APPENDIX 4 - LIFE INSURANCE POLICIES PREMIUMS, RESERVES AND TAX TREATMENT

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1 APPENDIX 4 - LIFE INSURANCE POLICIES PREMIUMS, RESERVES AND TAX TREATMENT Topics in this section include: 1.0 Types of Life Insurance 1.1 Term insurance 1.2 Type of protection 1.3 Premium calculation for term insurance 1.4 Example of premium calculation for term insurance 1.5 Conversion options 1.6 Joint coverages 1.7 Forms of term insurance Annual renewal term Five-year, 10-year, and 20-year renewable term insurance Level term insurance to age 65 or Term-to-100 (T-100) Traditional term-to Non-traditional term-to Whole-Life Insurance Level premium concept Participating whole-life insurance Coverage options 1.10 Universal Life (UL) Insurance Attributes Flexibilities of universal-life policies Investment options Bonus Illustrations 1.11 Taxation of Insurance Policies Disposition Proceeds of disposition Disposition of a life-insurance policy 1.12 Transfer of interest Transfer of ownership 1.13 Exempt and Non-Exempt Policies Policies last acquired prior to December 1, Policies last acquired after December 1, 1982 Copyright 2011 Oliver Publishing Inc. All rights reserved 1

2 1.0 Types of Life Insurance 1.1 Term insurance Term insurance provides life insurance protection in the event of death of the life insured during a specified period of time. The period of time may be a 5-year, 10-year term or term coverage to the age of 65, 70 or 75 years. 1.2 Type of protection Term insurance provides temporary protection with no cash values for a wide variety of financial needs. It is for these reasons that term insurance can be an inexpensive insurance solution. 1.3 Premium calculation for term insurance For term insurance the premium is calculated as the net amount at risk times the probability of death in that year. 1.4 Example of premium calculation for term insurance The premium calculations are shown below, assuming renewable term insurance in a face amount of $1,000 and a term of five years. Calculations show how guaranteed renewal premiums are arrived at. The assumed age of the life insured is 40 years. 1 Assume $1,000 face amount and five-year term 2 The mortality rate increases every year, and therefore the premium 3 To arrive at a level premium for the term, one selects the equated cash flow that generates the same PV On Purchase with medical underwriting Year Mortality rate per 1,000 Premium/$1,000 PV of premium PV of Level premium Copyright 2011 Oliver Publishing Inc. All rights reserved 2

3 Level premium for five-year term = 9.33 per $1,000 of insurance Assume a male aged 40 buys a five-year term term-insurance policy for $100,000. His actual premiums would be calculated as follows: 1. Mortality cost = $100,000 x $9.33 $1,000 = $ Policy fee: $ 100 Total annual premium $1,033 For a monthly premium, if the modal factor is 0.09 The monthly premium = $1,033 x 0.09 = $92.97 per month Renewal after five years no medical Year Mortality rate per 1,000 Premium/$1,000 PV of premium PV of Level premium If a ten-year renewable policy was purchased, the premiums would have been calculated as: Level premium for next five-year renewal = $ $2 = $18.30 per $1,000 of insurance The $2 added is just to demonstrate that the insurer will adjust for guarantees of renewal premium, since a sizeable percentage of the population who are renewing may be higher risks. Copyright 2011 Oliver Publishing Inc. All rights reserved 3

4 The table below shows the calculation for a 10-year term policy. Year Mortality rate per 1,000 Premium/$1,000 PV of premium PV of level premium Conversion options Many term-insurance policies also offer a feature called convertibility. This feature allows the owner of the policy to convert the term coverage to one of the permanent polices offered by the company, without having to provide evidence of insurability. When such a feature is available, the policy is called a convertible policy. This feature is especially attractive to individuals who need a large amount of permanent insurance protection, but are currently unable to afford it, due to budget constraints. This also provides flexibility to some individuals who may need permanent insurance to cover a need that arises later when they are no longer insurable. There are two forms of conversion: Attained-age conversion, in which the rate for the new permanent policy is calculated at the current age of the insured when the policy is being converted. Original-age conversion, under which option the rate for the new permanent policy is calculated using the rate that would have been charged had a permanent policy been purchased in the first place. The owner will have to pay the difference in premium between that for the permanent and the term policies for the elapsed period. An interest charge may also apply to the amount determined as arrears. Copyright 2011 Oliver Publishing Inc. All rights reserved 4

