within an insurance company that’s responsible for reviewing applications, approving or declining applications, and assigning risk classifications.
Unearned Premium: This includes the premium that has been paid by a policy owner for insurance coverage which has not yet been provided.
Uniform Simultaneous Death Act: This act states that if the insured and the primary beneficiary die in a common accident at approximately the same time, with no clear evidence as to who died first, the law will assume that the primary died first. Therefore, the death benefit proceeds are paid to the contingent beneficiaries.
Viatical Settlement: This settlement involves a person with a terminal illness selling his existing life insurance policy to a third party for a percentage of the death benefit.
Viatical (Viatee): This is the new third-party owner in a viatical settlement.
Viator: This is the original policy owner in a viatical settlement.
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INTRODUCTION
When individuals buy life insurance, they’re trading their money (in the form of premium payment) for future financial security (typically in the form of a death benefit). Upon the insured’s death, policy proceeds (the death benefit) are payable to the beneficiary in any one of a variety of methods, depending on the unique situation and needs of the beneficiary. Additionally, many policies include living benefits to address an insured’s pre-death needs. This chapter will examine how premiums are determined and collected, how and to whom benefits are paid, and the various tax consequences that are related to life insurance premiums and benefits.
This chapter will introduce the primary factors in premium calculations, policy proceeds, settlement options, the tax treatment of proceeds, the types of beneficiary designations, and the distribution of death benefits.
The chapter is broken down into the following sections:
▪ Life Insurance Premiums
▪ Comparing Life Insurance Policy Costs
▪ Viatical Settlements
▪ Life Insurance Death Benefits
▪ Benefit Distributions
▪ Special Situations
▪ Tax Consequences of Life Insurance
The state-specific portion of this course (located at the end) will detail the specific insurance definitions, rules, regulations, and statutes for your state. In the event of a conflict, state law will supersede the general content.
Review of this chapter will enable a person to:
▪ Understand the purpose of premiums in life insurance policies
▪ Identify the different factors in premium calculations
▪ Distinguish between mortality factor and mortality rate
▪ Identify the different options that a policy owner has to pay for the insurance policy
▪ Distinguish between level, modified, flexible, and graded premium funding
▪ Distinguish between earned and unearned premium
▪ Understand the costs associated with life insurance contracts
▪ Understand death benefit settlement options and payment of claims
▪ List and distinguish between the different types of beneficiary designations
▪ Understand the different methods of benefit distribution
▪ Distinguish between the Uniform Simultaneous Death Act and the Common Disaster Provision
▪ Understand the tax consequences of life insurance
Chapter 6: Life Insurance Premiums Proceeds and Beneficiaries
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LIFE INSURANCE PREMIUMS
PURPOSE OF PREMIUMS
Once an insurance company determines that an applicant is insurable, it needs to establish the payment (premium) for the insurance policy. The premium is both an exchange for insurance protection and a portion of the policy owner’s consideration. The consideration is the “binding force” in the contract, which solidifies the agreement between the insurer and policy owner.
As previously described, the policy owner is expected to remit premiums by the due date. However, as with most bills, insurance companies allow for a grace period (a time after the due date) during which payment may be made without penalty. The effect of non-payment of premium before the expiration of a grace period will cause a policy lapse.
FACTORS IN PREMIUM CALCULATION
Life insurance premiums are calculated per $1,000 of coverage. There are three primary factors or elements that are utilized in determining what an insurer will charge for its life insurance product. The three factors that influence the gross premiums charged for life insurance are:
Mortality
Interest and
Expenses
Mortality Factor or Mortality Rate
The mortality factor has the greatest effect on premium calculations or rate-making since it can vary greatly based on the personal characteristics of an individual to be insured. The mortality factor is determined from a mortality table which provides an indication of the “probability of death” of an individual at a particular age. In other words, the mortality table provides the death rate (i.e., the average number of deaths that will occur each year in each age group). For a mortality table to be accurate, it must be based on a large cross-section of individuals and time. This mortality factor originates from the Commissioners Standard Ordinary (CSO) Mortality Table. Today, this is the generic table that’s used by most insurers; however, some insurance companies utilize mortality factors that are derived from their own experience (i.e., death claims paid).
The number of deaths in a group of people is typically expressed as deaths per thousand. Insurance companies use mortality tables to help predict the life expectancy and probability of death for a given group.
For example, when determining the premium amount per $1,000 of coverage for a standard risk 35-year-old male, the company will consult the mortality table to view the average number of deaths per thousand for standard risk 35-year-old males.
Interest/Investment Factor
Insurance companies invest the premiums they receive in an effort to earn interest. This interest is one of the ways an insurance company can lower the premium rates. Premium calculations are made with the expectation that the company will earn an assumed rate of interest. A higher assumed (predicted) rate will lead to lower premiums. However, the actual interest earned may be higher or lower than the assumed rate.
The interest factor is a reflection of an insurer’s return on its investments. An insurer invests the premiums it collects in multiple different investment vehicles. The wiser its investment decisions, the better return it will realize.
Expense Factor
The expense factor—also referred to as the loading charge or factor—is derived from operating expenses, or funds that the insurer “pays out.” These expenses include, but are not limited to, death benefits paid, commissions or salaries to producers and other employees, and other administrative costs (i.e., rent). As described previously, each state sets a minimum reserve (or funds) that the insurer must set aside to pay future claims. Additionally, companies need to build in profit, also referred to as surplus. If a company is not generating a profit, it will likely need to raise premiums; however, if a company is generating a profit, it will likely maintain premiums or possibly lower them.
Additional factors that may influence the premium cost include:
▪ Age of the Proposed Insured – The older the person, the higher probability of death and disability.
▪ Sex / Gender – Women tend to live longer than men; therefore, their premiums are typically lower.
▪ Health History of Proposed Insured – Poor health increases the probability of death and disability.
