Life Insurance — A Practical Guide for Evaluating Policies (Portfolio 827)

Tax Management Portfolio, Life Insurance — A Practical Guide for Evaluating Policies, No. 827-2nd, is a guide to the evaluation, selection, and purchase of life insurance.

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Tax Management Portfolio, Life Insurance — A Practical Guide for Evaluating Policies, No. 827-2nd, is a guide to the evaluation, selection, and purchase of life insurance. The portfolio provides a brief section on life insurance basics and a description of the tax preferences life insurance enjoys. The portfolio then provides a detailed analysis of the six basic questions that an insured and his or her advisor should ask when purchasing life insurance.
As part of the basics, the portfolio defines life insurance terms and clauses, such as cash value, term life insurance, and permanent insurance. The portfolio then outlines the income-tax-favored nature of life insurance, the tax-deferred growth of cash value accounts, and how to access those cash value accounts.
The portfolio provides guidance on the amount of life insurance to buy. The portfolio analyzes such factors as the insured's death benefit needs, estate tax payments, estate liquidity, and pension maximization plans. The portfolio also discusses cash accumulation needs and business needs.
Next, the portfolio examines the types of life insurance available to buy. The portfolio analyzes term insurance, whole life policies, universal life policies, and variable life policies. The portfolio addresses single versus joint policies, policy riders, and the allocation of risk among the various types of life insurance.
The portfolio outlines the steps in the purchasing process. The portfolio addresses third-party advisors, agents and brokers, solicitation of multiple offers, and the application process. The portfolio also analyzes the medical examination process and the underwriting process.
The portfolio provides strategies on obtaining the best deal. The portfolio points out hidden costs and discusses guarantees, agent/broker commissions, and the differences among various jurisdictions. The portfolio tells the insured how to compare offers and evaluate life insurance illustrations, policy performance, and carriers.
The portfolio next examines ways to structure life insurance holdings, private placement life insurance, leveraged life insurance, and offshore life insurance products.
The portfolio concludes with guidance on obtaining in-force illustrations, premium payment considerations, common pitfalls, and exit strategies.
This portfolio may be cited as Lee and Wilkey, 827-2nd T.M., Life Insurance — A Practical Guide for Evaluating Policies.


Gary R. Lee, Esq.

Gary R. Lee, B.A., cum laude, University of Connecticut; J.D., McGeorge School of Law, University of the Pacific; LL.M. in taxation, Boston University School of Law; member, California State Bar; member, Massachusetts State Bar; Certified Public Accountant (CPA); Certified Financial Planner (CFP); field experience as Advanced Sales Attorney advising on life insurance purchases; author/co-author, various life insurance articles in tax publications; speaker, various life insurance forums; formerly National Director of Insurance Consulting Services for Deloitte & Touche, LLP.

Craig Wilkey

Craig Wilkey, B.A., Tufts University; M.B.A., Northeastern University; Certified Life Underwriter (CLU); Chartered Financial Consultant (ChFC); Fellow, Life Office Management Association; life insurance consulting experience at Deloitte LLP; product development and advanced sales development experience at New England Life, a MetLife subsidiary.

Table of Contents

Detailed Analysis

I. Introduction

Introductory Material

A. Questions This Portfolio Will Address

1. How Much Life Insurance Do I Need?

2. What Type Should I Buy?

3. What Are the Steps in the Purchasing Process?

4. How Do I Get the Best Deal?

5. What Other Things Should I Consider?

6. How Do I Evaluate My Policy on an Ongoing Basis?

B. Life Insurance Basics

1. Term vs. Permanent Life Insurance Policies

2. Cash Value - What It Is and How It Works

3. Income Tax Favored Nature of Life Insurance

a. Tax-Deferred Growth of Cash Value Account

b. Ability to Access Cash Values Tax-Free

(1) In General

(a) Policy Loans

(b) Surrenders

(2) Limitations on Tax-Free Access

(a) Modified Endowment Contracts (“MECs”)

(b) Benefit Reduction in the First 15 Years - § 7702(f) Distributions

c. Income-Tax-Free Death Benefits

(1) In General

(2) Limitations on Tax-Free Death Proceeds

II. How Much Life Insurance Do I Need?

A. Assessing the Purpose of the Purchase

1. Death Benefit Needs

a. Personal Needs

(1) Death of the Income Earner

(2) Pension Maximization Plans

(3) Estate Tax Payment

(4) Estate Liquidity

b. Business Needs

(1) Death Benefit Only Plans

(2) Section 162 Bonus Plans

(3) Key Person Insurance

(4) Buy-Sell Insurance

2. Cash Accumulation Needs

a. Personal Needs

b. Business Needs

(1) Corporate Owned Life Insurance (COLI)