5 1.6 Joint coverages Many term plans are offered on a joint-coverage basis, where more than one life insured is covered under the same policy. The joint coverage comes as either joint-first-to-die coverage or joint-last-to-die coverage. Under joint-first-to-die coverage, two or more lives are insured jointly, and the death benefit is payable on the death of the first life insured. This kind of coverage is useful when individuals share a common liability that will be due on the death of any one of them (e.g., a buy-sell arrangement between the owners of a business). The cost of a joint first-to-die policy will be greater than the premium paid for an individual policy on the life of the person insured whose premium would be higher, but much less than the total premiums paid for individual policies for the lives insured. Under the joint-last-to die coverage, two or more lives are insured jointly, and the death benefit is payable on the death of the last life insured. Such coverage is desirable where two or more lives share a common liability that will be due when the last of them dies (e.g., capital-gains taxes on properties owned by spouses). The cost of a joint last-to-die policy will be less than the premium paid for an individual policy on the life of the person insured whose premium would be lesser. 1.7 Forms of term insurance Annual renewable term The premium increases every year, based on the age of the life insured. The premium is calculated as: net amount at risk x probability of death in that year The premium starts low and increases rapidly with age Five-year, 10-year, and 20-year renewable term insurance We illustrated this in our tables at the beginning. The premium is level for each term, but increases with each renewal Level term insurance to age 65 or 70 A level premium is charged until the life insured attains the age specified, which is usually 65 or 70 years of age. Copyright 2011 Oliver Publishing Inc. All rights reserved 5

6 1.8 Term-to-100 (T-100) Traditional term-to-100 Traditional term-to-100 policies follow the premium calculations of the term policy by levelling the premium to age 100. When the client reaches age 100, the premium payment obligations cease. The premiums are guaranteed never to change through the life of the policy. As long as premiums are paid, the insurer will pay out the insurance amount in the event of death, whenever it occurs. Therefore, the term-to-100 policy is a form of permanent insurance achieved by levelling the premium to age Non-traditional term-to-100 Newer term-to-100 designs range from policies that become paid up after premiums are paid for a specified period say, 20 years to those that provide a guaranteed cash value if the policy has been in force for a specified number of years say, 10 years. 1.9 Whole-Life Insurance Level premium concept The level premium for the whole life insurance is calculated as shown in the table below. You will note that the level premium arrived at is $14.73 per thousand. Whole life policy achieves permanence by building a reserve to pay the death benefits. Copyright 2011 Oliver Publishing Inc. All rights reserved 6

7 Year (1) Mortality rate per 1,000 (2) Survivors from original 1,000 (3) Claims for the year (4) PV of 3% (5) PV of $1 premium per survivor 3% (6) Total premium for the year (7) Total reserves (8) Reserve per policy (9) 0 0 1, , , , , , , , , , , ,216 1, , , ,403 1, , , ,620 1, , , ,885 1, , , ,149 1, , , ,421 1, , , ,701 1, , , ,028 2, , , ,440 2, , , ,936 2, , , ,494 2, , , ,345 3, , , ,960 3, , , ,603 3, , , ,270 4, , , ,007 4, , , ,865 4, , , ,873 5, , , ,079 5, , , ,447 6, , , ,910 6, , , ,381 7, , , ,873 7, , , ,338 8, , , ,871 8, , , ,488 8, , , ,254 9, , , ,110 9, , , ,958 10, , , ,714 10, , , ,301 10, , , ,593 10, , , ,740 10, , , ,879 11, , , ,016 11, , , ,050 11, , , Copyright 2011 Oliver Publishing Inc. All rights reserved 7

