THE CONSTRUCTION OF A SURVIVORSHIP LIFE INSURANCE POLICY

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1 THE CONSTRUCTION OF A SURVIVORSHIP LIFE INSURANCE POLICY PERTINENT INFORMATION Mr. and Mrs. Kugler are considering $1,000,000 of life insurance to provide estate liquidity at the survivor s death to cover their projected estate settlement costs. GOALS AND OBJECTIVES They are concerned about finding a life insurance solution to provide sufficient liquidity at the second death, either to pay estate taxes and administrative costs, or to provide an inheritance for their children. They want to review: The main features of life insurance can provide estate liquidity at the survivor s death, and The advantages and disadvantages of the proposed life insurance. MAIN FEATURES OF THE POLICY The survivorship life policy is constructed in a manner consistent with construction of either the ordinary whole life or flexible premium (universal or adjustable life) policies covered earlier in this text. The one difference is that the mortality charge will be substantially lower because there are two insureds. Both must die before the death benefit is paid out. Ordinary whole life Design Pure Life Insurance Protection (Amount at Risk) Cash Value Illustrated to equal face amount at age 100 $1,000,000 At 1 st Death - NO DEATH BENEFIT PAID At 2 nd Death - DEATH BENEFIT OF $1,000,000 PAID Age Age The annual premium may be structured (assuming a specified rate of return) so the cash value at age 100 equals the death benefit, or to provide $1 of cash value at age 100, or any other premium structure desired by the policyowner (subject to minimum and maximum limits). $1,000,000 Flexible Premium Design Pure Life Insurance (Amount at Risk) Cash Value Illustrated to Equal OR face amount at age Cash Value Illustrated to maintain the death benefit At 1 st Death - NO DEATH BENEFIT PAID At 2 nd Death - DEATH BENEFIT OF $1,000,000 PAID Age 40 Age 100

2 ADVANTAGES OF SURVIVORSHIP LIFE INSURANCE A survivorship policy has a lower premium than two separate policies for the same total coverage (each policy for half the face amount). This is because the life insurance death benefit payout is not paid until the second death. The policy death benefit provides estate liquidity exactly when the estate tax is generally due for married individuals, or provides an inheritance exactly when it is desired, which is at the second death. Because the risk in a second-to-die policy is based jointly on two lives, the life insurance company is more likely to accept the risk and issue a policy, even if one insured has health problems and would be considered uninsurable for a single-life policy. The policy generally provides a higher cash value per $1,000 of premium because of the lower mortality charges. A rider may be available at the time of purchase which allows the joint life policy to be split into two policies without additional individual underwriting, each for one half of the original face amount. DISADVANTAGES OF SURVIVORSHIP LIFE INSURANCE The survivor does not receive any death benefit payments at the first death, and must continue to make any required premium payments until his or her subsequent death. If there is a divorce, the joint life policy may lose its usefulness because the estate arrangement may change. Two single-life policies may then be needed to maintain the required death benefit. Note: The exchange of a survivorship policy for two single life policies is not considered an exchange under IRC Section 1035 and may have tax consequences. If the survivorship life insurance policy is to be owned inside an irrevocable trust, the owners should make sure the trust document gives the trustee the power to divide the policy into two equal ones. TAX ASPECTS Estate Tax The death proceeds will be included in the surviving insured s estate if he/she retains any incidence of ownership in the policy (IRC Section 2042) or the death proceeds are paid to the survivor s estate. However, if the policy is owned by a family member or a life insurance trust, the death proceeds may be excluded from the estate. Note: Mr. Kugler may provide funds for premiums via annual gifts to a family member or an irrevocable trust. Income Tax Life insurance premiums are generally not tax deductible. Policy cash value accumulates on a tax-deferred basis and is only taxable if there is a gain on policy surrender or if withdrawals or dividends received exceed cost basis. Losses are not tax deductible. (IRC Section 72(e)) Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1). See tax chapter for transfer-for-value exception.

