FINANCIAL PLANNING AND THE ROLE OF INSURANCE.doc by handongqp

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									                                                         FINANCIAL PLANNING

                                                          TABLE OF CONTENTS

CHAPTER ONE – PROFESSIONALISM & TRADITIONAL POLICIES 1
        Certified Financial Planners (CFP) ............................................................................................................2
        The Chartered Financial Consultant (ChFC). ............................................................................................3
        Masters of Science in Financial Services (MSFS). ....................................................................................3
        Personal Financial Specialists (PFS). ........................................................................................................3
        College/University Courses. ......................................................................................................................4

WHY LIFE INSURANCE ................................................................................................................................5
   Death..........................................................................................................................................................5
   Death Benefits ...........................................................................................................................................5
 CASH ACCUMULATION ............................................................................................................................6
 PERMANENT AND TERM INSURANCE ..................................................................................................6

TERM INSURANCE ........................................................................................................................................7
  LEVEL TERM ...............................................................................................................................................7
  DECREASING TERM ...................................................................................................................................7
  INCREASING TERM ....................................................................................................................................8
    The Policy Period ......................................................................................................................................8
    The Premium .............................................................................................................................................8
    Automatically Renewable Term ................................................................................................................8
    Indeterminate Premiums ............................................................................................................................9
    Re-Entry Feature ........................................................................................................................................9
    Renewability ..............................................................................................................................................9
  CONVERTIBLE TERM ................................................................................................................................9
    Attained/Original Age ............................................................................................................................. 10
    Family Coverage ...................................................................................................................................... 10
    Family Income Coverage ......................................................................................................................... 11
    How Cash Values Accumulate ................................................................................................................ 11
    Single Premium ....................................................................................................................................... 12
  LIMITED PAYMENT POLICIES ............................................................................................................... 12
    Advantages of Limited Pay Policies ........................................................................................................ 13

Chapter 1 – STUDY QUESTIONS ................................................................................................................ 13


                       CHAPTER TWO - UNIVERSAL LIFE INSURANCE                                                                           15
      Willingness to Take Risks ....................................................................................................................... 15
      Flexibility................................................................................................................................................. 15
      Insurance Industry Response: Universal Life ......................................................................................... 15
      An Adjustable Death Benefit ................................................................................................................... 16
      Death Benefit Options ............................................................................................................................. 16
      Interest On The Cash Value Account ...................................................................................................... 17
      Charges to the Account ............................................................................................................................ 18
      Other Charges: ......................................................................................................................................... 18
    Universal life premium ................................................................................................................................. 19
      The Adjustable Premium ......................................................................................................................... 19
         Example of Universal Life Flexibility ................................................................................................ 20
      Universal Life and the Stages of Economic Life ..................................................................................... 21
    UNIVERSAL LIFE DURING PERIODS OF ECONOMIC DOWNTURN ................................................ 22
        Multiple Uses for Cash Value .................................................................................................................. 23
        Back-End Loading vs Front End Loading ............................................................................................... 24
        Partial Withdrawals ................................................................................................................................. 24
        Repayment of Withdrawal ....................................................................................................................... 24
        Partial Withdrawals ................................................................................................................................. 24
        Withdrawal of Entire Cash Value ............................................................................................................ 25
        Repayment of Policy Loan ...................................................................................................................... 25

CHAPTER 2 – STUDY QUESTIONS .......................................................................................................... 27


                      CHAPTER THREE - VARIABLE LIFE INSURANCE                                                                       30
    THE VARIABLE DEATH BENEFIT ......................................................................................................... 30
      The Assumed Interest Rate ...................................................................................................................... 30
      The Separate Account .............................................................................................................................. 30
    FIXED PREMIUMS .................................................................................................................................... 31
      Single Premium Variable Life ................................................................................................................. 31
      Loans and Withdrawals ........................................................................................................................... 32
      Regulation of Variable Life ..................................................................................................................... 32
         Professional Account Management..................................................................................................... 33
      Exchange for Fixed interest ..................................................................................................................... 33

VARIABLE LIFE REGULATIONS ............................................................................................................. 33
  CONCERNS REGARDING THE SAFETY OF VARIABLE LIFE INSURANCE ................................... 35

CHAPTER 3 – STUDY QUESTIONS ........................................................................................................... 37


                      CHAPTER FOUR - VARIABLE UNIVERSAL LIFE                                                                        40
      POLICY EXPENSES .............................................................................................................................. 40
      VUL DURING TIMES OF DECLINE IN FINANCIAL MARKETS .................................................... 41
      COMPETING WITH OTHER INVESTMENT PRODUCTS ................................................................ 42
        Also Known As: .................................................................................................................................. 43
      Average Variable Universal Life Premium ............................................................................................. 43
    APPLICATIONS OF VARIABLE UNIVERSAL LIFE .............................................................................. 43

POLICY COMPARISONS OF VARIABLE LIFE & VARIABLE UNIVERSAL LIFE ......................... 44

COMPARISON OF VARIABLE LIFE AND VARIABLE UNIVERSAL LIFE ...................................... 45

COMPARISON OF VARIABLE LIFE AND VARIABLE UNIVERSAL LIFE (2)................................. 46
    Estate Tax Repeal Rider .......................................................................................................................... 47
  INTEREST SENSITIVE WHOLE LIFE ..................................................................................................... 47
    Indeterminate Premiums .......................................................................................................................... 47
    Reduction in Death Benefit...................................................................................................................... 47
    Fixed Premium Plans ............................................................................................................................... 48
    Other Provisions ...................................................................................................................................... 48
  SECTION 1035 EXCHANGES ................................................................................................................... 48
    Policy Loans on Exchanged Policies ....................................................................................................... 48

CHAPTER 4 – STUDY QUESTIONS ........................................................................................................... 50


                      CHAPTER FIVE – PROVISIONS OF LIFE INSURANCE 53
    LAPSE PROTECTION ................................................................................................................................ 53
    BENEFICIARY DESIGNATIONS ............................................................................................................. 53



                                                                              ii
      Primary and Contingent ........................................................................................................................... 53
      Revocable or Irrevocable Designations ................................................................................................... 54
      Class Designation .................................................................................................................................... 54
      Per Capita and Per Stirpes Designations .................................................................................................. 54
      Minors as Beneficiaries ........................................................................................................................... 55
      Estates as Beneficiaries............................................................................................................................ 55
      Spendthrift Clause ................................................................................................................................... 55
      Uniform Simultaneous Death Act ............................................................................................................ 56
      Common Disaster Provision .................................................................................................................... 56
      Dividends ................................................................................................................................................. 57
      Participating and non-participating Policies ........................................................................................... 57
      Dividend Payment Options ...................................................................................................................... 57
    The Cash Value ............................................................................................................................................ 58
    SETTLEMENT OPTIONS .......................................................................................................................... 60
      Lump Sum ............................................................................................................................................... 60
      Interest Option ......................................................................................................................................... 60
      Fixed Amount .......................................................................................................................................... 60
      Fixed Period Option ................................................................................................................................. 61
      Life income Option .................................................................................................................................. 61
    JUVENILE Insurance ................................................................................................................................... 61
      Jumping Juvenile ..................................................................................................................................... 62
    BUSINESS PROTECTION ......................................................................................................................... 62
    THE BUY/SELL AGREEMENT ................................................................................................................. 62
    THE CROSS-PURCHASE PLAN ............................................................................................................... 63
    ENTITY PURCHASE PLAN ...................................................................................................................... 63
      Buy/Sell Agreement With A Closely Held Corporation .......................................................................... 63
    KEY MAN INSURANCE ............................................................................................................................ 64

CHAPTER 5 – STUDY QUESTIONS ........................................................................................................... 66


                                                 CHAPTER SIX - ANNUITIES 68

WHAT ARE ANNUITIES? ............................................................................................................................ 68
 PAYING OF BENEFITS ............................................................................................................................. 68
     Immediate Annuity ............................................................................................................................. 69
     Deferred Annuity ................................................................................................................................ 69
 PREMIUM PAYMENTS ............................................................................................................................. 69
 BENEFIT PAYMENTS ............................................................................................................................... 71
     Annuity Certain (Period Certain) ........................................................................................................ 71
     Life Annuities (straight life annuities) ................................................................................................ 71
     Life Income with Period Certain ......................................................................................................... 72
     Life Income with Refund Annuity ...................................................................................................... 72
     Temporary Life Annuity ..................................................................................................................... 72

JOINT AND SURVIVOR ANNUITIES ........................................................................................................ 72

VARIABLE ANNUITIES............................................................................................................................... 73
  THE SEPARATE ACCOUNT ..................................................................................................................... 73
  SECURITIES AND INSURANCE REGULATION ................................................................................... 74
  THE VALUE OF THE FUND: ACCUMULATION UNITS ..................................................................... 74
  LOADING AND OTHER CHARGES ........................................................................................................ 75
  IMMEDIATE VARIABLE ANNUITIES .................................................................................................... 76
  COMPANY-MANAGED VS. SELF-DIRECTED ACCOUNTS, ............................................................... 77
  OPTIONS AVAILABLE AT DEATH ......................................................................................................... 77
    Ratcheted or Step-Up Death Benefit........................................................................................................ 77



                                                                               iii
      Death Benefit Adjustment ....................................................................................................................... 78
      Annually Increasing Death Benefit .......................................................................................................... 78
    FIXED AND VARIABLE PAYOUTS ........................................................................................................ 78
      Fixed Payments........................................................................................................................................ 78
      Variable Payments ................................................................................................................................... 79
      Variable Annuity Units ............................................................................................................................ 79
      Risk .......................................................................................................................................................... 80
    EARNINGS, GUARANTEED OR NOT GUARANTEED ......................................................................... 80
      Liquidity .................................................................................................................................................. 81
    TAXATION OF VARIABLE ANNUITIES ................................................................................................ 81
    USING A VARIABLE ANNUITY? ............................................................................................................ 82
    ENHANCED ANNUITIES .......................................................................................................................... 84
      What Is Happening To Annuities Today? ............................................................................................... 85

CHAPTER 6 – STUDY QUESTIONS ........................................................................................................... 86


                       CHAPTER SEVEN - EQUITY INDEX ANNUITIES                                                                              89

BACKGROUND ............................................................................................................................................. 89

WHAT IS IT? .................................................................................................................................................. 89

HISTORY OF THE EIA ................................................................................................................................ 90

WHY INDEXING? ......................................................................................................................................... 91

THE TRUST FACTOR .................................................................................................................................. 92