8 ,922 10, , , ,574 10, , , ,965 10, , , ,070 10, , , ,700 9, , , ,767 9, , , ,229 8, , , ,136 8, , , ,505 7, , , ,554 6, , , ,421 5, , , ,240 4, , , ,151 3, , , ,245 3, , , ,631 2, , ,332 1, , ,323 1, , ,592 1, , , , , , , , , , , , , , Total PV of TOTAL PV of claims $1 per survivor Level premium per $1,000 of insurance Source: mortality tables of the Canadian Institute of Actuaries, cited in the Income Tax Act for determining the net cost of pure insurance (NCPI). This table assumes that each individual considered has been subject to a medical exam, and that less-healthy individuals have been rejected or that an extra cost will be charged for the medical condition that leads to reduction in life expectancy. Column (1) Policy year Column (2) Mortality rate per 1,000 Column (3) Survivors from original 1,000 Column (4) Claims per year calculated s mortality rate times $1,000 person, assumed to be paid end of year. Copyright 2011 Oliver Publishing Inc. All rights reserved 8

9 Column (5) Present value of all claims paid out, at a discount factor of 3%, a conservative estimate. The sum total of the present value of all claims is arrived at. Column (6) Present value of $1 received from each survivor as a premium. Premiums are assumed to be received at the beginning of the year. The sum total of $1 of the present value of $1 premium received from all survivors is arrived at. The sum total of column (5) divided by the sum total of column (6) gives the insurance rate per $1,000 of insurance, which in our example works out to $ Column (7) Total premium received at $14.73 per survivor. Column (8) Total reserves calculated as (total reserve previous year + premiums received for this year) x 1.03, less the claims paid out this year. The 3% is the investment return earned by the reserve. Column (9) The reserve per policy, calculated as the total reserve, divided by the number of survivors. Note: The calculations shown above are only examples, so that the student can grasp the concept behind the calculations. The real actuarial calculations are a lot more complex. For example, they need to consider the lapse rate of policies and surrenders for cash values. Also the insurer will add an expense load to the premium calculated to arrive at the gross premium. This is explained in the next section Participating whole-life insurance Whole-life policies are either non-participating policies or participating policies. Both have a level premium and guaranteed cash values. However, the participating policy may receive dividends. The reserve of a whole-life policy is calculated on assumptions to arrive at the premium rate. Once the net premium is calculated to arrive at gross premiums, the insurer adds an expense load to cover costs, such as underwriting costs, commissions paid to the salespersons, expenses of the company (such as rents, salaries, etc.), and the profit of the insurance company. In reality, the insurer may have more money available in the reserve or his expenses may be lowered, thereby making a surplus for the insurer. Therefore, a policy may have surplus at the end of the year when the insurer does the actual calculations. This may be on account of reduced insurer expenses, reduced mortality costs, if the mortality experience is better than estimated, or on account of the reserve earning more on the invested assets than was anticipated. In the event that the policy is a participating policy, such a surplus is returned to the insured in the form of dividends. These dividends are a return of excess premium that was charged by the insurer by way of estimate when compared to the actuality. Since premiums are paid with after-tax dollars, the policy dividend Copyright 2011 Oliver Publishing Inc. All rights reserved 9

10 is a tax-free refund. The insured has many options to choose from, called dividend options. The dividend options are: Cash The insured receives the dividend in cash. Premium reduction The premium for the next year is reduced by the amount of the dividend. Paid-up Additions (PUAs) The dividend is used to buy another participating policy, based on the dividend as a single premium. The amount of coverage will depend upon the age, sex, and smoking status of the life insured. Thus each dividend is used to increase the insurance benefit. There is no medical exam for the issuance of such additions. Term enhancements Under this option, the dividend is used to buy a one-year term insurance policy for an amount equal to the lesser of: o The amount of insurance the dividend will purchase; and o The amount equal to the cash value of the policy at the end of the following year Coverage options Whole-life insurance coverage options include single life coverage, joint-first-todie coverage, as well as joint-last-to-die coverage Universal Life (UL) Insurance Attributes Universal life (UL) insurance, a form of non-participating permanent insurance plan, was introduced in Canada in Like a whole-life policy, it combines cash accumulations with insurance protection. Unlike whole-life policies, where the insurer maintains the reserve and the cash values guaranteed, the investment account of a universal-life policy is maintained by the insured. The insured may invest his accumulations in a vehicle of his choice and may be able to get better returns than that provided by a guaranteed whole-life policy. The pricing of a universal life policy consists of three major components, namely: 1. How much is charged for the insurance protection (the rate per $1,000 of risk faced by the insurer). The rate may be a yearly renewable term rate (YRT), in which case the rate per $1,000 of insurance increases every year. The rate may be a level rate per $1,000 of insurance which is constant every year. Such a level rate is the term-to-100 rate of insurance. 2. How much is being charged for the expenses of the insurer. (This is often called the policy fee). Copyright 2011 Oliver Publishing Inc. All rights reserved 10