3 ORDINARY SURVIVORSHIP WHOLE LIFE DESIGN PERTINENT INFORMATION Mr. and Mrs. Kugler are considering $1,000,000 of survivorship (joint life) life insurance. GOALS AND OBJECTIVES Mr. and Mrs. Kugler want to pay a guaranteed level premium throughout their lives for a guaranteed $1,000,000 death benefit payable at the survivor s death. The Kuglers want to provide at the second death 1) either estate liquidity to pay their estate settlement costs, or 2) an inheritance for their children. Mr. and Mrs. K are concerned about Mr. K s insurability because he has had some health problems. They d like to review the following: The main features of the proposed life insurance functions. The advantages and disadvantages of the proposed coverage. The tax aspects of premiums, cash value and death proceeds. PROPOSED ARRANGEMENT Consider purchasing a survivorship ordinary whole life insurance policy. Note: The ordinary whole life design will have a fixed premium, eligible for non-guaranteed dividends, and cause the policy cash value to equal the face amount at age 100. MAIN FEATURES OF THE POLICY The survivorship ordinary whole life offers all of the dividend options (i.e. reduce premiums, accumulate cash value and paid-up additions) and most of the riders (i.e. additional insurance rider, LTC rider, no-lapse guarantee, etc.), that are available for a single life policy and are illustrated in chapter three. $1,000,000 Annual Premium: $7,000 (Assume Dividend Applied to Reduce Premium) Pure Life Insurance st Death Cash Value 30 2 nd Death At First Death in 20, No Death Benefit Paid At Second Death in 30, $1,000,000 Death Benefit Paid

4 Example: The following illustration assumes a $1,000,000 Ordinary whole life policy for a male age 40 and female age 40. Dividends are applied to reduce premiums. Net Premium Cash Death Outlay Value Benefit 1 7, ,000, ,000 7,000 1,000, ,500 14,100 1,000, ,200 21,500 1,000, ,000 29,100 1,000, ,900 37,000 1,000, ,800 45,400 1,000, ,600 54,100 1,000, ,300 63,200 1,000, ,100 72,600 1,000, ,300 86,700 1,000, , ,500 1,000, , ,800 1,000, , ,700 1,000, , ,200 1,000, , ,300 1,000, , ,900 1,000, , ,200 1,000, , ,000 1,000, , ,400 1,000, (4,000) 448,100 1,000,000 Note: Based on the assumed dividend scale, the net outlay would go below zero beginning in year 26. If the dividend scale were reduced by 1%, the net outlay would go below zero beginning in year 29.

5 ADVANTAGES OF A SURVIVORSHIP ORDINARY WHOLE LIFE POLICY Premium payments are guaranteed and may not be increased by the life insurance company. They are typically 30% to 50% less than the combined premium for two single-life ordinary policies. Payment of the death benefit is guaranteed exactly when it is needed (at the survivor s death), either to provide the desired estate liquidity or to provide an inheritance. Because the risk in a second-to-die policy is based jointly on two lives, the life insurance company is more likely to accept the risk and issue a policy, even if one insured has health problems and would be considered uninsurable for a single-life policy. Since the mortality charges are reduced (joint lives), the policy cash value will be greater, assuming comparable premium payments. Policy Dividends: the annual premiums are calculated based upon either conservative or guaranteed interest and joint life mortality rates and maximum expense charges to endow the policy at the survivor s age 100. If the current experience is more favorable (i.e., an interest rate higher than the guaranteed rate, mortality experience better than guaranteed, or expense charges lower than guaranteed), then a portion of the premium will be returned to the policyowner via a generally tax-free dividend (up to cost basis). However, dividends are based on the company s actual experience and are not guaranteed. Dividends may be higher or lower than those illustrated. DISADVANTAGES OF A SURVIVORSHIP ORDINARY WHOLE LIFE POLICY Lack of premium flexibility, because the premium must be paid every year. However, this problem is reduced as the policy dividends become available for premium payments. The survivor receives no death benefit payment at the first death, and must continue to pay the premiums even though one insured has already died. TAX ASPECTS Estate Tax The death proceeds will be included in the surviving insured s estate if he/she retains any incidence of ownership in the policy (IRC Section 2042) or the death proceeds are paid to the survivor s estate. However, if the policy is owned by a family member or a life insurance trust, the death proceeds may be excluded from the estate. Note: The Kuglers may provide funds for premiums via annual gifts to a family member or an irrevocable trust. Income Tax Life insurance premiums are generally not tax deductible. Policy cash value accumulates on a tax-deferred basis and is only taxable if there is a gain on policy surrender or if withdrawals or dividends received exceed cost basis. Losses are not tax deductible. (IRC Section 72(e)) Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1). See tax chapter for transfer-for-value exception.