▪ Occupation – Having a hazardous job can increase the risk of loss.
▪ Personal Activities and Hobbies – High-risk activities or hobbies (e.g., parachuting) also increase the risk of loss.
▪ Personal Habits – Tobacco use, DWI, or DUI presents a higher risk.
▪ Travel Outside the United States – This travel can expose a proposed insured to additional risks and/or illnesses.
NET VERSUS GROSS PREMIUMS
The net (single) premium is a premium that makes provision for mortality cost (death benefit) and interest. The “net single premium” is influenced by the assumed interest rate, the proposed insured’s gender, the benefits to be provided, and the mortality rate (death benefit).
Net single premium = Mortality cost – Interest
The net level annual premium allows for a small adjustment to the interest rate to account for the fact that most people don’t pay the policy’s required premium in a single payment; instead, they typically pay over a period of years.
The gross premium is the premium charged by an insurer that is comprised of, or influenced by, the factors described previously of mortality, interest, and expenses. This represents the actual premium that’s paid by the policy owner for life insurance coverage.
Gross premium = Net premium + Insurer expenses.
The gross annual premium is the gross premium that’s adjusted for the fact that most people don’t pay the policy’s required premium in a single payment; instead, they typically pay over a period of years.
The mortality rate refers to the frequency of deaths, while the morbidity rate refers to the occurrence of diseases in a defined population at a specific time interval.
Higher morbidity and mortality rates equate to higher insurance premiums.
The term “premium mode” refers to the policy feature that permits the policy owner to select the timing of premium payments. Insurance policy rates are based on the assumption that the premium will be paid annually at the beginning of the policy year and that the company will have the premium to invest (interest factor) for a full year. If the policy owner chooses to pay the premium more than once per year (e.g., monthly, quarterly, semi-annually), there normally will be an additional charge because the company will incur additional charges in billing and collecting the premium payments. This may be referred to as the Mode of Premium provision. The effect of non-payment of premium before the expiration of a grace period will cause a policy lapse.
The higher the frequency of payments, the higher the premiums. This is because the interest earned to the insurer is decreased while the administrative costs are increased.
FUNDING INSURANCE PREMIUMS
Whole life policies may be purchased by paying a single premium or by paying periodically. With single premium funding, the policy owner pays a single premium that provides protection for the life of the policy. Single premium funding is generally associated with “single pay whole life insurance.” Since a single premium is generally too expensive for the average person, alternative periodic options were developed to be more cost-effective or affordable for the purchaser.
Fixed/level premium funding averages the “single premium” over the policy period. The policy owner pays more than the actual cost of insurance in the early years to help cover the cost of insurance in later years. This allows the premiums to remain level throughout the life of the policy.
Modified premium funding is characterized by an initial premium that’s lower than it should be during an introductory period. After this time, the premium will increase to an amount that’s greater than what the initial level premium would have been and then remain level or constant for the life of the policy. Some customers may find this advantageous as it allows them to purchase permanent insurance for a more manageable initial price with a higher percentage of the cost added to a later period when the policy owner’s income is expected to be higher.
Graded premium funding is a contract that’s characterized (like modified) by a lower premium in the early years of the contract. However, premiums increase annually for the initial period. Thereafter, it increases to an amount that’s higher than what the initial level premium would have been, and then remains level or constant for the life of the policy. The premiums for these policies are predetermined, but are not level in the traditional sense.
Flexible Premium Funding allows the policy owner to adjust the premiums throughout the life of the contract.
PAYING PREMIUMS FROM POLICY VALUES
Depending on the type of policy, a policy owner may be able to use the policy’s cash value and dividends to pay the premium. With dividends, a policy owner could choose to pay down premiums on the existing policy or buy additional coverage in the form of paid-up whole life additions or one-year term.
While using the policy (cash) value to pay premiums is an option, this funding method also decreases the value of the policy. The policy will lapse if the policy’s value becomes insufficient, and the policy owner fails to pay the required premium.
MINIMUM DEPOSIT (FINANCED) INSURANCE
Although it’s occasionally grouped with “types of whole life insurance,” minimum deposit or financed insurance is not an actual policy type. Minimum deposit financing is a method of financing life insurance that’s best suited for individuals who are in high marginal tax brackets. It allows the policy owner to use policy loans to pay premiums that are due each year.
For example, each year, the policy owner is allowed to borrow (subject to certain tax restrictions) that year’s cash value increase and use it to pay the premium.
The policy owner only pays the difference between the premium due and the amount borrowed (plus interest on the policy loan). For this payment method to work, the policy owner must make two to three initial premium payments to build up the cash value. Additionally, under IRS rules, at least four of the initial seven annual premiums must be paid from funds other than policy loans to avoid classification as an MEC.
PREMIUM COLLECTION AND RESERVES
Producers generally collect the initial premium from the applicant at the time of application. The insurer will bill all future premiums to the insured who will then remit the payments to the company. Policy owners who are unable to pay their premiums may potentially use a premium financing organization that will function similar to an entity that provides installment loans.
Earned versus Unearned Premium
Earned premium is the amount to which an insurer is entitled since it’s providing coverage for a specific period.
Unearned premium is an amount of premium for which the policy owner has made a payment to the insurance company, but coverage has not yet been provided. Unearned premium typically becomes earned premium as an insurance contract progresses, but represents the amount that an insurer will return to an insured if the policy is canceled.
For example, let’s assume that an individual’s insurance policy costs $120 per year, and she pays the full amount on January 1. On April 1, the insurance company only earned $30 ($120 ÷12 months x three months of coverage). If the individual cancels her policy with an effective cancellation date of 7/1, the insurance company owes her a refund of $60 for unearned premium ($10/month x six months remaining of the amount paid in advance).
The earned and unearned premiums make up the insurer’s total premium.