11 3. How much is the accumulation in the investment income earning. (This goes to determine the value in the investment account. The difference between the amounts the insurer will pay out on death less t he accumulation in the investment account determines the net amount at risk to the insurer. The net amount at risk x the rate from і. above determines the insurance charge. Premium tax that is paid to the provincial governments. 1. The charges (i.e., the insurance charge and the expense charge) are taken from the investment account. As long as there are funds available in the investment account to pay these charges, the policy is good. If there are insufficient funds in the investment account, the policy may lapse. 2. From the foregoing, it could be deduced that the policy provides for a great deal of flexibility. The policy owner may decide upon how much he wants to deposit into the investment account and where he wants to invest it for growth. If the investment account has grown to a level where the future growth is sufficient to fund the future costs of keeping the policy in force (insurance + expense charges) the owner may discontinue further deposits. 3. Universal-life (UL) policies also provide flexible protection. The coverage amounts can be increased or decreased, as the policy owner s needs change, though an increase will call for satisfactory evidence of insurability Flexibilities of universal-life policies These include: Persons to be insured can be added or deleted, though adding may call for evidence of insurability of the person to be added; Choice of coverage, including single life, joint-first-to-die, joint-last-to-die; Choice of death benefits (level or increasing); Flexible deposits (amount, timing); Type of insurance cost structure (yearly renewal term [YRT] or level) Copyright 2011 Oliver Publishing Inc. All rights reserved 11

12 Investment options Universal-life (UL) policies provide the policy owner with a wide variety of investment options. These include: Daily interest accounts; Fixed-term investments; Equity index accounts, in which the rate of return reflects the performance of a market index (e.g., S&P/TSX60 index, the S&P 500 index, the NASDAQ 100 index, the Nikkei index, and various global indices); Managed accounts, where the rate of return reflects the performance of an outside actively managed mutual fund (e.g., AGF Canadian Equity, Dynamic Bond Fund, Franklin Templeton Dividend Fund, etc.) Thus, the policy owner may expect the market returns, and the policy owner faces the investment risk Bonus Many insurance companies give bonuses periodically, depending upon the amount held in the investment accounts. These bonuses may be guaranteed (such as 2% of the fund value each year) or may be conditional (such as a 2% bonus if the fund value is greater than $20,000) Illustrations Universal Life policy Face amount + Account Value (YRT form of cost of insurance) The table below shows the illustration for a Universal Life (UL) policy for a 40- year-old male, with a face amount of $100,000, and with a face amount + account value death-benefit option. The cost of insurance selected is the yearlyrenewable-term (YRT) option. As the account value will be paid out, the net amount at risk to the insurer remains $100,000 every year. The costs increase every year with age. The annual costs start at $ at age 40, and go up to $46, at age 100.The illustration assumes an annual return of 4%. You will also observe that the net cost of pure insurance (NCPI) increases every year and that adjusted cost basis (ACB) increases up to a number of years, and then declines. The death benefit also increases every year up to a certain point, and then reduces. You will also notice that the cash surrender value (CSV) is less than the fund value in the initial years. This is due to surrender charges that the insurer will charge for early cancellation of the policy. Copyright 2011 Oliver Publishing Inc. All rights reserved 12