6 FLEXIBLE PREMIUM SURVIVORSHIP LIFE POLICY DESIGN PERTINENT INFORMATION Mr. and Mrs. Kugler are considering $1,000,000 of survivorship (joint life) life insurance. GOALS AND OBJECTIVES Mr. and Mrs. Kugler want to pay a level planned premium throughout their lives to provide a no-lapse guaranteed $1,000,000 death benefit payable at the survivor s death. They would also like to have the flexibility to vary their premium outlay from year to year should their funding objectives change. The Kuglers want to provide either estate liquidity at the second death or an inheritance for their children. Mr. and Mrs. K are concerned about Mr. K s insurability because he has had some health problems. They d like to review the following: The main features of the proposed life insurance functions. The advantages and disadvantages of the proposed coverage. The tax aspects of premiums, cash value and death proceeds. PROPOSED ARRANGEMENT Consider purchasing a survivorship flexible premium life insurance policy. MAIN FEATURES OF THE POLICY ASSUME 1 ST DEATH IN YEAR 20 AND 2 ND IN YEAR 30 $1,000,000 Death Benefit $6,600 Pure Life Insurance Planned premium Cash Value st Death At First Death in 20, No Death Benefit Paid At Second Death in 30, $1,000,000 Death Benefit Paid 30 2 nd Death Flexible premium survivorship life offers all of the funding flexibility (i.e. limited pay, stop and go, endow at age 100, lapse at age 100, secondary no-lapse guarantee, etc.,) and riders (i.e. premium cost recovery, LTC rider, etc.,) generally available for single life flexible premium policies illustrated in chapter 4.

7 Example: The following illustration assumes a $1,000,000 Flexible premium life policy for a male age 40 and female age 40. Planned Account Death Premium Value Benefit 1 $6,600 4,800 $1,000, ,600 9,900 1,000, ,600 15,300 1,000, ,600 21,000 1,000, ,600 28,400 1,000, ,600 36,200 1,000, ,600 44,400 1,000, ,600 53,000 1,000, ,600 62,100 1,000, ,600 71,700 1,000,000 Crossover 11 6,600 82,500 1,000, ,600 93,800 1,000, , ,000 1,000, , ,900 1,000, ,900 1,000, ,300 1,000, ,200 1,000, ,500 1,000, ,300 1,000, ,500 1,000, ,000 1,000,000 Any change in the interest rate, mortality charges or expense charges will impact the policy performance which will in turn impact the crossover year. For example, if immediately after the policy is issued, the interest rate were reduced by 1%, the crossover year would be extended to year 26. The alternative would be to increase the premium in year one to $9,900 to make up for the reduced interest rate.