Reserves
As required by law, reserves (also referred to as unpaid claim reserves) are the funds that are set aside by an insurer to pay current and future claims. This is a fixed liability of an insurer and represents the amount that’s expected to be available to pay future benefits under a policy. An insurer’s reserve supports its promise to pay as identified in the policy’s insuring provision.
Each state has its own requirement with regard to the amount of funds that make up the reserve. Reserves also demonstrate the solvency of an insurer. The reserves are funded through future premium payments from policy owners and the interest (investment return) earned on those premiums.
A legal reserve is the amount of funds an insurance commissioner (or director/superintendent) requires an insurer to maintain based on the CSO mortality table and the assumed rate that’s designated by the state’s commissioner or state insurance law.
COMPARING LIFE INSURANCE POLICY COSTS
The cost of a policy may be defined as the difference between what a person pays and what the person receives back. If a person pays a premium for life insurance and receives nothing back, the cost for the death protection is the premium. If a person pays a premium and receives something in return (e.g., a dividend or cash value), the true cost is less than the premiums paid. Therefore, a lower premium doesn’t automatically mean a lower-cost policy. Cost comparative methods are designed to evaluate the true cost of a policy against this standard.
INTEREST ADJUSTED NET COST METHOD
Interest adjusted cost indexes are designed to provide information on the following four items:
Premiums
Death benefits
Cash value
Dividends
These are the variables that must be considered when evaluating cost, and they’re the basis for the life insurance policy cost comparison methods.
The index numbers are designed to give consumers a means of comparing the cost of policies of the same generic type. The indexes also factor the insured’s age and the amount of coverage desired. Each insurer and its producers must use the same computation formulas to determine the index numbers or the purpose would be defeated. Due to the increasing complexity of life insurance policy structures, premium payment methods, benefits, and dividend configurations, the average consumer would not be able to make cost comparisons without these index figures.
The NAIC Model Life Insurance Solicitation Regulation requires two interest-adjusted cost indexes for policy illustrations—a surrender cost index and a net payment cost index. These indexes show average annual costs and payments per $1,000 of insurance, while also recognizing that $1.00 payable today is worth more than $1.00 payable in the future (i.e., the time value of money).
LIFE INSURANCE SURRENDER COST INDEX
The surrender cost index uses a calculation formula in which the net cost is averaged over the number of years that the policy was in force to arrive at the average cost-per-thousand for a policy that’s surrendered for its cash value at the end of the period. The surrender cost index is important to the consumer who places a high priority on the growth of cash value in the policy. It aids in cost comparisons if the policy owner plans to surrender the policy for its cash value in 10 or 20 years.
NET PAYMENT COST INDEX
The net payment cost index uses a similar formula, but it doesn’t assume that the policy is surrendered at the end of the period. As such, the cash value element is omitted. The net payment cost index provides the policy owner with an estimate of her average annual premium outlay, adjusted for the time value of money.
The net payment cost index is useful if an insured’s primary concern is the amount of death benefit provided in the policy and is not as concerned with the build-up of cash value. It helps compare future costs, such as in 10 to 20 years, if the insured continues to pay premiums and doesn’t take the policy’s cash value.
COMPARATIVE INTEREST RATE METHOD
The comparative interest rate method determines the rate of return that’s required on an investment account to yield the same return as a life insurance policy that has cash value. This method may also be referred to as the “buy term and invest the rest” strategy.
The amount spent on the term insurance plus the hypothetical investment account must be the same as the required premiums for permanent insurance. The face value of the temporary and permanent insurance products being compared must also be the same.
For example, let’s assume that a 30-year-old man wants $150,000 in permanent insurance coverage. One insurance agent shows the man a $150,000 whole life insurance policy that requires annual premiums of $2,000 per year for 30 years. A second insurance agent shows the man a $150,000 decreasing term life insurance policy that costs $500 per year. The second agent further explains that the man could place the $1,500 premium difference in an investment account to grow. This second account can be used to offset the decreasing term policy or replace it entirely when it expires. This combination will essentially allow him to have permanent coverage.
The comparative interest rate is the rate of return required on the investment account, so that the value of the investment is equal to the surrender value of the higher premium policy at a specific point (i.e., 30 years or death). The higher the comparative interest rate (CIR), the less expensive the higher-premium permanent policy is compared to the alternative plan.
VIATICAL SETTLEMENTS
A viatical settlement allows a person with a chronic or terminal illness to sell his existing life insurance policy to a third party for a percentage of the face value. The new owner continues to make the premium payments and eventually collects the full death benefit when the original owner dies. The original policy owner is referred to as the viator, while the new third party owner is referred to as the viatical or the viatee.
Due to the nature of the contract, most states require a special license for viatical settlement providers and, at a minimum, require a viatical company to recommend that the client consult a tax adviser as the proceeds could be taxable in certain situations. Tax laws require viators to be chronically or terminally ill to receive payments from viatical settlements on a tax-free basis.
▪ Chronically ill – This is a person who needs considerable supervision due to cognitive impairment or is unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, or continence).
▪ Terminally ill – This is a person who’s not expected to survive a medical condition for more than 24 months.
LIFE SETTLEMENT
In many states, viatical settlements are being replaced by life settlements. A life settlement is the sale of an existing life insurance policy to a third party for more than its cash surrender value, but less than its net death benefit. Unlike viatical settlements, life settlements don’t require the insured to be suffering from a chronic or terminal illness to sell and transfer the policy. With a life settlement, the policy owner may sell the policy to a life settlement firm for any reason. As with viatical settlements, a life settlement broker represents the policy owner and must hold an appropriate life settlement license. Disclosure requirements (e.g., right of rescission within 15 days) are also similar.