MARKETING THE EIA ................................................................................................................................ 93
 SEC REGULATION/NON-REGULATION ............................................................................................... 93
 PROVISIONS OF EQUITY INDEX ANNUITIES ..................................................................................... 94
 CALCULATION OF YIELD ....................................................................................................................... 95
 DETERMINING INTEREST RATES - METHODS OF INDEXING ........................................................ 96
   Point-To-Point ......................................................................................................................................... 96
   High Water Mark Method ....................................................................................................................... 97
   Annual Reset Method .............................................................................................................................. 98
   Low Water Mark Method ........................................................................................................................ 98
   Digital Method ......................................................................................................................................... 99
   Multi-Year Reset ..................................................................................................................................... 99
   Averaging .............................................................................................................................................. 100
 What’s Out There? Summary Of Present Products ................................................................................... 100
   Types of Premiums ................................................................................................................................ 101
   Methods of Indexing .............................................................................................................................. 101
   Features as Gauged By Use In Current Products ................................................................................... 101
   Interest Calculation ................................................................................................................................ 101
 THE PURPOSE OF THE EIA ................................................................................................................... 101
 Dividends ................................................................................................................................................... 103
 Guaranteed Rate ......................................................................................................................................... 103
 TIME LENGTH OF THE EIA ................................................................................................................... 104
 How Much Is Subject To Interest Participation.......................................................................................... 104
 CAPS .......................................................................................................................................................... 105
 The Floor .................................................................................................................................................... 106
 Vesting And Surrender ............................................................................................................................... 106

ANNUITIZATION ........................................................................................................................................ 107


                                                                                 iv
Relationship of Return And Risk ................................................................................................................. 108

COMPARISON OF EQUITY INDEX ANNUITIES ................................................................................. 109

COMPARISON OF EQUITY INDEX ANNUITIES ................................................................................. 110

COMPARISON OF EQUITY INDEX ANNUITIES ................................................................................. 111

THE EIA IN A VOLATILE MARKET ...................................................................................................... 112
  The Market ................................................................................................................................................. 112

CHAPTER 7 – STUDY QUESTIONS ......................................................................................................... 114


               CHAPTER EIGHT – ANNUITIES AND FINANCIAL PLANNING117

LONG TERM INVESTMENT STRATEGIES .......................................................................................... 117

QUALIFIED AND NON-QUALIFIED ANNUITIES ................................................................................ 118
  Individual Retirement Annuity (IRA) ........................................................................................................ 118
  Nonqualified Individual Annuities ............................................................................................................. 119
  Annuities for Senior Age Groups ............................................................................................................... 120
     Features and Options ............................................................................................................................. 120

GROUP/BUSINESS-OWNED ANNUITIES .............................................................................................. 120
   Keogh Plans (HR 10) ............................................................................................................................. 120
   Defined Benefit Plan.............................................................................................................................. 121
   Defined Contribution Plan ..................................................................................................................... 122
   Corporate Pension and Profit Sharing Plans .......................................................................................... 122
   Group Deferred Annuity ........................................................................................................................ 123
   Group Deposit Administration Contract ................................................................................................ 123
   401(k) Plans ........................................................................................................................................... 123
   Tax Sheltered Annuities ........................................................................................................................ 124

TAXATION OF ANNUITY PRODUCTS .................................................................................................. 125
  The Accumulation Phase ............................................................................................................................ 125
     Tax Implications On Premium Payments .............................................................................................. 125
     Current Income Taxation ....................................................................................................................... 126
     State Premium Taxes ............................................................................................................................. 126
     Tax Deferral Of Interest Accumulations ................................................................................................ 126
     Taxes On Withdrawals, Loans and Surrenders ...................................................................................... 126
     Distributions of Qualified Plans ............................................................................................................ 126
     Installment Payments of Qualified Plan Distributions ........................................................................... 127
     Requirements For Lump Sum Distributions .......................................................................................... 128
     Tax Relief Act 1986............................................................................................................................... 128
     Rollovers ................................................................................................................................................ 129
  Income Tax and the Interest-Out-First Rule ............................................................................................... 129
     Taxing Annuity Loans ........................................................................................................................... 130
     Annuity Liquidation Payments .............................................................................................................. 130
     Exclusion Ratio ...................................................................................................................................... 131
  Variable Annuities Exclusion Ratio ........................................................................................................... 131
     Applying the Exclusion Ratio to Death Benefits ................................................................................... 132
     Death Prior to Liquidation Phase ........................................................................................................... 132
  Federal Estate Taxes and annuities ............................................................................................................. 132
  More About Taxes ...................................................................................................................................... 133



                                                                                v
CHAPTER 8 – STUDY QUESTIONS ......................................................................................................... 133


                                     CHAPTER NINE - RETIREMENT PLANS 136

INDIVIDUAL RETIREMENT ACCOUNTS (IRAS) ................................................................................ 136
  “Regular” IRA ............................................................................................................................................ 136
  Education IRA ............................................................................................................................................ 138

ROTH IRA ..................................................................................................................................................... 139
  New Account .............................................................................................................................................. 139
  Roth IRA Conversion ................................................................................................................................. 139
    Taxes on Conversion ............................................................................................................................. 140
    Why Convert? ........................................................................................................................................ 140

SALARY CONTINUATION / DEFERRED COMPENSATION PLANS ............................................... 141
    Qualified Pension Plans .............................................................................................................................. 142
    Defined Benefit Plan .................................................................................................................................. 142
        1. Fixed Dollars: .................................................................................................................................... 143
        2. Variable Amount Plans ...................................................................................................................... 144
        Integration With Social Security............................................................................................................ 144
        Elimination of Optional Forms of Distribution under Defined Contribution Plans ............................... 144
        Elimination of Optional Forms of Distribution under Defined Benefit and Defined Contribution Plans
........................................................................................................................................................................ 145
    Defined Contribution Pension Plan (Money Purchase Plan) ...................................................................... 145
    Taxation of Qualified Defined Contribution Plan ...................................................................................... 145
    Money Purchase Plan ................................................................................................................................. 146
    Pension Trust Funding ................................................................................................................................ 146
    Group Deposit Administration ................................................................................................................... 147
    Group immediate Participation (IPG) Contract Annuity ............................................................................ 147
    Group Permanent Contract ......................................................................................................................... 147
    Individual Contract Pension Plan ............................................................................................................... 148
    Pension Plan Integration With Social Security ........................................................................................... 148
    Pension Plans Distributions ........................................................................................................................ 148
        Withdrawal Benefits .............................................................................................................................. 148
        Pension Plan Termination Insurance ..................................................................................................... 149
    Vesting ....................................................................................................................................................... 149

PROFIT – SHARING PLANS – 401(k) ...................................................................................................... 150

SIMPLIFIED EMPLOYEE PENSIONS (SEP).......................................................................................... 152

SIMPLE RETIREMENT PLANS ............................................................................................................... 153

VARIABLE LIFE IN NON-QUALIFIED BENEFIT PLANS .................................................................. 154
    Executive Bonus Plans .......................................................................................................................... 154
    Split-Dollar Plans .................................................................................................................................. 154
    Non-Qualified Deferred Compensation Plans (NQDC) ....................................................................... 155
    Supplemental Executive Retirement Plans (SERPS) ............................................................................. 155
  USING VARIABLE LIFE INSURANCE FOR FUNDING ...................................................................... 156
    Why Variable Life? ............................................................................................................................... 156
  IRS NOTICE 2002-8, PROPOSED TAX REGULATIONS FOR SPLIT-DOLLAR PLANS .................. 157
    “Pure” Bonus Approach ........................................................................................................................ 158
    The Two-Regime Approach .................................................................................................................. 159
    Summary................................................................................................................................................ 159




                                                                                    vi
KEOGH PLAN (HR 10) ............................................................................................................................... 160

TAX DEFERRED ANNUITY - 403(b) ........................................................................................................ 160
  GOVERNMENT RETIREMENT PLANS ................................................................................................ 162

CHAPTER 9 – STUDY QUESTIONS ......................................................................................................... 163


        CHAPTER TEN – LIFE INSURANCE FOR ESTATE PLANNING                                                                                          166
    EIGHT COMMON PROBLEMS IN ESTATE PLANNING .................................................................... 166

OBJECTIVES OF ESTATE PLANNING .................................................................................................. 167
  CREATE LIQUIDITY ............................................................................................................................... 167
    SOLUTIONS TO LACK OF LIQUIDITY............................................................................................ 168
  AVOID PROBATE COSTS ....................................................................................................................... 169
  REDUCE TAXES ...................................................................................................................................... 169
  DOCUMENTS USED TO DISPOSE OF PROPERTY ............................................................................. 170

ESTATE PLANNING PROCESS ............................................................................................................... 171
  1. DATA MUST BE GATHERED AND COMPILED ............................................................................ 171
  2. IDENTIFYING THE PROBLEMS. ...................................................................................................... 171
  3. DEVELOPING THE PLAN .................................................................................................................. 172
  4. PRESENTING THE PLAN................................................................................................................... 172
  5. IMPLEMENTING THE PLAN ............................................................................................................. 173
       SAMPLE ACTION CALENDAR .................................................................................................... 174
  6. REVIEWING AND UPDATING THE PLAN ..................................................................................... 174


                     LIFETIME TRANSFERS - GIFTS AND THE GIFT TAX 175
    iNTRODUCTION ...................................................................................................................................... 175
    GIFT GIVING BASICS ............................................................................................................................. 176
      POTENTIAL PROBLEMS WITH COMPLETED TRANSFERS ........................................................ 176
    TYPES OF GIFTS...................................................................................................................................... 177
      DIRECT GIFTS ..................................................................................................................................... 177
      INDIRECT GIFTS................................................................................................................................. 177
    GRATUITOUS TRANSFERS ................................................................................................................... 178
      Property/Interest In Property Must Be Transferred ............................................................................... 178
         SERVICES NOT CONSIDERED AS A GIFT................................................................................. 178
      DISCLAIMERS..................................................................................................................................... 178
      Promise To Make A Gift ....................................................................................................................... 179
    TRANSFERS IN THE ORDINARY COURSE OF BUSINESS ............................................................... 179
      Compensation For Personal Services..................................................................................................... 179
      Bad Bargains.......................................................................................................................................... 179
      Sham Gifts ............................................................................................................................................. 179
      Exempt Gifts .......................................................................................................................................... 179