13 Premium Total Bonus Interest Total Net Cost of Policy credited Sum Cost of Premium Policy Annual credited credited Fund Cash Death Net sum Adjusted pure Year Age to fund Insured insurance Tax Fee Costs to Fund to fund Value Value Benefit at risk Cost Base Insurance , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 1, , , , , , , , , , , ,000 2, , , , , , , , , , , ,000 2, , , , , , , , , , , ,000 2, , , , , , , , , , , ,000 2, , , , , , , , , , , ,000 3, , , , , , , , , , , ,000 3, , , , , , , , , , , ,000 4, , , , , , , , , , , ,000 4, , , , , , , , , , , ,000 5, , , , , , , , , , , ,000 5, , , , , , , , , , , ,000 6, , , , , , , , , , , ,000 7, , , , , , , , , , , ,000 7, , , , , , , , , , , ,000 8, , , , , , , , , , , ,000 9, , , , , , , , , , , ,000 10, , , , , , , , , , , ,000 11, , , , , , , , , , , ,000 13, , , , , , , , , , ,000 14, , , , , , , , , , ,000 15, , , , , , , , , , ,000 17, , , , , , , , , , ,000 18, , , , , , , , , , ,000 20, , , , , , , , , , ,000 22, , , , , , , , , , ,000 24, , , , , , , , , , ,000 26, , , , , , , , , , ,000 29, , , , , , , , , , ,000 31, , , , , , , , , , ,000 34, , , , , , , , , , ,000 36, , , , , , , , , , ,000 39, , , , , , , , , Copyright 2011 Oliver Publishing Inc. All rights reserved 13

14 Universal-life policy Face amount + Account value (Level or Term-to-100 form of cost of insurance [COI]) The table below shows the illustration for a universal-life policy for a 40-yearold male, with a face amount of $100,000, and with a face amount + account value death-benefit option. The cost of insurance (COI) selected is the level or term-to-100 option. As the account value is paid out, the net amount at risk to the insurer remains $100,000 every year. The costs remain the same every year at $ You will also observe that the NCPI increases every year and that the ACB increases up to a number of years, and then declines. The death benefit also increases every year up to a certain point, and then reduces. You will also notice that the cash surrender value (CSV) is less than the fund value in the initial years. This is due to surrender charges that the insurer will charge for early cancellation of the policy. You will also note that the death benefit increases every year until it reaches $241,822 at age 100. It is clear that, for an increasing death benefit, the level cost of premium is a better choice. Compare the annual deposit required, $1,000, with the $2,500 annual deposit required in the case of the YRT option. Also the death benefit is much greater at age 100. The advantage of the YRT is that there is a greater fund value built up over time. Copyright 2011 Oliver Publishing Inc. All rights reserved 14

15 Policy Year Age Premium credited to fund Total Annual Costs Bonus credited to Fund Interest credited to fund Total Death Benefit Net Cost of pure Insuranc e Sum Cost of Premium Policy Fund Cash Net sum Adjusted Insured insurance Tax Fee Value Value at risk Cost Base , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Copyright 2011 Oliver Publishing Inc. All rights reserved 15

16 1.11 Taxation of Insurance Policies Disposition The term disposition, as it relates to interest in a life-insurance policy is defined under the Income Tax Act as: A surrender or partial surrender of the interest; A policy loan taken after March 31,1978, including automatic premium loans; A disposition of interest by operation of law only, such as transfer to a successor owner or by right of survivorship in a joint tenancy Proceeds of disposition Proceeds of disposition is the amount of proceeds that a policyholder is entitled to receive on the disposition of interest in the policy. In the case of surrender of a policy, the proceeds of disposition is equal to the cash surrender value (CSV) of the policy Cash surrender value (CSV) The term cash surrender value (CSV) is the CSV of the policy reported by the insurer without regard to any loans taken Adjusted cost basis (ACB) The adjusted cost basis (ACB) represents the cost amount to the policyholder. This is the base from which policy gains are calculated. The ACB of a policy is calculated using a complex formula set out in the Income Tax Act. As per this formula, certain factors increase the ACB, while certain factors reduce the ACB. Factors that increase ACB: The cost paid to acquire the policy; Premiums paid by the policyholder. For policies acquired after May 31, 1985, only premiums for basic policy and term riders are included. Premiums for accidental death benefits, disability benefits, premium ratings for substandard risks, and guaranteed insurability benefits (GIB) are not included. Interest paid on policy loan; Policy gains required to be included in the policyholder s income from the disposition of an interest in the policy; Policy loan repayments. Copyright 2011 Oliver Publishing Inc. All rights reserved 16