Life settlement contracts don’t include the following alternatives:
▪ An assignment of a policy as collateral for a loan
▪ The making of a policy loan, or the paying of surrender benefits or other benefits, by the issuer of a policy with respect to that policy
▪ A 1035 exchange of a life insurance policy as described by the Internal Revenue Code
▪ An agreement in which all of the parties are closely related to the insured by blood, law, or have a lawful substantial economic interest in the continued life, health, and bodily safety of the person insured, or are trusts that are established primarily for the benefit of such parties
▪ Legitimate corporate or pension benefit plans
LIFE INSURANCE DEATH BENEFITS
DEATH BENEFIT SETTLEMENT OPTIONS AND PAYMENT OF CLAIMS
Life insurance policies contain a provision that settlement shall be made on receipt of proof of death (death certificate). Most states require insurers to pay interest on any proceeds that are not paid within a specific period. Death benefits can be paid out in a variety of methods which are referred to as settlement options.
The policy owner may select a settlement option at the time of the application and may change the option at any time during the life of the insured. If the policy owner selects a settlement option, it cannot be changed by the beneficiary. However, in most cases, the settlement selection is made by the beneficiary at the time of the insured’s death.
Unless the policy owner specifies an irrevocable settlement option, the beneficiary always possesses the right to withdraw proceeds at any time in the future. Under any option selected in which the policy proceeds are left “at interest” with the insurer, the beneficiary is protected against the claims of creditors.
Death benefit settlement options include the following:
Lump-Sum (Cash Payment)
Under this option, the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums. The lump-sum option is the most common option used and is considered the automatic (or “default”) option for most life insurance contracts. The lump-sum option is used when the policy owner wants funds to be paid in one single disbursement.
Interest Only
Under this option, the insurance company holds the death benefit for a period and pays only the interest that’s earned to the named beneficiary. A minimum rate of interest is guaranteed, and the interest must be paid at least annually. This option provides the beneficiary with flexibility since the proceeds may be left with the insurer, which eliminates her investment concerns while guaranteeing both principal and a minimum rate of return (i.e., interest).
As always, interest that’s paid by an insurer on policy proceeds is taxable. Again, even when the policy proceeds are left with the insurer and the beneficiary selects this option, she continues to possess the right to withdraw the proceeds in the future at her discretion unless the policy owner explicitly listed restrictions.
For example, if a policy owner selects the interest only settlement option, she could choose for the beneficiary to have the option to pull out 100% of the principal at any time or to be unable to withdraw any of the principal until after a preset age or number of years.
The next three settlement options available are simplified versions of an annuity.
Fixed Amount
The fixed amount installment option permits the death proceeds to be left “at interest” with the insurer and used to pay a fixed death benefit in specified installment amounts until the principal and interest are exhausted. The amount of monthly income selected by the beneficiary, the amount of proceeds, and the interest rate paid by the insurer will all determine the length of time during which the beneficiary receives the monthly income. The larger the installment payment, the shorter the payout period. Under this option, the amount of income is the primary consideration rather than the period over which the proceeds and interest are to be liquidated.
The fixed amount option allows the beneficiary to designate an amount of income to be replaced (e.g., $1,200 per month). These payments continue until the principal and interest are exhausted.
Fixed Period
When either the fixed period or period certain option is chosen, the death benefit proceeds are paid in equal installments over a set period of years. The fixed period option is one of the two options that’s based on the concept of systematically liquidating principal and interest over a period of years without references to life contingencies.
Under this option, the beneficiary leaves the death proceeds with the insurer. Interest is paid on the proceeds (i.e., principal) by the insurer. Monthly income is then paid to the beneficiary for a specified period as selected by the beneficiary (e.g., 10 years). Part of the installments that are paid to a beneficiary consists of interest which is calculated on the proceeds of the policy. This option provides for the payment of proceeds in installments over a definite number of years. The amount of each installment is determined by the amount of proceeds, the selected period (total number of installments), the guaranteed rate of interest, and the frequency of payments.
The fixed period option is valuable when the most crucial consideration is to provide income for a definite period (e.g., until all children graduate from high school).
The face amount and the length of time during which payments will be made are the primary factors that determine the monthly income amount that’s paid to the beneficiary.
Life Income
The life income settlement option liquidates policy proceeds (i.e., principal) and interest with regard to life contingencies. Installment payments are guaranteed for as long as the recipient lives. Therefore, the life income option provides the beneficiary with an income that she cannot outlive. The amount of each installment is based on the recipient’s life expectancy and the amount of principal. Using the recipient’s life expectancy gives the potential for a greater return, or the potential for greater loss, based on how long the insured lives. The life income option is used to ensure that the beneficiary receives a payment for as long as she’s alive.
There are several life income options available from which the beneficiary may select, including:
Single, Pure, or Straight Life Income Option
Under the single, pure or straight life income option (as with a straight life annuity), monthly installments are paid to the beneficiary for as long as she lives. In other words, income payments end upon the death of the recipient (i.e., the beneficiary). No refund or any other payments are made once the beneficiary dies. This option potentially provides the most significant amount of income per $1,000 of proceeds. However, it also possesses the most significant amount of risk since there’s no survivorship.
Refund Life Income Option
The refund life income option—also referred to as the joint life option—guarantees the return of an amount that’s equal to the principal less any payments which have already been made. In other words, it provides a minimum guaranteed return. Once the primary beneficiary dies, his survivors may receive the refund on an installment basis (referred to as the installment refund) or in a lump-sum (which is referred to as a cash refund).
Life Income Option with a Period Certain
The life income option with a period certain pays a monthly income for as long as the beneficiary lives. However, if the beneficiary dies before a predetermined number of years have elapsed, the insurer will continue monthly payments to a second beneficiary for the remainder of the designated period certain (e.g., 10 years).
For example, let’s assume that the settlement option is designated as life income with a 20-year period certain. If the primary beneficiary dies after 15 years, the insurer will continue monthly payments to the second beneficiary for the remaining five years.
Joint and Survivor Option
The joint and survivor option guarantees that benefits will be paid on a life-long basis to two or more people. This option may include a period certain with a reduction in benefits after the death of the first beneficiary. The amount payable is based on the ages of both beneficiaries.