VALUATION OF PROPERTY FOR GIFT TAX PURPOSES ................................................................ 180
  INDEBTEDNESS AND TRANSFERRED PROPERTY .......................................................................... 180
    Restrictions On Use ............................................................................................................................... 180
    Valuation Of Mutual Fund Shares ......................................................................................................... 180

GIFTS OF LIFE INSURANCE/ANNUITY CONTRACTS ...................................................................... 180

CONCEPTS TO REMEMBER ................................................................................................................... 181

GIFT TAX COMPUTATION ...................................................................................................................... 182



                                                                              vii
    GIFT SPLITTING ...................................................................................................................................... 182
    ANNUAL EXCLUSION ............................................................................................................................ 183
    GIFTS TO MINORS .................................................................................................................................. 184
      BONA-FIDE GIFT ................................................................................................................................ 185
    UNIFORM GIFTS TO MINOR ACT ........................................................................................................ 185
    OUTRIGHT GIFTS.................................................................................................................................... 186

CHAPTER 10 – STUDY QUESTIONS ....................................................................................................... 186


        CHAPTER ELEVEN - TRANSFERRING PROPERTY AT DEATH                                                                                         189

HOW PROPERTY PASSES AT DEATH .................................................................................................. 189
  CONTRACT DESIGNATION................................................................................................................... 189
     Estate Taxation Of Annuities ............................................................................................................ 190

MARITAL DEDUCTION AND LIFE INSURANCE ................................................................................ 191

COMPUTATION OF THE ESTATE TAX ................................................................................................ 191
  DEDUCTIONS FROM THE GROSS ESTATE ........................................................................................ 192
      A. FUNERAL EXPENSES.............................................................................................................. 192
      B. ADMINISTRATIVE EXPENSES .............................................................................................. 192
      C. CLAIMS AGAINST THE ESTATE ........................................................................................... 193
      D. MORTGAGE DEBTS ................................................................................................................ 193
      E. LOSSES....................................................................................................................................... 193
      F. OTHER ADMINISTRATIVE EXPENSES ................................................................................ 193
  BACKGROUND OF THE MARITAL DEDUCTION .............................................................................. 193
  MARITAL DEDUCTION BASIC RULES ............................................................................................... 194
      GENERAL RULE: ........................................................................................................................... 194
      NET VALUE OF GROSS ESTATE: ............................................................................................... 194
      PROPERTY PASSAGE: .................................................................................................................. 194
      RESIDENCE OR CITIZENSHIP REQUIREMENT: ...................................................................... 195
      INCLUSION OF PROPERTY REQUIREMENT: ........................................................................... 195
      MARITAL STATUS REQUIREMENT: .......................................................................................... 195
  TERMINABLE INTEREST RULE ........................................................................................................... 196
    DISQUALIFICATION RULES ............................................................................................................ 196
      EXAMPLES OF TERMINABLE INTERESTS: .............................................................................. 196
  POWER OF APPOINTMENT TRUST ..................................................................................................... 197
    Advantages Of Life Insurance For Liquidity ......................................................................................... 198
  OWNERSHIP AND BENEFICIARIES OF ESTATE LIQUIDITY .......................................................... 199
    Ownership .............................................................................................................................................. 200
    Beneficiary Concerns............................................................................................................................. 200
    Beneficiary Designations ....................................................................................................................... 200
      1. ESTATE BENEFICIARY: .......................................................................................................... 200
      2. INDIVIDUAL - BENEFICIARY: ............................................................................................... 200
      3. TRUST AS BENEFICIARY: ...................................................................................................... 201
  THE LIFE INSURANCE TRUST ............................................................................................................. 201
    Assignment Of Group Insurance ........................................................................................................... 202

ESTATE TAXATION OF LIFE INSURANCE ......................................................................................... 202
  POLICIES ON OTHER LIVES ................................................................................................................. 203
  PROCEEDS PAYABLE TO AN ESTATE ............................................................................................... 203
  PROCEEDS PAID TO A TRUST.............................................................................................................. 203
  STATE DEATH TAXES ........................................................................................................................... 203

STRATEGIES FOR USING LIFE INSURANCE IN THE ESTATE ...................................................... 203


                                                                             viii
   PROTECTING AN ESTATE WITH LIFE INSURANCE ........................................................................ 203
   JOINT AND LAST SURVIVOR LIFE INSURANCE .............................................................................. 205
   THE IRREVOCABLE LIFE INSURANCE TRUST ................................................................................. 206
   PRIVATE SPLIT DOLLAR PLANS ......................................................................................................... 207
   SURVIVORSHIP ACCESS TRUSTS ....................................................................................................... 209
     Shared Ownership Within an ILIT ........................................................................................................ 210

ESTATE TAXATION OF ANNUITIES ..................................................................................................... 210

CHAPTER 11 – STUDY QUESTIONS ....................................................................................................... 211


                                                BIBLIOGRAPHY                             214
       BOOKS, REFERENCE AND TEXT .................................................................................................... 214
       PERIODICALS, NEWSPAPERS AND MAGAZINES........................................................................ 216
       INTERNET INFORMATION ............................................................................................................... 220




                                                                      ix
                                     FINANCIAL PLANNING




     Using life insurance and annuities for planning during time of great uncertainty for other
forms of investments has most recently revived a rather dormant industry in many respects. The
days of the “dot-com” millionaires seems to have peaked, and in many cases, have crashed.
Many, if not most, of the experienced life insurance agents and general agents have become “fi-
nancial planners” with considerable success in many instances. Those who have not forgotten
the basics of life insurance and annuities find the present atmosphere as that of encouragement
and opportunities.

     Suddenly, to many producers, the guarantees of the life and annuity policies, are appealing,
but at the same time, the past experiences of those planners and the concerns of their patrons
does not allow them the luxury of totally ignoring the non-insurance investment vehicles. But
there still remains the variable and interest-sensitive products that can grow when the financial
and investment climate grows, and still furnish a guarantee, or a “floor,” if these markets de-
crease.

     This text addresses the newer type of life and annuity policies with emphasis on those that
depend upon the ups-and-downs of the traditional investments – stocks, bonds, mutual funds,
REITs, etc. – and the indexing of such investments in some cases, to determine the amount that
is available or would be available for the financial or estate planning purposes.

     Obviously, this is an area that requires the highest degree of training and experience in or-
der to fulfill the expectations of the clientele. In-depth knowledge on how various types of
products actually “operate” and the provisions thereof, plus knowledge of how results of these
products are taxed, are most important before a proper, professional and meaningful program
can be presented to the client. While many of the students of this text may already have reached
their pinnacle of professionalism, many have not. Therefore, a brief review of courses, many of
which lead to professional designations that can provide the foundation for success, is in order
here.

      There are many types of planners, obviously, that use life insurance or annuities very little,
and many of these non-insurance planners have their “own horse to ride” as they may principal-
ly represent mutual funds, stockbrokers, etc. This can lead to the situation where certain advi-
sors are driven by the products that they represent which can lead to the situation that (1) the
customer may lose confidence in the individual if it appears that this is the situation, and (2)
even worse, there is a tendency for the “advisor” to work independently of any other expert in
financial planning, e.g. an insurance agent may emphasize only insurance products, where a mu-
tual fund may be much more appropriate, but will not be introduced because of lack of securi-
ties license. An insurance agent recently complained in an industry magazine article, that be-
cause a tax savings for the customer was discovered by the agent, the customer’s accountant
convinced the customer that the work done by the agent was useless, obviously because the ac-
countant was felt that his professional expertise was being questioned by the insurance agent.
This does not indicate that the agent should become an accountant or an attorney, but a profes-
sional agent with expert knowledge of the various products that he offers, can obtain the respect
of non-insurance professionals – indeed, there are many insurance agents who are very success-
ful and that work closely with attorneys and accountant on planning matters, particularly if the
customer has considerable assets.

    Financial Planners, in particular, are usually loosely divided into two categories:
          (1) Those whose compensation is based upon the commissions they receive from the
               sale of their particular product. This applies to insurance agents and securities
               dealers generally. They provide advice in financial planning, and then to accom-
               plish their recommendations, they offer their products. This can be considered as
               an advantage as it can all be “rolled into one single package.” Conversely, they
               can be accused of not being objective because of this arrangement. There is a
               distinct possibility that a competitor would point out this perceived conflict of in-
               terest to further their interests.

           (2) The other side of the coin is the fee-based financial planners, who do not “sell” a
               product used in the process, but for a fee paid by the consumer, they make rec-
               ommendations. Many individuals appreciate their independence and their objec-
               tivity since they have no financial interest in which product is sold to accomplish
               their financial planning objectives. The disadvantage of this type of planning
               provider is that the fee must be paid whether the customer accepts they’re plan-
               ning recommendations or not. Any purchase of securities or insurance would
               contain commission costs on top of the consulting fee. The fee-based financial
               planners are usually accountants.

     There obviously is considerable confusion among those who feel the need for financial
planners, to determine who, besides their brother-in-law, is qualified to advise them on financial
matters. As indicated earlier, there are many titles of financial planners, but only some have
professional designations. To add to the confusion, there are several types of professional des-
ignations and consumers may easily become totally confused by the plethora of initials follow-
ing the advisor's name. Some (not all) of the “titles” or designation are as follows”

CERTIFIED FINANCIAL PLANNERS (CFP)

     CFP’s receive their designation from the Certified Financial Planner Board of Standards af-
ter completing a (normally) three-year course. The CFP Board designed the home-study cours-
es, but one may obtain the designation by completing certain college courses and pass a com-
prehensive examination. The courses include Financial Planning & Insurance, Investment
Planning, Income Tax Planning, Retirement Planning, Employee Benefits and Estate Planning.
They have recently introduced an “Associate” CFP designation after certain experience re-
quirements and passing an examination. Both designations require 30 hours of Continuing Ed-
ucation each year.



                                                   2
THE CHARTERED FINANCIAL CONSULTANT (CHFC).

     The ChFC designation is considered by many as the most prestigious designation and it is
awarded by the American College of Life Underwriters, Bryn Mawr. PA, the same institution
that awards the Chartered Life Underwriter (CLU) designation. Obviously, the majority of the
ChFC’s come from the insurance industry, and nearly all are CLU’s also.
     The 10 home-study courses are:
       Insurance and Financial Planning
       Income Taxation
       Individual Life Insurance
       Planning for Retirement Needs
       Investments
       Fundamentals of Estate Planning
       Financial Planning Applications
       Wealth Accumulation Planning
       Financial Decision-Making at Retirement
        - Plus any one of the following:
          The Financial System in Our Economy
          Planning for Business Owners and Professionals
          Estate Planning Applications
          Life Insurance Regulation, Compliance and the Political Process.
          These examinations are offered twice a year, but may be completed via the Internet at
          any time.