17 Factors that decrease ACB: Proceeds of disposition of an interest in the policy, including policy loans; For policies acquired after December 1, 1982, the net cost of pure insurance (NCPI). The NCPI represents the pure cost of mortality costs under the policy each year. The NCPI is deducted from the premiums to arrive at the ACB. The calculation of NCPI is also complex and laid out in the Income Tax Act. It is enough to know that the NCPI increases every year. If premium deposits exceed NCPI, the ACB will increase. If the NCPI exceeds premium deposits, then ACB will decrease. For the purpose of this course, the ACB will be calculated as: ACB = premiums to date NCPI Disposition of a life-insurance policy Full surrender Assume the following data in year 32 of a policy: Policy Year Age Premium credited to fund Sum Insured Cost of insuranc Premium e Tax Policy Fee Total Annual Costs Bonus credited to Fund Interest credited to fund Fund Value Cash Value Total Death Benefit Net sum Adjusted at risk Cost Base Net Cost of pure Insurance , , , , , , , , , The CSV is $28,969.82, and the ACB is $1, If the policy owner surrenders this policy, and he receives proceeds of disposition of $28,969.82, he will have to declare the policy gain as income and pay tax at his marginal tax rate (MTR). In this example, he would have to declare an income of $28, $1, = $27, as income on his tax returns. Copyright 2011 Oliver Publishing Inc. All rights reserved 17

18 Partial surrender Assume that the policy owner surrendered 50% of his interest in the policy in year 32: Policy Year Age Premium credited to fund Sum Insured Cost of insuranc Premium e Tax Policy Fee Total Annual Costs Bonus credited to Fund Interest credited to fund Fund Value Cash Value Total Death Benefit Net sum Adjusted at risk Cost Base Net Cost of pure Insurance , , , , , , , , , As the policy owner is surrendering 50% of his interest in the policy, he would receive a CSV of $28, = $14, The ACB corresponding to this partial surrender would be $1, = $ He will have to declare as income $14, $ = $13, Policy loans If a loan is taken from the insurer against the policy, the portion of the loan that exceeds ACB will be taxable in the year the loan is taken. However, when the loan is subsequently repaid, the Income Tax Act allows for a deduction up to the amount declared as income Transfer of interest Transfer of ownership Any transfer of ownership of a policy is considered a disposition under the tax laws and the transferor will be liable for tax on the policy gain. The exceptions that do not trigger a tax consequence and are considered rollovers of the property are: Transfer of a policy to a child or grandchild. Transfer of a policy to a spouse or common law partner. (If the transfer is inter-vivos, attribution rules will apply.) 1.13 Exempt and Non-Exempt Policies Policies last acquired prior to December 1, 1982 Policies that were last acquired before December 1, 1982, are exempt policies. They may hold any amount in their investment account and will not be taxable. The last-acquired date of a policy as defined in the Income Tax Act is the latest of: Policy issue date; Policy reinstatement date; Policy transfer date. Copyright 2011 Oliver Publishing Inc. All rights reserved 18

19 Policies last acquired after December 1, 1982 Policies last acquired after December 1, 1982, may be exempt or non-exempt, depending on a test carried out on the policy at its anniversary date. The test compares the value of the investment account to a standard policy s account value for the policy year. The standard policy is a 20-pay policy with endowment at age 85. The value in the account of the standard policy is called the Maximum Tax Actuarial Reserve (MTAR). If the value in the policy being tested is less than, or equal to, MTAR, the policy is exempt and will not be liable for taxation. If the policy being tested has more value in its investment account than the MTAR, the policy is declared non-exempt, and the policy owner is given 60 days to rectify this problem. The policy owner may rectify the situation in one of the following ways: The policy owner may withdraw funds from the investment account and pay the taxes due on such withdrawals, bringing the policy back to exempt status. The policy owner may decide to increase his face amount thus bringing the value below the new MTAR, making the policy exempt once again. If the policy owner does not rectify the situation in 60 days, the policy is declared non-exempt for life, and, in the year it is declared non-exempt for life, the policy owner will have to include the entire policy gain in his income and file taxes. Thereafter, any growth in the investment account will be subject to taxation like any open account. These days, insurers attach a transitory account that is non-exempt to the policy, and when they find that the account value is likely to exceed the MTAR, they transfer the funds from the investment account to the transitory account. Any interest earned in the transitory account will be taxable to the policy owner. However, the policy is kept exempt. Copyright 2011 Oliver Publishing Inc. All rights reserved 19

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