BENEFICIARY QUALIFICATIONS
The beneficiary of a life insurance policy is the person or entity who’s been designated in the policy to receive the death proceeds. The owner of the policy is the ultimate decision-maker and is responsible for handling, naming, or changing a beneficiary. There are few restrictions on who may be named a beneficiary of a life insurance policy. However, in the underwriting process, the underwriter may consider the issue of insurable interest. When the policy owner (other than the insured) lists themselves as the beneficiary, they will require proof of insurable interest.
Although not a full list, examples of acceptable beneficiaries include:
▪ Individuals – a person who’s identified by name and relationship (e.g., spouse, daughter)
▪ Class designations – a group of individuals (e.g., children of the insured, all siblings)
▪ Businesses – businesses often hold life insurance policies on the owner or key personnel to help mitigate the expense involved in finding a replacement
▪ Charities – as a lump-sum donation or to create continued funding (e.g., a scholarship fund)
▪ Trust – provides management of the proceeds
▪ Estate – although a policy owner may choose to list an estate as a beneficiary, it’s typically not advisable
CHANGING A BENEFICIARY
If a policy owner wants to change the beneficiary, there are two standard methods:
Filing (recording) method and
Endorsement method
The filing method is the predominant method used and requires the policyholder to notify the insurer in writing of the desired change. The effective date of the change is the date of the request. Some insurers require a witness to sign the request.
When the endorsement method is utilized, the policy is returned to the insurer so that the new beneficiary designation can be added to the policy. The effective date of the change is the date that the new policy is printed.
A revocable beneficiary may be changed or removed by the policy owner at any time without notifying or obtaining the beneficiary’s permission.
An irrevocable beneficiary cannot be changed without the beneficiary’s written consent. The irrevocable beneficiary has a vested interest in the policy; therefore, the policy owner cannot exercise certain rights (e.g., assignment, policy loans, surrender, etc.) without the beneficiary’s consent. In addition, an irrevocable beneficiary has the right to receive a copy of the policy.
BENEFIT DISTRIBUTION
DISTRIBUTION BY DESCENT
Per Capita
Per capita (i.e., per person or per head) evenly distributes benefits among all named living beneficiaries; typically the surviving children.
Per Stirpes
Per stirpes (i.e., by the bloodline) makes distributions according to a family line, branch, or root (children and grandchildren). If a beneficiary dies before the insured and no changes are made to the policy, benefits from that policy will be paid to that deceased beneficiary’s heirs.
DISTRIBUTION BY ORDER OF SUCCESSION
Primary Beneficiary
The primary beneficiary is the first or principal person in line to receive the policy proceeds income tax-free. A policy owner may designate multiple primary beneficiaries and choose different or equal amounts for each beneficiary (e.g., 50% to a son, 25% to a grandson, and 25% to a granddaughter). If one of the primary beneficiaries dies prior to the insured, the face amount is paid to the surviving primary beneficiary(s). Unless specifically requested as part of the contract (per stirpes) or required by law, the estate or heirs of a deceased beneficiary will not receive any payment in this case.
Secondary or Contingent Beneficiary
The secondary or contingent beneficiary is the second individual(s) in line to receive the death benefit and will only receive the death benefit only if the (or all) primary beneficiary(s) has died prior to the insured. The primary beneficiary must predecease the insured in order for this secondary beneficiary to receive any proceeds.
Tertiary Beneficiary
A tertiary beneficiary is third in line to receive policy proceeds when the insured dies (assuming the insured outlived both the primary and contingent beneficiaries). Technically, the policy owner may continue the succession by listing a fourth in line, fifth in line, etc. In other words, there’s no limit as to the depth of the succession.
DISTRIBUTION TO AN ESTATE
It’s important for a policy owner to list all desired beneficiaries and keep the designations updated as needed. The policy proceeds will be paid to the estate of the insured if none of the listed beneficiaries are still alive at the time of the insured’s death. Benefits that are paid to an estate are subject to possible federal and state estate (death) taxes, as well as probate fees, prior to being passed on to any other person. Additionally, creditors may have a right to funds in an estate and, therefore, a right to the proceeds of a life insurance policy that’s paid to an estate.
For example, let’s assume that an individual purchases a $100,000 life insurance policy covering his life and he designates his spouse as the primary beneficiary. His only daughter is designated as the contingent beneficiary. However, the individual fails to designate any of his four sons as beneficiaries. If his spouse and daughter are killed in an auto accident and, five years later, the individual dies and had not made any alterations to the life insurance contract, the death benefit or policy proceeds will be paid to his estate, not to the sons.
DISTRIBUTION TO A MINOR
A life insurance company typically will NOT pay policy proceeds directly to a minor beneficiary. Although any entity can be named as a beneficiary, many states don’t permit proceeds to be paid to a minor since she lacks “legal capacity.” In addition to a minor potentially not being competent to handle a large sum of money, a minor may not be able to receive the payment and return a receipt legitimately. For these reasons, a guardian or trustee will typically need to be appointed. In some cases, the insurance company may hold the proceeds and pay interest on them until the beneficiary reaches legal age.
DISTRIBUTION TO A TRUST
Trusts may be named as the beneficiary of a life insurance policy and manage the proceeds upon the insured’s death. Naming a trust as beneficiary is the most advantageous designation to use if a policy owner wants to leave policy proceeds to a “minor” child. In this case, a trustee will manage the trust for the benefit of the child (or children). However, trust administration fees may reduce policy proceeds. Two forms of trust are testamentary and inter vivos trusts. A testamentary trust is created at the time of the insured’s death according to a will. An inter vivos (living) trust is created during the life of the insured.