MASTERS OF SCIENCE IN FINANCIAL SERVICES (MSFS).

     This designation is also awarded by the American College of Life Underwriters, and is
awarded after a 40 hour, 2-week residency course. The student may specialize in either finan-
cial planning or financial services. Courses consist of Financial Planning, Advanced Pension &
Retirement Planning, Advanced Estate Planning (2 courses), Personal Tax Planning and Execu-
tive Compensation. They also have courses in Business Valuation and Professional Self-
Management. For Financial Services, the courses offered are Professional & Organizational
Behavior, Human Resource Management, Marketing Management of Services, Decision Mak-
ing in Financial Services, and Professional Self-Management.

PERSONAL FINANCIAL SPECIALISTS (PFS).

     The PFS designation is awarded only to Certified Public Accountants (CPA’s) after com-
pleting a comprehensive financial planning examination administered by the American Institute
of Certified Public Accountants, have a minimum of 3 years of financial planning experience,
and have at least 500 hours of financial planning every year.




                                                 3
COLLEGE/UNIVERSITY COURSES.

    Several colleges, such as Georgia State University, San Diego State University, Purdue and
Brigham Young University, offer courses in financial planning, in undergraduate, masters or
doctoral programs.

     The discussion of insurance for planning purposes and the success of the producers, have a
similarity to a discussion of about any other successful business, whether professional football
teams, huge conglomerations, or any other area of business – basics. For the football fan, it
may be recalled that very recently one team paid a huge sum of money and several high-draft
picks for eternity (almost) in order to get a new coach that has a particularly successful record.
Then what did this high-priced coach do – return to basics. Therefore, in this text, there will be
a certain amount of “basics.”

    Investments that are designated as vehicles for future retirement or estate planning must be
protected against various risks that may or may not arise. Insurance is unique as it provides a
service that the purchaser hopes that they will never have to use. While the “old” Whole Life
Insurance policies have fallen into disfavor by many during the recent past, it certainly is not a
product that a responsible financial planner would hesitate to recommend.

     Universal Life and Variable Life will be discussed in this text. These are the “new genera-
tion” of life insurance plans that combine the security of insurance with the flexibility of other
investments and indexes. It will become apparent that there are multitudes of solutions to plan-
ning problems that can be alleviated by using these complex products. However complex these
products may be, a basic axiom of the function of insurance is that of risk management. Ac-
cording to Barron’s Dictionary of Insurance Terms, Risk Management is a “procedure to mini-
mize the adverse effect of a financial loss by (1) identifying potential sources of loss, (2) meas-
uring the financial consequences of a loss occurring; and (3) using controls to minimize actual
losses or their financial consequences.” Ernst & Young’s Personal Financial Planning Guide
states: “Risk Management: the discipline of determining how likely certain events will be, then
deciding what steps will limit or transfer the consequences.”

      Many of the “risks” that are encountered in everyday life are “managed” by individual
choice, such as exercising regularly, not smoking, eating proper foods, getting physical check-
ups, etc. However, there are more deleterious risks that are beyond the ability of an individual
to control. These risks can be transferred to another, and the “transferee” is insurance – indeed,
that is the purpose of insurance. For those and other risks, the personal decision of the client
must be first and foremost in the determination of transferring risk. The client must consider
how much risk they are willing to tolerate, and then determine how much of that risk can be
transferred. The likelihood of that risk affecting the client is important, but the insurance indus-
try, if anything, is a gatherer of statistics and can help determine this. The last, but certainly not
the least, factor is the cost to the client of transferring that risk. It is important to understand
that one should never underinsure a risk that they could cover for little cost. A good example of
this is liability insurance on an automobile policy – it is quite inexpensive, but a million-dollar
lawsuit as the result of an auto accident is not unreasonable in today’s society.



                                                     4
                                WHY LIFE INSURANCE

    A working definition of life insurance begins with understanding why the concept of insur-
ance originally developed. In all lives, uncertainty exists about what will happen tomorrow,
next month, next year. The future holds unknown events, some that will be positive, others,
negative. Negative events include the possibility of loss. Insurance is specifically concerned
with financial loss. For example, because most people own and rely upon the availability of
cars, they can envision the financial loss that will occur if the car is damaged in an accident. As
a result, people buy auto insurance to protect themselves against the uncertainty - the risk they
take by driving - that they will suffer a financial loss if an accident occurs.

DEATH

   Fewer people readily envision the financial loss that will occur as the result of death. One
might argue that there is no uncertainty here because everyone will die sooner or later. While
death is certain, however, the uncertainty is this: When will it occur? And more importantly,
what will be the consequences?

   If one wants to know exactly how much life insurance premium they should pay, all they
have to know is two items: (1) Date of Birth. (2) Date of Death!

    In addition to the emotional consequences of death, the financial consequences can be dev-
astating, especially if the deceased has financial obligations that extend to others. The death of
a person who provides the primary income for a family can result in the loss of everything - the
home through lack of funds to continue making mortgage payments; the source of ongoing in-
come for food, clothing, utilities and more; the children's education; the survivor's retirement.

    Insurance is obviously the answer to this uncertainty because it produces a substantial sum
of money that becomes available precisely when it is needed - when the financial loss occurs. If
all people could personally generate and accumulate enough wealth to cover financial losses,
there would be no need for insurance. Since most people are not wealthy, insurance was devised
as a way of having a large number of people share in the loss.

    Instead of pooling money with private parties, people who purchase life insurance make
small payments to an insurance company in return for the guarantee of a substantial sum of
money if death occurs. The financial loss is still spread among many others who also purchase
insurance from the same company, but it is the insurer who accumulates the funds and is re-
sponsible for paying for losses. In this way, the financial risk is transferred from one person to
a group through an insurance company.

DEATH BENEFITS

   The best understood and most obvious purpose of life insurance is to pay a certain amount
of money to survivors when the insured person dies. Paying death benefits was the original


                                                   5
purpose of life insurance policies and continues to be the major reason people buy life insur-
ance. Life insurance paid at the time of death can be used for many purposes, including:

          Ongoing living expenses for survivors.
          Retiring a mortgage on the survivors' home,
          Establishing a fund for children's future college costs.
          Paying off debts existing when the insured person dies.
          Paying death expenses, Such as medical and funeral costs.
          Buying out a surviving partner's interest in a business.
          Replacing income lost by the death of a key employee.

    While life insurance has traditionally been used for purposes such as these, contemporary
policies can provide additional benefits, whether the insured person lives or dies.


                                   CASH ACCUMULATION

    As life insurance policies evolved, more emphasis was placed on the cash values that accu-
mulated in policies as premiums were paid. Certain policies have features allowing cash ac-
cumulation that may be used by the insured person who does not die. For example, a policy
might accumulate cash values that would be payable to the policyowner when she or he reaches
a certain age or after the policy has been in force for a specified number of years. With the re-
cent wild fluctuations of the stock market, cash accumulation has taken on a life of its own and
will be discussed in great detail later in this text.


                          PERMANENT AND TERM INSURANCE

    A basic (very basic!) distinction to be made about life insurance policies is whether the in-
surance is permanent or term. Permanent insurance, which is also called cash value life in-
surance, is permanent only insofar as the policy language is concerned. Originally, "perma-
nent" meant that the policy was in force until the insured person died or lived to age 100,
whichever came first. If the insured were still alive at age 100, the policy would pay its full
amount of insurance to the insured instead of continuing until the insured person died. More
recent policies often have earlier payoff dates.

    In addition, permanent policies typically build some type of cash value that is available
while the insured person is living. For example, the cash value may be borrowed or used to help
pay premiums. In more contemporary policies, cash values can grow significantly to provide
retirement income. While the more appropriate terminology for these policies is ”cash value life
insurance," they are still often called permanent insurance.

    Term Insurance, conversely, does not build cash values and does not continue "permanent-
ly." Instead, a term policy is written to pay a specified amount of insurance only if the insured
dies within a specified "term" or period of time. When the term ends, so does the insurance
coverage. In the past, if the insured wanted to continue coverage, a new term policy usually


                                                   6
was required. In recent years, however, most term policies are written with an automatic renew-
al feature.

    Permanent life insurance ("Whole life") also refers to the premium-paying period. Premiums
are paid for the entire period the insurance is in force, again either until the insured dies or
reaches age 100 (or other age the insurer selects). The advantage of making premium payments
for a long period is that each payment will be relatively small for the benefit provided. At the
time the policy is purchased, each payment is determined and "fixed" so it never changes during
the policy lifetime.


                                   TERM INSURANCE

    Term Insurance is basic insurance and it must be assumed that any licensed insurance agent
fully understands Term Insurance. However, since it is used for a wide variety of purposes, in-
cluding financial and estate planning, therefore a brief discussion of this product is in order.

  Term Insurance is defined as coverage that:
  Applies only for a limited, specified period of time - the "term.”
  Does not build cash values. It is written strictly to provide a death benefit, therefore pay-
   ing nothing unless the insured person dies within the specified term.


                                        LEVEL TERM

     Level Term: When the amount of coverage in a term policy remains the same throughout
the policy period, the policy is called level term. This is the typical way to purchase Term In-
surance. So, for example, if the term is for five years and the amount of insurance is $150,000
when the policy is purchased, the coverage remains at $150,000 through the end of the five
years or when the insured dies, whichever comes first.


                                    DECREASING TERM

    Decreasing term Insurance has a death benefit that gradually becomes smaller over the poli-
cy period. A popular use of decreasing term is to provide having a lump sum of money, which
is available to pay off a mortgage if the insured should die before doing so. Decreasing term
policies used for this purpose are informally called mortgage insurance or mortgage redemption
insurance and many are structured so that every year the death benefit exactly equals the re-
maining mortgage amount.

    For example, the term might be the same number of years as the mortgage. If a 30-year
mortgage were $100,000, the decreasing term policy would be written originally for $100,000,
reducing as the amount of the mortgage reduces.




                                                  7
                                     INCREASING TERM

    Some insurers also offer the option of Increasing Term Insurance, which is typically writ-
ten as a rider or endorsement to a cash value life policy. The increasing term provision operates
much as a Rider, as it “rides" along with the cash value policy. This will be discussed in more
detail later.

   With such a rider, the policyowner pays an additional premium; the death benefit amount
gradually increases during the term the rider is in effect.