(a) In General

(b) Informal Funding of Deferred Compensation

(2) Bank-Owned Life Insurance

B. Crunching the Numbers

III. What Type of Life Insurance Should I Buy?

Introductory Material

A. Types of Life Insurance Policies

1. Types of Term Insurance

a. Group Term

b. Annual Term

c. Level Term

d. Decreasing Term

2. Types of Permanent Insurance

a. Whole Life Policies

(1) In General

(2) Dividends

(3) Paid-Up Additions

(4) Whole Life Variations

(a) Ordinary Life

(b) Whole Life/Term Blend

(c) Limited Pay Contracts

(d) Graded Premium Life

(e) Modified Premium Life

(f) Single Premium

(g) Interest-Sensitive Whole Life

b. Universal Life

(1) In General

(2) Cash Value vs. Surrender Value

(3) Universal Life Variations

(a) Death Benefit Options

(b) Secondary Guarantees

c. Variable Life

(1) In General

(2) Variable Life Variations

3. Single vs. Joint Life Policies

a. Single Life Policies

b. Second-to-Die Policies

c. First-to-Die Policies

4. Policy Riders

a. Waiver of Premium

b. Accidental Death Benefit Rider

c. Spousal/Children's Death Protection Rider

d. Accelerated Death Benefit Rider

e. Cost of Living Rider

f. Guaranteed Purchase Option

g. Extended Maturity Rider

h. Policy Split Rider

B. Allocating Risk

1. The Sharing of Risk

a. Whole Life

b. Universal Life

c. Variable Life

2. Types of Risk in Life Insurance

a. Mortality Risk

b. Interest/Investment Risk

c. Expense Risk

d. Lapse Risk

3. Product Type Risk Chart

4. Death Benefit Guarantees

C. Constructing an Insurance Plan

1. Who Should Be Insured?

2. How Long Is the Coverage Needed?

3. Are Guarantees More Important Than Premium Flexibility or Product Performance?

4. Cash Flow Considerations

D. Making the Product Decision

IV. What Are the Steps in the Purchasing Process?

Introductory Material

A. Using Third Party Advisors

B. Evaluating Agents and Brokers

1. In General

2. National Producer Groups

C. Soliciting Offers from Multiple Sources

1. Involving More Than One Producer

2. Involving More Than One Insurance Carrier

3. The Importance of Diversification

D. The Application Process

E. The Medical Examination Process

1. Preparing for the Physical Examination

a. Examination Requirements

b. Smoking Status

2. Attending Physician Statements

3. Medical Information Bureau

F. The Underwriting Process

1. Financial Underwriting

2. Medical Underwriting

3. Ratings and Flat-Extra Charges

4. Reinsurance

V. How Do I Get The Best Deal?

Introductory Material

A. Product Design Secrets - Where the Costs Are Hidden

1. Obtaining the Most Favorable Underwriting Class

a. In General

b. Tobacco Use

c. Reinsurance Issues

d. Broadening the Case Underwriting

2. Reassessing Guarantees/Policy Riders

3. Agent/Broker Compensation - Commissions

a. Commission Structures

b. Planning Opportunities

4. Consider a Change in Jurisdiction

B. Comparing Offers

1. Understanding Life Insurance Illustrations

a. In General

b. Guaranteed Values vs. Projected Values

(1) Guaranteed Values

(2) Current Values

2. Evaluating Policy Performance

a. Present Value of Outlay

b. Internal Rate of Return on Cash Value

c. Internal Rate of Return at Death

3. Other Considerations

a. The Importance of Cash Value

b. Short-Term Projections

c. Assessing the Reliability of the Underlying Illustration

(1) Cost of Insurance Charges

(2) Interest Crediting Rates

(3) Dividend Rates

4. Evaluating Carriers

a. Rating Agencies

b. A Note on Demutualization

C. Documenting the Purchase

1. Sales Illustrations

2. Life Insurance Contract

3. Confirmation of Underwriting Classification

4. Confirmation of § 7702 Compliance

5. Confirmation of MEC Status

VI. What Other Things Should I Consider?

A. Ways to Structure Life Insurance Holdings

1. Individual Ownership

2. Irrevocable Life Insurance Trusts (“ILIT”)

3. Split-Dollar Arrangements

B. Private Placement Life Insurance

C. Premium Financed Life Insurance

D. Offshore Life Insurance Products

1. Asset Protection

2. Greater Fund Choice

3. Improved Performance Through Tax Savings

4. Other Considerations

VII. How Do I Evaluate My Policy on an Ongoing Basis?

A. Obtaining In-Force Illustrations

B. Premium Payment Considerations

1. Change In Smoker/Non-Smoker Status

2. Reapplying for Coverage

C. Common Planning Pitfalls

1. Outdated Beneficiary Designations

2. Gifts of Policies with Outstanding Loans

3. Transfers for Value

D. Exit Strategies

1. Carrier Elections

a. Policy Surrender

b. Extended Term Insurance

c. Reduced Paid Up Election

2. Section 1035 Exchange to an Annuity

3. Life Settlements

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Risk Tolerance Flowchart

Worksheet 2 Selecting Policy Type Flowchart

Worksheet 3 Selecting Carrier Flowchart

Worksheet 4 Preliminary Underwriting Questionnaire

Worksheet 5 Broker Questionnaire

Worksheet 6 Illustration Request Form

Worksheet 7 Rating Categories and Distribution

Worksheet 8 Sample Universal Life Policy

Worksheet 9 Buy Term or Permanent Insurance

Worksheet 10 Carrier Rating Evaluation

Worksheet 11 Sample for Non-Smoker Risk Classification

Worksheet 12 Sample Medical Underwriting

Worksheet 13 Sample Financial Underwriting





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