FACILITY OF PAYMENT
The facility of payment provision permits an insurer to pay a portion (or all) of the policy proceeds to ANY individual who appears to be equitably entitled. Such payment may be provided to a party who paid for the medical or final expenses of the insured who has died. Typically, the facility of payment provision arises when a death claim is not filed within two months following the death of the insured. Additionally, this provision may be triggered to assist a guardian when a minor is listed as the beneficiary.
SPECIAL SITUATIONS
UNIFORM SIMULTANEOUS DEATH ACT AND COMMON DISASTER PROVISION
How a policy responds to common disaster deaths is governed by the Uniform Simultaneous Death Act. The act states that if the insured and primary beneficiary both die in a common disaster (e.g., a plane crash) and it cannot be determined who died first, the insured will be considered to have survived the primary beneficiary (or died last). In other words, the primary beneficiary will be considered to have died before the insured. Therefore, the face amount is paid to the contingent beneficiary.
The problem with the Uniform Simultaneous Death Act is that it only applies to situations in which it cannot be definitively determined whether the insured died before the beneficiary. If it can clearly be determined who died first, even if the difference is only a few minutes or hours, the insurance company will follow the normal succession process that’s outlined in the policy:
▪ If the primary beneficiary clearly died first, and then the insured died, the benefits are payable directly to the contingent beneficiary.
▪ If the insured died first, the death benefit is payable to the primary beneficiary. If the primary beneficiary then dies shortly thereafter, the face amount will be paid to the estate of the primary beneficiary and not directly to a contingent beneficiary. Again, possible death taxes and probate charges may be assessed before the heirs receive the remainder.
The common disaster provision further clarifies these complicated situations by adding a survivorship clause. This clause requires that the primary beneficiary not just survive longer, but also outlive the insured for a specified period (typically 14 to 30 days). The common disaster provision ensures a policy owner that, if both the insured and the primary beneficiary die within a short period, the death benefits will be paid to the contingent beneficiary. Benefits will only be paid to the primary beneficiary’s estate if the primary beneficiary lives past the minimum period.
The goal of both the Uniform Simultaneous Death Act and the common disaster provision is to protect the contingent beneficiary by not paying the proceeds to the primary beneficiary’s estate. Paying the benefits to the beneficiary’s estate will likely defeat the purpose of the insurance policy. Furthermore, it potentially causes undesired death taxes and probate charges to be assessed, which significantly reduce the benefit before the heirs receive the remainder. If there’s no contingent beneficiary listed, the benefits will be paid to the insured’s estate, just as if the primary beneficiary had died before the insured.
For example, let’s assume that John has a life insurance policy covering his life. He designates his wife, Mary, as the primary beneficiary and all of his children equally as the contingent beneficiaries. While traveling for business, John and Mary are involved in a plane crash. When the paramedics arrive, John is found dead at the scene of the crash, but Mary is found alive and is rushed to the hospital. Unfortunately, Mary succumbs to her injuries and dies on the way to the hospital.
In this case, Mary definitively outlived John. Under the Uniform Simultaneous Death Act, since John technically died first, the proceeds of John’s life insurance policy will be paid to Mary’s estate, potentially creating both probate and tax issues, but also possibly being subject to creditors. However, since John’s policy also contained the common disaster provision, the insurance company will act as if Mary died first and pay John’s death benefit directly to his children.
SPENDTHRIFT CLAUSE
This provision protects a beneficiary from creditors with regard to life insurance proceeds. When the death benefit is left with the insurer, no creditors can attach a lien of any kind to the proceeds. The spendthrift clause also protects a beneficiary by minimizing or restricting the use of proceeds as long as the insurer holds them. Only after proceeds have been distributed can the beneficiary assign or transfer the benefits to a creditor. Additionally, under the spendthrift clause, a beneficiary cannot take the present value of future payments in a lump-sum (commuting) or use future payments as collateral for a loan (encumbering).
The spendthrift clause is most often used to prevent a beneficiary from recklessly spending benefits by requiring the benefits to be paid in fixed amounts or installments over a certain period. Beyond preventing distribution directly to the insured’s creditors, this clause doesn’t have any effect if the beneficiary receives the proceeds as one lump-sum payment. Additionally, once the beneficiary receives the payment, creditors may be able to take steps to collect on any money owed.
TAX CONSEQUENCES OF LIFE INSURANCE
TAX TREATMENT OF INDIVIDUAL LIFE INSURANCE
According to the Internal Revenue Code, premiums that are paid for individual life insurance policies are considered a personal expense and, as such, are not tax-deductible. Just because a premium is used to purchase life insurance on a spouse or in a third-party ownership situation doesn’t mean that the premiums will be tax-deductible.
Premiums paid on life insurance may be tax-deductible:
▪ To an employer if the insurance is used as an employee benefit
▪ To provide for charitable contributions
▪ To benefit an ex-spouse as court-ordered alimony
TAXATION OF PROCEEDS PAID AT DEATH
Since the premiums paid are not tax-deductible (they’re paid after-tax), the proceeds (death benefit) from the life insurance policy are generally paid to the named beneficiary on a tax-free basis if paid out as a lump-sum. The exception to this rule is the transfer for value rule, which applies when a life insurance policy is sold to another party before the insured’s death. The value of a life insurance policy (death benefit) is included in the policy owner’s estate, despite the fact that the face amount is paid to the beneficiary income tax free. If death benefits are paid in installments rather than as a lump-sum, the principal is received tax-free and any interest that’s received is taxable.
ECONOMIC BENEFIT DOCTRINE
According to the Economic Benefit Doctrine, if any benefit is granted to an individual that has an economic or financial value, it must be included as compensation for income tax purposes in the year in which the benefit is granted. The key to avoiding the imposition of the Economic Benefit Doctrine is the existence of a substantial risk of forfeiture. Therefore, individual life insurance avoids this doctrine since premature death can cause a substantial risk to a surviving family.