THE POLICY PERIOD
     Term Insurance policies are written for various periods of time, depending upon the particu-
lar insurer. While most term policies have periods of one, five or 10 years, terms of 15, 20 or 25
years may be available. Other policies might be written for a term associated with the insured's
age, such as until the insured reaches age 55 or 65.

   From the options offered by a particular insurer, the policyowner may choose the term most
appropriate for his or her needs.

THE PREMIUM
   A feature that often attracts insurance buyers to Term Insurance is the lower premiums -
lower at least initially as compared to permanent types of coverage. Premiums can initially be
lower because

        There are no cash values, so no premium is required for this purpose.
        The insurer, allowing more certainty about the actual cost of the insurance knows the
         exact premium-paying period.
        If the policyowner renews the policy at the end of the term, a higher premium will
         then be required.

    Term policy premiums typically remain level during the entire policy period. So, for exam-
ple, an insured that purchases a 10-year term policy pays the same premium for the 10-year pe-
riod. Then, if the term policy is renewed, as discussed in the next section, the new premium is
calculated and likewise remains the same for the subsequent 10-year period.

AUTOMATICALLY RENEWABLE TERM

   Most insurers offer their term policies on an automatically renewable basis. Under this ar-
rangement, when the original policy period expires, the insurer automatically renews the insur-
ance for a "like term" - a 10-year term policy for an additional 10 years, a 15-year policy for 15
more years, etc. - unless the insured specifically refuses the renewal. All policies specify a max-
imum age, however, after which the policy will no longer be renewed. The precise age differs
among insurers, but age 60, 65 and 70 are typical.




                                                   8
     The primary benefit to the insured is the ability to renew the policy for many years without
proving insurability - which he or she is still in good health. Without the renewability feature,
an individual must have another medical examination to prove insurability.

    At renewal, the new premium is determined according to the attained age - the age the in-
sured is on the renewal date. The premium, therefore, is higher because of the increased age of
the insured - not because of a change in health. These premiums are sometimes called step rate
premiums because they "step up" to a higher level as the insured ages. Some policies guarantee
what the attained age premiums will be, others do not.

INDETERMINATE PREMIUMS

     When a policy does not guarantee the premium amount, the premium is indeterminate.
Like the indeterminate premiums discussed previously, such premiums might be higher or lower
than the last premium the policyowner paid. A maximum premium must be established, howev-
er, and typically, few companies ever charge the maximum.

     The original premium for a renewable term policy is somewhat higher than for a term poli-
cy that is not renewable since the insurer takes a greater risk by offering renewability in the fu-
ture when the insured's health may have deteriorated.

RE-ENTRY FEATURE

    While automatically renewable term policies do not require a medical exam, an insured
might choose to have a medical examination because of the re-entry feature included in some
term policies. This feature offers two possible levels of premium increases - a higher level for
choosing not to take a medical exam and a lower level for having the exam to prove that the in-
sured is still in good health.

RENEWABILITY

     While most contemporary Term Insurance is automatically renewable, a few term policies
still follow the older historical pattern of offering renewability, but not automatically. In such
policies, a very short time window typically exists during which the policyowner may exercise
the renewal option after a term policy expires - 30 days is common. Under this type of policy,
failure to renew within the time limit means the individual once again must prove insurability
and meet any other insurer requirements in order to purchase a new term policy.


                                    CONVERTIBLE TERM

    Convertible term policies permit the policyowner to convert from term to cash value life
insurance. A term policy that includes this right often has the word "convertible" in its name.

    Insurers vary significantly on the period of time but will state the maximum age that the in-
sured may convert in the policy.



                                                   9
  One may also encounter older policies that require much earlier conversion, such as:
  Only during the first two years of the term policy.
  Up to three years before the policy's original term ends.
  Up to five years before the policy's original term ends.

ATTAINED/ORIGINAL AGE

       The rate will be determined based upon either the insured person's attained age or original
age.

    Attained age refers to the person's age at the time conversion occurs. Conversion at at-
tained age means the premiums will be higher since the person is older once the policy is con-
verted, a new policy is issued and the policyowner starts paying the higher premiums. The new
cash value policy is then no different from any other cash value policy.

   Original age is the insured's age when the policy was originally written. Since the insured
was younger, the rates are lower than for attained age policies. However, there is an additional
lump-sum cost for original age conversion.

     The amount of this additional charge is the difference between the premiums actually paid
to date and the higher premiums that would have been paid had the insured purchased cash val-
ue insurance originally. Added to that amount is a small percentage to cover the insurer's ex-
penses.

   An increasing term rider could be added to cash value life insurance, making the policy a
combination of' permanent and Term Insurance and thereby satisfying specific needs.

FAMILY COVERAGE

    Some cash value policies permit the permanent insurance on one individual - usually the
family breadwinner – to be supplemented by Term Insurance on other family members. Such a
combination policy permits family coverage-insurance on all members of the family under a
single policy at rates lower than for individual policies. For example, a married man who is the
sole wage-earner might purchase cash value insurance on his own life and add Term Insurance
to cover just his wife or both his wife and their children.

    Varying amounts of Term Insurance are permitted for family members in these combination
policies, usually based upon some mathematical portion of the permanent coverage and sold in
"units." For example, the permanent coverage on the primary breadwinner might be one unit of
$10,000, and based upon that unit, the other spouse will be covered for $2,500 of Term Insur-
ance and any children will have $1,000 of insurance each. If the breadwinner purchases two
units instead of one, the coverages would be $20,000 permanent insurance, $5,000 of term on
the spouse and $2,000 of Term Insurance on each child. The exact dollar amounts are stipulated
by the particular insurance company.




                                                    10
    Any children born or adopted after a family policy goes into effect are automatically cov-
ered at no additional premium. Insurance on children expires when each child reaches an age
stated in the policy, usually 18 or 21. Some policies allow coverage to continue longer if the
child is a dependent, full-time student. Children's coverage sometimes may be converted to
permanent insurance.

    There are many different ways to write family coverages, some permitting a small amount
of permanent coverage on the breadwinner's spouse. Other policies might provide that the cash
value coverage would be equal to four times the Term Insurance on a spouse. Still others might
limit the Term Insurance on family members to very small amounts designed to cover the cost
of burial and little more.

   Family plans, while historically providing an economical insurance solution for lower in-
come families, may not be appropriate for many contemporary families in which both adults
provide a significant part of the family's income.

FAMILY INCOME COVERAGE

     Another use for combination policies is to provide family income when the breadwinner
dies. Under these policies, the cash value insurance death benefit is paid in a lump sum and the
Term Insurance is paid in installments over a certain period. Options of 10,15, or 20-year peri-
ods are commonly offered.

      When decreasing Term Insurance is used for this purpose, the period begins on the date the
policy is issued and the amount of insurance begins decreasing gradually. The longer the in-
sured person lives, then, the smaller the amount of Term Insurance available. This assumes that
if the insured lives longer, less money from insurance will be required for the survivors because
the insured continues to earn the money for ongoing living expenses. If the insured dies before
the decreasing term period expires, income payments from the Term Insurance begin to be paid
to the family.

    The lump-sum death benefit portion of family income policies is typically paid at the time
the insured dies.

    Some family income policies include level Term Insurance instead of decreasing term. In
this case, the "term" begins when the insured dies and continues for the stipulated period, with
income payments to the family made during the entire term. This arrangement may also be
called a family maintenance policy.


HOW CASH VALUES ACCUMULATE

    Because Whole Life policies are permanent insurance, cash values build during the policy
period. In the early years of a Whole Life policy, typically while the insured person is young,
more premium money is paid in than is actually required based upon the mortality tables for a




                                                  11
younger person. The insurer accumulates, as cash values, the difference between the premium
actually required to cover mortality costs and the premium the policyowner pays.

    Cash values grow not only from the excess premium payments, but also from interest paid
on the cash value. At some point, as the insured ages, the level premium that is still being paid
no longer covers the mortality risk, but the larger premiums paid in the earlier years balance the
cost.

     Whole life policies guarantee that specific amounts will accumulate each year the policy is
in force and will be available to the policyowner as cash values. A table included in the policy
itself shows the guaranteed cash values. The rate of interest is typically low simply because it is
guaranteed rather than tied to anything going on in the financial world that might otherwise af-
fect interest rates. While relatively low, these guaranteed rates help the cash values grow over
the years of a Whole Life policy.

SINGLE PREMIUM

    While fixed, level premium payments represent the most common method for purchasing
insurance, single premium Whole Life policies are also available. In this case, the insured
buys the policy with just one large lump-sum premium and the policy is paid-up for life, provid-
ing both the insurance protection and an immediate cash value. Because a large cash value is
available from the onset of the policy, the interest earnings over the years are likely to be great-
er. And, while a single premium policy requires a greater cash outlay initially, it actually costs
less in the long run since it is not subject to the ongoing administrative charges the insurance
company incurs each time a premium payment is made.


                               LIMITED PAYMENT POLICIES

    Not all insurance purchasers want a policy that requires them to make premium payments
for a lifetime. This criticism led to the development of limited payment or limited pay poli-
cies. As the name implies, these policies require the insured to pay premiums for only a limited
period of time.

    Like Whole Life policies, limited pay policies require a certain premium amount that never
changes during the policy period. Because the number of years during which premiums are
paid is shorter, limited pay premiums are higher than Whole Life premiums.

   Insurance companies offer various types of limited payment policies such as 10-pay life,
20-pay life, 25-pay life, 30-pay life, Life paid up at 65, Life paid up at 80, etc.

    These types describe how long the policyowner pays premiums. For example "10-pay"
means premiums are paid for 10 years and the insured then has coverage for life. "Life paid up
at 65" means the insured pays until his or her age 65 and then is covered for life.




                                                   12
    Like Whole Life insurance, limited pay policies also pay the face amount if the insured lives
to age 100, or other age the insurance company specifies.

ADVANTAGES OF LIMITED PAY POLICIES

    Paying the higher premiums for limited pay policies can additionally benefit the
policyowner. Cash values accumulate at a faster rate simply because more money is available
earlier to earn interest. Since these cash values are guaranteed, more value is available sooner
than with a Whole Life policy. And, of course, there is the advantage of knowing exactly how
long premiums must be paid.




                           CHAPTER 1 – STUDY QUESTIONS


1.     A customer may not feel comfortable with a financial planner if
       A.      the planner receives commissions from an insurance company that he/she repre-
               sents.
       B.      the planner is licensed to sell mutual funds.
       C.      the planner is a registered stockbroker..