8 ADVANTAGES OF A SURVIVORSHIP FLEXIBLE PREMIUM LIFE POLICY A survivorship policy is more likely to be issued than two single-life policies where one of the insured has health issues. Premium payments are less (typically 30 to 50%) than the combined premium for two single-life flexible premium policies. Since the mortality charges are reduced (joint lives) the policy account value will be greater than for a single life policy assuming comparable premium payments. The policy design that provides a secondary no-lapse guarantee of the death benefit is also available for flexible premium survivorship life policies. The death benefit will be paid at the death of the surviving insured when it is needed, either to provide the desired estate liquidity or to provide an inheritance. Premium payments are flexible and can be structured to meet the policyowner s budget and funding limits. It is possible for the owner to make unscheduled premium payments, pay less than the planned premium, or even skip payments, so long as the net account value is enough to pay the mortality and expense charges. Itemized policy costs of insurance, current and guaranteed interest-crediting rates and the account values are all provided to the policyowner each year. DISADVANTAGES OF A SURVIVORSHIP FLEXIBLE PREMIUM LIFE POLICY The survivor receives no death benefit payment at the first death, and must continue to pay the mortality and expense charges even though one insured has already died. This funding method must be monitored closely because, if the policy cash value is reduced below the amount required to pay the mortality and expense charges, the policy will lapse. The life insurance company has the contractual right to change the mortality and expense charges and the current interest-crediting rate. However, the amount these rates can be changes is contractually limited. TAX ASPECTS Estate Tax The death proceeds will be included in the surviving insured s estate if he/she retains any incidence of ownership in the policy (IRC Section 2042) or the death proceeds are paid to the insured s estate. However, if the policy is owned by a family member or a life insurance trust, the death proceeds may be excluded from the estate. Note: Mr. Kugler may provide funds for premiums via annual gifts to a family member or an irrevocable trust. Income Tax Life insurance premiums are generally not tax deductible. Policy cash value accumulates on a tax-deferred basis and is only taxable if there is a gain on policy surrender or if withdrawals or dividends received exceed cost basis. Losses are not tax deductible (IRC Section 72(e)). Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1). See tax chapter for transfer-for-value exception.

9 ORDINARY SURVIVORSHIP WHOLE LIFE DESIGN WITH A CASH VALUE INCREASE AT THE FIRST DEATH PERTINENT INFORMATION Mr. and Mrs. Kugler are considering $1,000,000 of survivorship (joint life) ordinary whole life insurance. GOALS AND OBJECTIVES Mr. and Mrs. Kugler want to pay a level premium throughout their lives for a guaranteed $1,000,000 death benefit, payable at the surviving spouse s death. They want to provide estate liquidity at the death of the second spouse to pay their estate settlement cost. The policy will be owned by an irrevocable life insurance trust for the benefit of their children. They would like to see a survivorship life policy structure that differs from the traditional structure by generally providing some additional policy value when the first of the two insureds dies. PROPOSED ARRANGEMENT Consider purchasing a survivorship life insurance policy that provides an increase in the policy cash value when the first insured dies. MAIN FEATURES OF THE POLICY At the death of the first insured, the cash value of the policy is increased to the cash value required for a single life policy at the surviving insured s attained age, to equal the face amount at age 100. The mortality charges for this cash value increase at the first death are factored into the overall premium. After the first death, the policy would in effect be treated as a single life policy with cash value and mortality charges for a single life policy. ASSUME FIRST DEATH IN YEAR 15 $1,000,000 Increase in Cash Value At 1 st Death Pure Life Insurance Cash value required for single life policy at surviving insured s attained age to allow the cash value to equal the face amount at age Age 100 Note: The gross premium does not change at the first death. However, the cash value increase should result in an increase in the policy dividends attributable to the interest portion of the dividend.