TAXATION OF CASH VALUES
The equity that builds within a whole life policy is referred to as the cash value. As the cash value increases or accumulates, the interest paid on it is tax-deferred. The total of the premiums paid into the policy, MINUS the total dividends received in cash or used to offset premiums, is referred to as the cost basis. According to the cost recovery rule, if the policy is surrendered for its cash value, the portion that exceeds the cost basis (or premiums paid) is considered ordinary income and taxable. As long as the cash value remains in the policy, taxes will never be imposed on any portion (not even the amount that exceeds the cost basis).
TAXATION OF POLICY LOANS
In most situations, if a contract owner borrows against the cash value in the contract (i.e., takes a policy loan), there are no tax consequences. However, if a policy is an MEC, distributions are subject to the interest first rule, which states that they’re taxable as income if the cash value of the contract immediately prior to the payment exceeds the cost basis in the contract.
Borrowing against the cash value may be referred to as a partial surrender. This action on the part of the owner, while not resulting in a taxable event, does lower the owner’s equity in the policy. If a total surrender occurs, the cash value received is not taxable as long as it doesn’t exceed the total of premiums paid by the owner (i.e., the cost basis). Additionally, when a contract owner borrows against the cash value of a whole life policy, the interest paid to the insurer is not tax-deductible.
For example, let’s assume that Bob is the owner of a $100,000 whole life insurance policy on his own life and the cash surrender value is $45,000. He has paid $35,000 in premiums over the years. If Bob borrows $40,000 against the policy, he will not be subjected to tax consequences as long as the policy remains active. Bob is obligated to repay the loan received from the insurer plus interest, but the interest is not tax-deductible.
If Bob surrenders the policy, he will realize a taxable gain of $10,000 (the difference between his $35,000 cost basis and $45,000 in surrender value) which must be reported as taxable ordinary income.
TAXATION OF ACCELERATED DEATH BENEFIT
Under a life insurance policy, when benefits are paid to a terminally ill person, the benefits are received on a tax-free basis. To be considered terminally ill, a physician must certify that the person has a condition or illness that will result in death within two years.
TAXATION OF POLICY DIVIDENDS
Dividends that are paid on a whole life policy are tax-exempt since they’re considered a return of overpaid or excess premiums. Although it’s unlikely to happen, any dividends that are received in excess of the premiums paid are taxable as ordinary income. If dividends are left with the insurer to accumulate interest, the interest earned will be taxable as ordinary income in the year in which it’s received. If the life insurance policy is determined by the IRS to be a Modified Endowment Contract (MEC), dividends will be taxable unless they’re used to purchase paid-up additional insurance. In addition, dividends payable under an MEC may be subject to a 10% penalty tax (applying to premature distributions before age 59 1/2).
MODIFIED ENDOWMENT CONTRACT
Recall from earlier that a Modified Endowment Contract is not a life insurance policy. It is an IRS classification or category of insurance contract if certain conditions are not satisfied with regard to the funding of the contract. Any life insurance policy purchased after 6/20/88 is considered by the IRS to be a MEC if it does not satisfy the seven-pay test.
The following are illustrations of the tax treatment of benefit distributions from an MEC:
Taxation only occurs when any cash is distributed to the contract owner or money is withdrawn, whether by surrender, loan, or dividends.
The gain (i.e., interest or appreciation) is taxable first when a distribution is made (i.e., LIFO).
The first dollars received by the contract owner are considered "earning first," or excess amounts of cash value beyond premiums and are taxable.
If a policy is an MEC and cash is withdrawn, appropriate amounts are still taxable, even if it will be used for a legitimate reason such as financial hardship or to pay medical expenses.
If cash is withdrawn prior to age 59 ½, a 10% penalty tax will be assessed.
1035 EXCHANGE
The Internal Revenue Code (IRC) permits an individual to trade or exchange a life insurance policy, endowment, or annuity contract for another of like kind. Since a life insurance policy is a form of property, exchanges of policies are allowed. When a less competitive policy is being replaced or exchanged with a more competitive policy, a Section 1035 exchange may be utilized which allows for the postponement of tax consequences. In other words, the IRC allows a tax-free exchange if it is done from insurer to insurer where the policy owner never receives any cash. This regulation allows the policy owner to move cash value from one contract to another without current tax considerations. As long as the transfer is transacted within or between insurance companies and the policy owner receives no money, the exchange is permitted (without tax ramifications). This means that, theoretically, the cost basis remains the same.
Therefore, the following types of exchanges are allowed under this section of the IRC;
(1) a life insurance policy for another life insurance policy, endowment, or annuity;
(2) an endowment policy for another endowment or an annuity; or
(3) an annuity contract for another annuity contract.
It is not permissible to exchange an annuity for a life insurance policy. The reason for this is that the IRS is not willing to allow a policy owner to exchange policies which will improve the income tax treatment of the benefits. If this were permitted, the policy owner could transfer funds from the annuity, which incurs income taxation on at least a portion of the benefits (i.e., tax deferral means that the annuitant will be taxed on interest sometime in the future), to a life insurance policy which pays a death benefit free of income taxation. If this were allowed, an annuity to life insurance exchange would move a tax-deferred characteristic to a tax-free characteristic.
With regard to a whole life insurance policy, a 1035 exchange involves the vesting of cash value from one permanent insurance plan to another. Some of the reasons why an individual considers such a transfer include: (1) the financial condition or rating of the current insurer; (2) the enhancement of benefits in newer policies; (3) higher interest rates being offered in the newer policies; or (4) the desire for additional investment alternatives not available under the older contract. When a policy owner decides to make a permitted exchange, the transfer, assignment or surrender of the policy to the insurer and the subsequent replacement with the new contract must be completed within sixty days. To ensure that there are no tax considerations because of the exchange, the policy owner should receive no cash proceeds.
CHAPTER SUMMARY: LIFE INSURANCE PREMIUMS, PROCEEDS, AND BENEFICIARIES
Life Insurance Premiums
The key points to remember from this chapter include:
▪ The premium is both an exchange for insurance protection and a portion of the policy owner’s consideration.