2.     What should you do if the clients wish to bring in their own attorney and tax consultant?
       A.      The agent/planner should refuse to allow them to become involved.
       B.      The agent/planner should then bring in another attorney and accountant.
       C.      The agent/planner should welcome their expertise and work closely with them.

3.     The original purpose of life insurance was
       A.      to provide funds from construction of homes and buildings.
       B.      to pay to estate taxes.
       C.      to pay death benefits.

4.     Term life insurance that decreases in death benefits over a specified period of time may
       also be known as
       A.      mortgage insurance or mortgage redemption insurance.
       B.      increasing term.
       C.      Universal Life.




                                                  13
5.    Because the number of years, during which premiums are paid, is shorter, limited pay
      premiums are
      A.     lower than Whole Life premiums.
      B.     higher then Whole Life premiums.
      C.     variable.

6.    In Term insurance, when the original term of issue expires, the policy will be
      A.     automatically renewed.
      B.     automatically cancelled.
      C.     automatically converted to Whole Life Insurance.

7.    A life insurance policy that guarantees a specific amount of cash value at a specific time,
      guarantees fixed payments and guarantees a specific death benefit is called
      A.     Universal Life.
      B.     Variable Life.
      C.     Whole Life.

8.    When the face amount of a Term life insurance policy remains the same throughout the
      policy period, the policy is called
      A.     Decreasing Term.
      B.     Increased Term.
      C.     Level Term.

9.    The type of family policy that combines Decreasing Term with Whole Life is called
      A.     Family Maintenance Policy.
      B.     Family Income Policy.
      C.     Family Policy.

10.   One of the following is the best reason to buy Whole Life insurance.
      A.     Buying out a surviving partner’s interest in a business.
      B.     Accumulation of cash assets.
      C.     Protect the mortgage on a home.
ANSWERS TO CHAPTER ONE REVIEW QUESTIONS
1A 2C 3C 4A 5B 6A 7C 8C 9B 10A




                                                14
    Whole life and limited pay life policies are the proven mainstays of the life insurance indus-
try. These traditional types of insurance, while still providing the best insurance answers for
some situations, came under fire in inflationary times, especially when interest rates rose dra-
matically. As a result, many consumers began to look for other sources of cash accumulation
that would provide a better return than the modest rates insurance policies guarantee. Now that
the “bloom is off the rose,” or so it seems, the “modest” rates are of interest because they are
guaranteed.

WILLINGNESS TO TAKE RISKS

    For those who wanted the security insurance provides, the answer was usually to buy Term
Insurance at a lower rate and invest the premium savings in higher-paying mutual funds, money
market funds, the stock market, and similar vehicles. Consumers who did not feel they needed
insurance took all of their money elsewhere, clearly signaling to insurers a readiness to take
some investment risk in order to get a higher return.

FLEXIBILITY

    Not only did consumers want more return on their money, they also wanted more flexibility.
Traditional life insurance policies require policyowners to pay the premium on time, every time,
or lose the insurance protection, retaining only the cash values protected by nonforfeiture provi-
sions. No matter how tight the policyowners finances might become due to unforeseen econom-
ic straits - loss of a job, an unexpected major expense, or whatever - the insurer demanded the
premium to be paid on time. Modern consumers also wanted payment flexibility in order to
deal with economic uncertainties.

INSURANCE INDUSTRY RESPONSE: UNIVERSAL LIFE

    The foregoing is a simplistic sketch of the environment that gave birth to Universal Life in-
surance policies. These policies will be discussed in detail in later chapters, but the essence of
these non-traditional policies is that they provide:

          The protection element of life insurance.
          An option to alter the death benefit amount during the policy period.
          A modest guaranteed interest rate.
          The potential for a higher, more competitive interest rate.
          Flexibility in the size and frequency of premium payments.

    These non-traditional policies have many of the same features as traditional cash value life
insurance. Also, like Term Insurance, the insurance protection could cease under certain cir-
cumstances, as you will see. Although these policies are most often called Universal Life, they
are also known as adjustable premium Whole Life and flexible-premium adjustable life pol-
icies. But it's not only the premium that is adjustable.



                                                  15
AN ADJUSTABLE DEATH BENEFIT

     When traditional types of' life insurance are written with a certain death benefit (face
amount), the policy remains in effect as long as the policyowner pays the premium, but if no
premium is paid, the insurance can terminate. One important feature of Universal Life policies
is that the death benefit is adjustable - it could be $100,000 at the beginning of the policy peri-
od, but it might drop down to $50,000 at some point and later rise to $175,000. Within certain
limitations, the policyowner controls these adjustments.

    With this adjustment feature, no new policy is needed to reflect the different amount of in-
surance. The adjustments are made to the existing policy. When the policyowner increases the
death benefit, some insurers require proof that the insured person is still insurable and in good
enough health to meet the insurer's standards.

DEATH BENEFIT OPTIONS

    At the onset of a Universal Life policy, the policyowner chooses one of' two death benefit
options:

   Option A: The first choice, Option A, provides a level death benefit similar to traditional
   life insurance policies. This level benefit is stated in the policy, but the insured still has the
   option to increase it or decrease it during the policy period.

   When the death benefit is selected, the premium is determined, with part of it destined to
   pay for the insurance coverage (the death benefit) and part to be deposited into the cash val-
   ue account to earn interest. The policyowner pays this same premium regardless of whether
   the death benefit is increased or decreased during the policy period. (An exception is when
   the policyowner exercises the premium-paying flexibility of Universal Life, discussed be-
   low) Thus, the policy provides a level death benefit and a cash value account that accumu-
   lates interest.

   It is important to differentiate between the death benefit - the insurance protection - and the
   cash value. For a Universal Life policy to receive the special Internal Revenue Code (IRC)
   tax considerations that apply to insurance policies, there must always be an amount at risk
   until the insured's age 95. The amount at risk refers to the amount for which the insurer is
   at risk, and is the difference between the face amount (death benefit) of the policy and its
   cash value. For example, a policy with a $100,000 death benefit currently has cash values
   totaling $20,000. The amount at risk in this case is $80,000.

   As the policyowner continues to pay premiums, the cash value increases while the amount
   at risk for the insurer decreases. The IRC mandates that the cash value must not equal the
   amount at risk until the insured reaches age 95. At times when earnings are high, it would
   be possible for the cash value and the amount at risk to be nearly the same.

   If the cash value begins to approach the amount of insurance, the death benefit must be
   raised. The Internal Revenue Code dictates a certain minimum amount at risk that must be
   maintained in order for the policy to continue to be treated as life insurance and not as an


                                                    16
   "investment." This minimum amount is often referred to as the tax corridor or the risk
   corridor.

   Option B: The second death benefit choice, Option B, provides for an ever-increasing
   death benefit that consists of not only the amount of insurance, but also the amount of the
   cash value account. For example, if the original death benefit at the onset of' the policy is
   $100,000 and the cash value is $45,000 when the insured dies, the beneficiary of' the policy
   will receive a $145,000 death benefit.

   Because it is known from the beginning that the death benefit will increase, the premium
   payment for Option B is greater than for Option A to pay for the increasing amount of insur-
   ance protection. An individual could choose to pay the same premium for an Option B type
   of policy as for an Option A type policy, but the cash values would grow at a reduced rate.

INTEREST ON THE CASH VALUE ACCOUNT

    Current Interest Rate: The insurance company periodically sets aside the dollars required to
pay for the Universal Life policy's insurance protection. On the remaining money in the cash
value account, the insurer pays interest at its current interest rate. The rate is made up of two
distinct rates:

    (1)        The minimum guaranteed interest rate specified in the policy, typically 4 to
41/2%, plus

(2) The excess interest rate, which is some rate in excess of the guaranteed interest.

    For example:

                       Guaranteed rate + excess rate = Current interest rate

                                          4.51 + 3.01 = 7.5*1

    The specific excess rate is set at the insurer's discretion. Some insurers use a rate that re-
flects a known financial index, such as the yield on U.S. Treasury securities. The excess rate
changes as financial indicators change. So, in the example above, 7.5% interest would be paid
for a period of time, but if the excess rate changed, let's say to 3.25%, the next time interest is
credited to the cash value account, it would be at a rate of 7.75% (4.5% + 3.25%).

     The period for which the current interest rate applies varies. Some companies guarantee a
rate for a full year, others for no more than three months. Additionally, some insurers pay excess
interest only on the cash value that is greater than a specified amount. For example, if the speci-
fied amount is $5,000 and the cash value is $8,000, the lower guaranteed rate would apply to the
first $5,000 and the higher rate to the remaining $3,000.




                                                   17
CHARGES TO THE ACCOUNT

    The Insurance Protection: Of each premium paid, a portion pays for the life insurance pro-
tection. This amount, based upon mortality rates for the particular individual, is typically taken
as an adjustment to the cash value account once a month. Then, another portion goes to the
cash value account to draw interest.

   Loading: Not all of the remaining payment draws interest, however, because sales and ad-
ministrative expenses must be paid. This charge is called a load or loading.

    Expenses may be deducted as front-end loads or back-end loads. In a front-end loaded pol-
icy; the insurer deducts a certain percentage from each premium payment before crediting it to
the cash value account. If the load is 6%, for example, and the premium payment is $1,000, $60
would be deducted, leaving $940 for the cash value account.

    Recent Universal Life policies are more often back-end loaded, which means the entire
premium payment is deposited into the cash value account. The back-end loading comes into
play if and when the policyowner performs certain transactions in the cash value account, such
as surrendering the policy for its cash value. The advantage of back-end loaded policies is that
the cash value account has more money to earn interest in the early years. The disadvantage is
that some back-end loads are quite high.

    Some insurers offer the equivalent of a no-load arrangement, whereby the insurance compa-
ny takes a percentage of current earnings, similar to no-load mutual funds. Transactions that
typically incur loading charges will be discussed below,

OTHER CHARGES:

    Insurers might also charge a flat fee to cover the cost of maintaining and servicing the poli-
cy. This may be an annual fee or a monthly fee.

     Some insurers have first year charges that apply in addition to all other policy charges. Af-
ter the first year the policy is in force, these charges no longer apply. The following are some
examples of first year charges:

         Up to one dollar per thousand dollars of insurance coverage.
     No excess interest paid on the first $1,000 cash value, which in effect is a charge because
that interest is lost to the policyowner.
         A flat monthly fee paid in addition to any other policy charges.

    Insurers provide the Universal Life policyowner with an annual statement that shows exact-
ly what transactions occurred and what charges were assessed during the year.