10 While both insureds are alive the policy essentially functions like the traditional survivorship policy (previous cases) except that there is a special actuarial calculation to factor in the increase in cash value at the first death. ADVANTAGES OF A SURVIVORSHIP ORDINARY WHOLE LIFE POLICY WITH A CASH VALUE INCREASE AT THE FIRST DEATH At the first death, the surviving insured may have a policy with substantially more cash value (equivalent to the cash value needed to support a single life policy at the survivor s age). The increase in cash value should cause a corresponding increase in policy dividends, because the major portion of the dividend usually comes from the interest earnings in excess of the guaranteed rate applicable to the policy cash value. Higher dividends generate lower net out of pocket costs. The increased dividends may be used to reduce premiums or increase policy benefits. Generally this policy design is most economical in situations when the first of the two insureds dies prior to attaining that insured s single life expectancy. Generally, this policy design creates a greater degree of complexity and uncertainty in the policy illustration. DISADVANTAGES OF A SURVIVORSHIP ORDINARY WHOLE LIFE POLICY WITH A CASH VALUE INCREASE AT FIRST DEATH In order to illustrate how the policy functions you must assume the year of the first death. This policy format may not be available if one individual is uninsurable. Also, this policy format is generally only available under the ordinary whole life policy design. The gross premium may be slightly higher for this policy design. Generally, this policy design is not as economical in situations when the first of the two insureds dies beyond that insured s single life expectancy. TAX ASPECTS Estate Tax The death proceeds will be included in the surviving insured s estate if he/she retains any incidence of ownership in the policy (IRC Section 2042) or the death proceeds are paid to the insured s estate. However, if the policy is owned by a family member or a life insurance trust, the death proceeds may be excluded from the estate. Income Tax Life insurance premiums are generally not tax deductible. Policy cash value accumulates on a tax-deferred basis and is only taxable if there is a gain on policy termination, or if withdrawals or dividends received exceed cost basis. Losses are not deductible. (IRC Section 72(e)) Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1). See tax chapter for transfer-for-value exception.

11 GUARANTEED LEVEL TERM INSURANCE WITH CONVERSION RIGHT PERTINENT INFORMATION Mrs. Kugler is considering $500,000 of life insurance. At the present time, her cash flow is fairly constant, but she has limited funds that can be allocated to life insurance premiums. GOALS AND OBJECTIVES Since Mrs. Kugler expects to have coverage for 10 years or so, she wants a policy that will produce a lower average premium over the period. She wants to be assured that should she develop health problems, and not be physically qualified to purchase subsequent coverage, that permanent life insurance will be available to her via the conversion option. She would like to review the following: The main features of the level term life insurance functions. The advantages and disadvantages of the level term life insurance coverage. General information on General information on the tax aspects of the premiums and the death proceeds. PROPOSED LIFE INSURANCE Consider purchasing a 10-year convertible guaranteed level term life insurance policy. MAIN FEATURES OF THE POLICY $500,000 $425 Level Death Benefit Guaranteed Level Premium 1 Term Period 10 The following provides a somewhat simplified version of a typical method used by a life insurance company to determine the level premium for a 10-year term life insurance policy: Calculate the increasing mortality costs required throughout the specified term (see previous discussion of ART policy) for the desired death benefit amount each year, then 1 Term Period Factor in costs for underwriting the policy, maintaining the policy and profit margin for the insurance company, then Using current interest rates determine the present value for above items, then, Determine the level premium to fund the present value over a period of 10 years. 10

12 As a result, in early policy years, the owner pays a slightly greater premium for the policy s death benefit protection as compared to the premium in an ART policy for the same policy years. In later years, the premium would be lower than the increasing ART premium. Note: The graphics and numerical illustrations are intended to demonstrate a generic illustration of the life insurance product and not actual figures for any particular age or life insurance company. ADVANTAGES OF GUARANTEED LEVEL TERM The most frequently issued term product because the level premium structure is more generally economical over the desired period of years. The level term policy duration would typically be between 10 to 30 years. The policy provides a death benefit to meet a need for which the policyowner wants to pay a level premium for a temporary period. The guaranteed premium remains level each year, even as the insured ages and the probability of death increases. As a result, the premium does not directly correlate to the insured s probability of death at the insured s current age. The policy will usually contain a convertibility feature, which protects against the future uninsurability by providing a contractual right to convert the term policy to a permanent policy. Therefore, Mr. Kugler should closely examine the quality of the permanent policies offered by the company providing the term coverage. DISADVANTAGES OF GUARANTEED LEVEL TERM The premium increases to current attained age rates at the end of the level period. The policy provides death benefit only; there is no cash surrender value. The cost of the convertibility right must be factored into the premium. Many companies limit the conversion right to a specified permanent policy which may not be the company s best policy. TAX ASPECTS Estate Tax The death proceeds will be included in the insured s estate if Mrs. K retains any incidence of ownership in the policy (IRC Section 2042) or the death proceeds are paid to the insured s estate. However, if policy is owned by a family member or a life insurance trust, the death proceeds may be excluded from the estate. Note: Mrs. Kugler may provide funds for premiums via annual gifts to a family member or an irrevocable trust. Income Tax Life insurance premiums are generally not tax deductible. Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1) (see tax chapter for transfer-for-value exception).