▪ Factors in premium calculations include:
‒ Mortality factor or mortality rate
‒ Interest factor
‒ Expense factor
▪ The mortality rate refers to the frequency of deaths in a defined population at a specific time interval.
▪ The morbidity rate refers to the occurrence of diseases in a defined population at a specific time interval.
▪ Interest is one of the ways an insurance company can lower the premium rates.
▪ The expense factor—also referred to as the loading charge or factor—is derived from operating expenses or funds that the insurer “pays out.”
▪ Net (single) premium is a premium that makes provisions for mortality (death benefit) losses only while being influenced by the interest rate assumed, gender, the benefit to be provided, and the mortality rate.
▪ Gross (annual) premium is the premium that’s charged by an insurer which is comprised of (or influenced by) the mortality, interest, and expenses.
▪ Additional factors that may influence the premium amount include:
‒ Age
‒ Sex/gender
‒ Health
‒ Occupation
‒ Hobbies
‒ Habits
‒ Benefits
‒ Options and riders
‒ Premium mode
▪ Premium mode refers to the policy feature that permits the policy owner to select the timing (frequency) of premium payments.
▪ With single premium funding, the policy owner pays a single premium that provides protection for the life of the policy.
▪ Fixed/Level premium funding averages the “single premium” over the policy period.
▪ Modified premium funding is characterized by an initial premium that’s lower than it should be during an introductory period (typically the first three to five years).
▪ Graded premium funding is a contract (like modified) that’s characterized by a lower premium in the early years of the contract.
▪ Flexible premium funding allows the policy owner to adjust the premiums throughout the life of the contract.
▪ Earned premium is the amount to which an insurer is entitled since it provided coverage for a specific period.
▪ Unearned premium is an amount of premium that the policyholder has paid to the insurance company, but coverage has not yet been provided.
▪ As required by law, reserves are the funds that are set aside by an insurer and used to pay current and future claims.
▪ A legal reserve is the amount of funds that an insurance commissioner (or director/superintendent) requires an insurer to maintain based on the mortality table and an assumed rate that’s designated by the state’s commissioner or state insurance law.
Comparing Life Insurance Policy Costs
▪ Surrender Cost Index uses a calculation formula in which the net cost is averaged over the number of years that the policy was in force to arrive at the average cost-per-thousand for a policy that is surrendered for its cash value at the end of that period.
▪ Net Payment Cost Index uses the same formula as the Surrender Cost Index; however, it doesn’t assume that the policy will be surrendered at the end of the period.
▪ During the life of the policy, the primary living benefit that a whole life (permanent life) insurance plan possesses is its cash value build-up.
Viatical Settlements
▪ The accelerated benefit—also referred to as the terminal illness rider—allows the policy owner to access a portion of the death benefit if a physician certifies that the insured is terminally ill.
▪ A viatical settlement allows a person with a chronic or terminal illness to sell his existing life insurance policy to a third party for a percentage of the face value.
‒ The original policy owner is referred to as the viator.
‒ The new third party owner is referred to as the viatical or the viatee.
▪ Chronically ill means a person who needs considerable supervision due to cognitive impairment or a person who cannot perform at least two activities of daily living.
▪ Terminally ill means a person who’s not expected to survive a medical condition for more than 24 months.
Life Insurance Death Benefits
▪ If a policy owner chooses to select a settlement option, it cannot be changed by the beneficiary.
▪ In a lump-sum settlement option, the death benefit is paid in a single payment, minus any outstanding policy loan balances and overdue premiums.
▪ Under the interest only settlement option, the insurance company holds the death benefit for a period and pays only the interest that’s earned to the named beneficiary.
▪ The fixed amount installment option permits the death proceeds to be left “at interest” with the insurer and to pay a fixed death benefit in specified installment amounts until the principal and interest are exhausted.
▪ The fixed period (period certain) option pays the death benefit proceeds in equal installments over a set period of years.
▪ The life income option provides the beneficiary with an income that she cannot outlive.
▪ Under the single, pure or straight life income option (as with a straight life annuity), monthly installments are paid to the beneficiary for as long as she lives.
▪ The refund life income option—also referred to as the joint life option—guarantees the return of an amount which is equal to the principal less any payments already made.
▪ The life income option with a period certain pays a monthly income for as long as the beneficiary lives. However, if the beneficiary dies before a predetermined number of years have elapsed, the insurer will continue monthly payments to a second beneficiary for the remainder of the designated period.
▪ The joint and survivor option guarantees that benefits will be paid on a life-long basis to two or more people.
▪ A revocable beneficiary may be changed or removed by the policy owner at any time without notifying or obtaining the beneficiary’s permission.
▪ An irrevocable beneficiary may not be changed without the beneficiary’s written consent.
Benefit Distribution
▪ Per capita means by the person or by the head.
▪ Per stirpes means by the bloodline.
▪ The primary beneficiary is the individual who receives the death benefit when the insured dies.
▪ The secondary or contingent beneficiary is the second individual(s) in line to receive the death benefit.
▪ A tertiary beneficiary is third in line to receive policy proceeds when the insured dies and this person survived both the primary and contingent beneficiaries.
▪ Testamentary trusts are created at the insured’s death according to a will.
▪ Inter vivos trusts or living trusts are created during the insured’s lifetime.
▪ The Uniform Simultaneous Death Act states that, if the insured and primary beneficiary both die in a common disaster and it cannot be determined who died first, the insured will be considered to have survived the primary beneficiary (or died last).
▪ The spendthrift clause provision protects a beneficiary from creditors with regard to life insurance proceeds.
▪ Dividends that are paid on a whole life policy are tax-exempt since they’re considered a return of overpaid or excess premiums.
▪ A Section 1035 exchange enables the postponement of tax consequences.