                                                  18
                               UNIVERSAL LIFE PREMIUM

     Like Whole Life policies, Universal Life insurance may be purchased with a single premi-
um paid at the policy's inception. The benefits of paying a single large premium are the same as
those for Whole Life and might even be magnified as the result of the current interest rate paid
on Universal Life cash values. Of course, all of the cautions about maintaining the risk corridor
in a Universal Life policy must be observed.

THE ADJUSTABLE PREMIUM

    Most Universal Life policies are purchased not with a single premium, but with periodic
payments spread over a number of years. Whereas traditional life insurance policies have a
fixed level premium, payable on a regular schedule, Universal Life offers an adjustable or flex-
ible premium. This feature permits the policyowner to raise, lower and even skip premiums.
However, lowering or skipping premiums is possible only if enough cash value has accumulated
to pay for the pure insurance costs and any administrative charges. If the cash value is not ade-
quate, a payment must be made to keep the insurance in force.

    When a Universal Life policy goes into effect, a certain level premium payment is estab-
lished. For the policy to have any cash value, obviously, some premiums must be paid. Once
the cash value grows adequately, this amount can be used to keep the insurance protection in
force whether or not the policyowner pays additional premiums.

    CONSUMER APPLICATION
    Duane purchased a Universal Life policy with a death benefit of $200,000, for which the
annual premium is $1, 000. Several years later when Duane’s son enters college, the cash value
has grown to $15,000. Duane feels that maybe he should drop his life insurance for the time
being as it is going to cost so much for his son to attend Yale. However, he finds that there is
adequate cash value to pay for the insurance protection.
    Duane could continue to skip payments until his son graduates and let the cash value ac-
count take care of the insurance protection. On the other hand, since his business seems to be
going well, he could possibly make reduced premium payments. However, at some point, the
cash value fund could be depleted, and then he would have to make a payment or the insurance
lapses - there is no more coverage. In addition, since the cash value account is being reduced
during the years no premium payments are made, the policyowner could not rely upon those
funds to be available for other purposes.


    CONSUMER APPLICATION
    As time goes on, Duane’s business goes public, and he is able to restore his Universal Life
policy. Since the premium originally was $1,000, he wants to double the payment to $2,000.
By doing this, Duane benefits because the cost of insurance protection remains the same, so the
additional amount of premium goes to the cash value account to earn interest.
    Duane gives consideration to increasing the death benefit. In order for the extra premium to
                                                                            (Cont. on next page)



                                                 19
pay for additional coverage, the “corridor,” as set forth by the IRS, must be maintained in order
for the cash value account to continue receiving favorable tax treatment. At any time, Duane
can revert to the original premium payment amount or again stop paying premiums entirely.

                           EXAMPLE OF UNIVERSAL LIFE FLEXIBILITY




    At age 30, the insured purchases a Universal Life death benefit of $100,000 for a $500 an-
nual premium. This coincides with the birth of a child. At $500 per year, the cash value grows
moderately. When the insured is age 33, she receives a $1,000 windfall, which she deposits in-
to the cash value account along with her usual premium. At age 36, she withdraws $500. She
continues to make level $500 payments and the death benefit remains at $100,000.

    At age 40, the insured increases the death benefit to $150,000 and begins making $900
premium payments. At age 42, she skips one premium payment, and then resumes paying at age
43.

    At age 44 she increases the premium payment to $1,500 per year, retaining the $150,000
death benefit.

   At the insured's age 48, her child enters college. She withdraws $4,000 that year and the
next year while continuing premium payments. At her ages 50 and 51, she withdraws $4,500
each year. At 52, when her child is graduated from college, the insured continues paying pre-
miums and keeps the $150,000 death benefit, making no further withdrawals. At age 55, she
lowers the premium payment and drops the death benefit to $100,000. At age 60, she stops pay-




                                                 20
ing premiums and lowers the death benefit to $50,000, at which time her cash value is sufficient
that no further premiums are required.

UNIVERSAL LIFE AND THE STAGES OF ECONOMIC LIFE

     While Universal Life can be used throughout the lifetime of the insured, many profession-
als have determined that the average individual goes through several specific states of life where
economics plays a large part. The example shown above indicates several, but it is worthwhile
to examine each of these stages.

     Career Stage: Universal Life (UL) is perhaps the very best solution for providing death
benefits at a minimum cost, which is so important in the early stages of ones career while the
future is bright but the income is still slight. The accumulation of the cash value and level life-
time premiums can be easily adjusted at a later date and with the same policy.

     Career Developing (usually age 35 to 50): This is a very financially active period, as
home buying, children to college, the need to purchase “big-ticket” items, and retirement plans
occur at this time. The career and family income generally is increasing during this period of
time, so the UL can be utilized by the increase of the cash value or of the death benefit, which-
ever was chosen. If the increasing death benefit option was elected, then there will be no insur-
ability problems.

     Phase of Accumulation Peaks: The kids are gone, consumer loans have been largely elim-
inated, and mortgage payments are either non-existent, or well under control. Now, cash values
can grow at current interest rates with a guaranteed interest rate minimum and the cash value
accumulations grow at tax-deferred basis. Also, because of TEFRA (1982) and TAMRA (1988),
federal guidelines now will cause the death benefits to rise automatically, even if the level death
benefit is elected.

    Just Prior to Retirement: The approximate five-year threshold just prior to retirement is
when close looks are made at retirement funds and the conservation of assets is of prime im-
portance. At this time, generally conservative investing of assets occurs. It is not too late to
change a pattern of funds, and UL can be used very effectively in this stage. If there are suffi-
cient cash value accumulations, then the cash outlay can be reduced – or even eliminated –
without sacrificing death benefits. If there may not be enough funds for retirement, then the
death benefit can be reduced which will increase the cash value growth.

     Retirement: Withdrawals and loans from UL can provide an income, either for life or for a
specific time. If retirement is prior to age 65, the cash value accumulation can be used until So-
cial Security benefits are available.

   Death: The final chapter. UL can pay a death benefit, even after it has paid a retirement in-
come.




                                                   21
         UNIVERSAL LIFE DURING PERIODS OF ECONOMIC DOWNTURN

     According to a Life Insurance Management and Research Association (LIMRA), for the
last quarter of 2001 84 insurance companies that had a Universal Life premium increase of
18%, annualized premium for UL grew 25% in the last quarter, while there were significant de-
creases of Variable Life , Variable Universal Life and Whole Life. LIMRA credits the fact that
owners of UL policies, as well as agents who sell them, are comfortable with the guarantees in
such a volatile economic environment.

     There are many and different types of Universal Life available, and the best type provide
excellent death benefits and competitive death benefit amounts (at all ages) and also secondary
guarantees for lifetime no-lapse protection. This should allow the policies to stay in force even
if there is no cash value, and the policy should be capable of guaranteeing the death benefit for
30, 40 or 50 years or for the lifetime of the insured.

     A good product also has a “super” preferred class for non-smokers in good health in ages
20 - 80, as they will be able to better enjoy the low cost of insurance (COI) charges which in
turn leads to better death benefit results.

    The policy should be able to allow the policyowner to increase, decrease or stop the premi-
um payments, and restart them later if there is sufficient cash value to keep the policy in force.

    Premium payments less a sales charge, should be invested in a general account by the in-
surer, and the interest should be earned at a pre-determined and stated rate.

    The “best” UL and Variable Universal Life (VUL) policies allow withdrawals from the cash
value, usually after the policy has been in force for one full year.

     Riders should be available, such as an accelerated benefit, which provides a living benefit
in case of a terminal illness, and other riders – such as supplemental term coverage.

     Leading producers of Universal Life products use the UL for business purposes, such as
where life insurance policies are used for a buy-out of a principal in case of death, as UL is
clearly the best method of funding for buy-outs in most situations of this type. If some of the
partners or owners are not insurable, a Joint and Last Survivor UL policy works well, even
though the company will have to wait for the death of the second insured to complete the ar-
rangement, but that would still be much better than funding the contract with after-tax dollars.

    Another situation would be where there is a wealthy insured approaching 90 who has a
Whole Life/term policy. A 100% guaranteed Joint and Survivor UL (JSUL) could be used, as in
these older years, the values of other types of insurance drop dramatically.

    There are a lot of questions floating about now in respect to the new Estate Tax Laws,
which can be reinstated after 2010 unless the congress does something about it. Term Insurance
won’t do nearly as well as JSUL in most of these situations, and questions must arise as to




                                                  22
whether the insured can convert the Term Insurance if the government decides not to repeal the
federal estate tax. (See later discussion of Estate Tax Repeal Rider later in this text)

    All-in-all, reports from top producers indicate that the fast cash buildup and low surrender
charges of the JSUL policies are very appealing for estate planning, even if the estate tax is re-
pealed (or not).

     Another enterprising agency markets a special Universal Life product to volunteer fire-
fighters, emergency medical technicians and rescue personnel – of which there is reported to be
in excess of 800,000 in the U.S. These persons receive no compensation for their work and
since most of them seem to come from middle income families, they usually do not have ade-
quate life insurance protection. This “special” UL product is used for a “Length of Service
Awards Program” which is a non-qualified plan funded by individual UL policies and a Variable
Annuity contract.

     The assets in the plan are owned by the plan trust and grow tax-deferred until the partici-
pant’s retirement, when the participant would receive a specified benefit - up to $250 a month,
depending upon length of service in the fire district. Eligibility is the attainment of age 65 with
a 10-year vesting schedule, when at retirement the participant may either surrender the policy
for cash to add to the monthly annuity benefit up the maximum; or they may take ownership of
the policy, retain the insurance protection and receive a lower monthly benefit.

     The “cap” of $250 per month is in response to the 1996 Minimum Wage Act, and they are
therefore exempt from Section 457 of the Federal Tax Code. By setting this $250 per month
maximum retirement benefit, the plan can provide life insurance protection of $25,000, and
premiums are usually set to endow the policy at age 100.

     Variable Universal Life is not considered for this program as the 1996 law does not allow
for employee-directed investment accounts.

     Underwriting is individually on a group basis, where the underwriters evaluates the entire
group and “trades” preferred risks for rated risks, thereby allowing for an across-the-board rate.
There are few uninsurables in this business, as most volunteer firefighters like to keep in shape,
just as the professional firefighters.

     Another example of how imaginative professionals can take advantage of the tremendous
flexibility of Universal Life.

MULTIPLE USES FOR CASH VALUE

   In addition to keeping the insurance protection in place, it may be used for other purposes.