13 ANNUAL RENEWABLE TERM INSURANCE WITH CONVERSION RIGHT PERTINENT INFORMATION Mrs. Kugler is considering $500,000 of life insurance. Presently, she has limited funds that can be allocated to life insurance premiums. GOALS AND OBJECTIVES She wants to pay the lowest possible premium for the next few years. She wants to be assured that should she develop health problems, and not be physically qualified to purchase subsequent coverage, that permanent life insurance will be available to her via the conversion option. She would like to review the following: The main features of renewable term life insurance functions. The advantages and disadvantages of the renewable term life insurance coverage. General information on the tax aspects of the premiums and the death proceeds. PROPOSED LIFE INSURANCE Consider purchasing a convertible annual renewable term (ART) life insurance policy. MAIN FEATURES OF THE POLICY The following provides a somewhat simplified version of a typical method used by a life insurance company to determine the annual premium for the annual renewable term policy: Using current mortality table, calculate the term premium (based on probability of death) for each age. Factor in costs for underwriting and maintaining the policy and a profit margin for the life insurance company. Charge the resulting annual premium each year. $500,000 1 $375 2 $405 3 $435 4 $465 Current Premium Death Benefit Note: The graphics are intended to demonstrate a generic illustration of the life insurance product and not actual figures for any particular age or life insurance company

14 ADVANTAGES OF ANNUAL RENEWABLE TERM The policy provides a death benefit to meet a need for which the policyowner wants to pay the lowest premium for the amount of death benefit at the insured s current age. The policy will provide the guaranteed maximum premium for each policy year. Most companies will also illustrate non-guaranteed rates based on the current mortality and expense experience of the life insurance company for the insured s age. In the early years the policy provides a lower premium which is advantageous to the policyowner that expects to convert the policy within a few years. The policy will usually contain a convertibility feature, which protects against the future uninsurability of the insured by providing a contractual right to convert the term policy to a permanent policy. Therefore, Mr. Kugler should closely examine the quality of the permanent policies offered by the company providing the term coverage. DISADVANTAGES OF ANNUAL RENEWABLE TERM Generally level term can be obtained for a comparable or lower premium for the desired term period. Since the insured provides evidence of insurability in the initial year, the life insurance company may guarantee the lowest premium for a period of years following the initial year. After that period, there may be a significant difference between the illustrated premium (not guaranteed) and the guaranteed premium the company may charge. After the initial years, the term premium is often higher than the premium for a comparable new term policy. As the premium increases each year the premium may become prohibitive at older ages. The policy provides death benefit only; there is no cash surrender value. The cost of the convertibility right must be factored into the premium. Many companies limit the conversation right to a specified permanent policy which may not be the company s best policy. TAX ASPECTS Estate Tax The death proceeds will be included in the insured s estate if Mrs. K retains any incidence of ownership in the policy (IRC Section 2042) or the proceeds are paid to the insured s estate. However, if the policy is owned by a family member or a life insurance trust, the proceeds may be excluded from the insured s estate. Note: Mr. Kugler may provide funds for premiums via annual gifts to a family member or an irrevocable trust. Income Tax Life insurance premiums are generally not tax deductible. Death proceeds of a life insurance policy are generally received income tax-free by a beneficiary under IRC Section 101(a)(1) (see tax chapter for transfer-forvalue exception).

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