    Withdrawals: Universal Life policyowners are permitted to make withdrawals from the
cash value account. Withdrawals of only a portion of the cash value (rather than all of it) are
sometimes called partial surrenders because the policyowner is surrendering or giving up part
of the policy. The withdrawal is made from the cash value account, so that portion of the cash



                                                   23
value is surrendered. Most Universal Life policies also reduce the death benefit by the amount
of the withdrawal.

    CONSUMER APPLICATION
    Brett has a Universal Life insurance policy with the death benefit of $100,000 and the cash
value is $13.000. He withdraws $10,000 from the cash value account, reducing it to $3,000.
The death benefit is reduced to $90,000.

BACK-END LOADING VS FRONT END LOADING

    While this illustration shows the cash value account reduced to $3,000, in reality it would be
reduced even more because of fees charged for the withdrawal. When a policy is back-end
loaded, this is one of the situations where the expense loading applies. Front-end loaded and
no- load policies are also likely to assess a charge for withdrawals.

PARTIAL WITHDRAWALS

     Policyowners who make partial withdrawals from cash value accounts may or may not have
to pay taxes on the withdrawal. For policies at least 15 years old, the portion withdrawn is not
taxed unless it is greater than the amount the policyowner has paid into the policy. For example,
if premiums paid total $20,000 and the policyowner takes out $20,000, there is no tax due since
$20,000 represents a return of capital on which the policyowner has already paid taxes. If the
same policyowner withdraws $21, 000, however, taxes are due on the $1,000, which is consid-
ered interest.

    Policies that have not been in force 15 years when a partial withdrawal is made are subject
to more complex rules dealing with the specific age of the policy, how much premium has been
paid and the amount of the withdrawal

REPAYMENT OF WITHDRAWAL

     Because a withdrawal is not the same as a loan, the amount withdrawn does not have to be
repaid, nor is any interest charged the policyowner for using the withdrawn sum. From the in-
surance company's viewpoint, withdrawal is simply a return of the policyowners money. Since
the money is no longer in the policies cash value account; no interest is earned on the account
withdrawn

PARTIAL WITHDRAWALS

    The policyowner is permitted to return the amount withdrawn to the Universal Life cash
value, but repayment does not restore the death benefit to its original level. The insurance com-
pany might permit the policyowner to restore the original death benefit, but usually will require
proof that the insured is still in good health and insurable.

    In addition, whether or not the death benefit is restored, repayment of the withdrawal is con-
sidered to be a premium payment and is subject to whatever fees the insurer normally charges.


                                                  24
     At first glance, partial withdrawals from a Universal Life policy might seem immensely
preferable to borrowing money - whether from an outside lending institution or from the policy
itself - since no interest is charged and the policyowner can return the money to the policy later.
However, careful consideration should be given to the actual costs of a withdrawal that will be
repaid to the cash value account, such as

       Fee paid to the insurer at withdrawal.
       Reduction of the death benefit (cost to the survivors).
       Loss of interest on the money while withdrawn.
    Charges assessed by the insurer when the amount is returned to the cash value account.

    Even apart from the reduction in the death benefit, the other costs can eventually be consid-
erably higher than a loan. For example, assume that the policyowner could borrow the same
amount of money from his bank at 10% interest or could withdraw the money from his cash
value without paying interest which could be as little as $25.

    Assume the cash value account is receiving a current interest rate of 10%. The policyowner
will not receive this 10% on the amount withdrawn. However, if the policyowner wants to re-
pay the amount withdrawn and the policy is front-end loaded with a 7% expense charge, then
the policyowner has lost 10% interest and paid the 7% expense charge. Therefore this “inter-
est-free” withdrawal has really “cost" 17% plus the $25 surrender fee.

     In some situations, it could be worthwhile from the policyowners point of view to make par-
tial withdrawals, but they should be informed about the cost of this decision.

WITHDRAWAL OF ENTIRE CASH VALUE

    Universal Life policyowners also may withdraw all of the cash value. However, as previ-
ously stated payment for the insurance protection is periodically taken from the cash value ac-
count. If the entire amount is withdrawn, no money is available to continue the insurance cov-
erage. Therefore, the policyowner must make another premium payment to keep the insurance
in force. Insurers are required to notify policyowners if the insurance protection becomes en-
dangered.

    Some insurers charge a penalty if the policyowner removes all of the cash values in the ear-
ly years of the policy. This typically involves taking back all or part of the excess interest
earned during the previous 12 months.

REPAYMENT OF POLICY LOAN

    Like other cash value life insurance, Universal Life policies allow policy loans up to the
cash value amount. Unlike a withdrawal discussed in this text, a loan is expected to be paid
back and the policyowner pays interest, typically at a low rate relative to interest rates in the
marketplace. While fixed interest rates are common, some insurers offer loans at variable rates,
similar to lending institutions. The rates charged for a policy loan are stated in the policy.




                                                   25
   For cash values that are drawing interest, some insurers pay a lower rate on the amount bor-
rowed than on the amount not borrowed.

    CONSUMER APPLICATION
    Glenn has a Universal Life policy with $10,000 in the cash value account. He wants to buy
a new bass boat, so he borrows $6,000 of the $10,000. The insurer would pay him only its
guaranteed interest rate of 4% on the $6,000 borrowed, but continue paying the current interest
rate (guaranteed interest rate plus excess rate) of 8% on the remaining $4,000.

    Other insurers may treat a Universal Life policy loan as a so-called wash loan because the
interest rate the borrower pays and the interest rate the insurer pays on the cash value are the
same, so each rate "washes out" or equalizes the other. For example, the current rate the insurer
is paying on the cash value account is 7% and the policy loan rate is 6%. With a wash loan, the
7% rate would be reduced to 6% to match the loan rate.

    There are many variations among the features of the Universal Life policies issued by vari-
ous companies. Even so, the advantage of these policies over traditional Whole Life policies is
evident.

      CUSTOMER APPLICATION
      Brian recently graduated from Medical School and contacted his family’s financial advisor.
Brian wanted protection against premature death and at the same time, he wanted a very flexible
plan so that he would not have to worry about it in the future. He specifically did not want
Term Insurance, as he wanted to be able to have some protection in the future, at a price he
could afford, and regardless of his health condition.
      The first “stage” of his career, when he first starts establishing a practice, can be amply pro-
tected with a Universal Life Insurance policy. That way, cash value accumulations and level
lifetime premiums can be adjusted later when needed, and he will not have to change policies.
      Later, when Brian is in his late 30’s to early 40’s, he will have college expenses; a home
purchase and a family to protect in case he should die. At this time, he will be making more
money. By increasing the cash outlay for the policy will increase the cash value, or increase the
death benefit, whichever he chooses. If he has chosen the increasing death benefit option when
he purchased the policy, he would not even have to submit to proof of good health in increase
the death benefit.
      When his children are ready to “fly the coop,” he should be making good money but the
costs of college for the children, mortgage payments and consumer loans are pretty much be-
hind him at this point. Now the Universal Life can function as it was designed to do. The cash
values can grow at current interest rates, and it will still have guaranteed interest rate minimum.
Death benefits will rise automatically as a result of legislation (TEFRA 1982 and TAMRA
1988) even though he has chosen the level death benefit option. (Continued next page)




                                                    26
     When Brian reaches his mid-fifties, he starts being concerned about retirement. He wants
to conserve his assets, and any investing that he has done, will also be more conservative. If
there are sufficient cash value accumulations in his Universal Life policy, his cash outlay may
be reduced or eliminated without reducing any death benefits. His policy’s death benefits can
be reduced, if he wishes, as it would increase the growth of the cash value, adding to retirement
funds.
     At the time that Brian retires, withdrawals or loans can provide income, either for the rest
of his life, or for a specific period of time.
     At Brian’s death, his policy will provide his widow with a death benefit, even after paying
funds during his retirement.
     Further, if Brian had elected a Waiver of Premium rider, then in case of disability, his poli-
cy could have continued to function, providing the protection and benefits even though Brian is
not able to work. Also, if Brian elects to go into a partnership with another doctor, the Univer-
sal Life policy will work well with a buy-sell agreement.




                         CHAPTER 2 – STUDY QUESTIONS

1.     One important feature of Universal Life policies is that the death benefit is
       A.      a fixed amount.
       B.      adjustable.
       C.      paid only in monthly installments.

2.     For a Universal Life policy to receive special tax consideration, there must always be
       A.      level premiums.
       B.      a level cash value.
       C.      an amount at risk until age 95.

3.     “Guaranteed rate + Excess rate = Current interest rate”
       A.      The method for determining the currant interest rate on a UL policy.
       B.      The method for determining the investment experience of a mutual fund.
       C.      The method for calculating the Target premium of a Universal Life policy.




                                                    27
4.   Most Universal Life policies are purchased
     A.     with fixed premiums, which are inflexible and level.
     B.     with adjustable and flexible premiums.
     C.     with a single premium.

5.   A “Wash Loan” with a Universal Life policy is
     A.     where the insurer forgives the loan.
     B.     when the insurer does not charge interest on a policy loan.
     C.     when the interest charged is equal to the interest paid and the cash value is equal
            to the loan amount.

6.   The option that allows the insured/owner of a Universal Life policy to select a death
     benefit that would include both the face amount of insurance and the cash value of the
     policy is generally known as
     A.     Option A.
     B.     Option B.
     C.     conversion option.

7.   In a front-end loaded Universal Life Policy.
     A.     the insurer does not charge any expenses towards the premium until the owner
            withdraws money from the account.
     B.     the insurer deducts a percentage from the premium before crediting the account.
     C.     the insurer does not deduct for any expenses either up front or back-end.

8.   Joe has a Universal Life policy with Option B. The death benefit is $50,000 and after 20
     years the cash value is $25,000. He borrows $10,000 from the policy and shortly there-
     after dies. His beneficiary will receive
     A.     $50,000.
     B.     $40,000.
     C.     $65,000.

9.   Under the same circumstances as Question 8, Joe has paid into the policy $20,000 and
     withdraws $25,000 from the cash value, before he dies. He will have to pay income tax-
     es on
     A.     $25,000.
     B.     $5,000.
     C.     $45,000.



                                               28
10.     In the last quarter of 2001 which cash value policy showed the most increase in sales?
        A.     Whole Life.
        B.     Variable Life.
        C.     Universal Life.



      ANSWERS TO CHAPTER TWO REVIEW QUESTIONS
      1B 2C 3A 4B 5C 6B 7B 8C 9B 10C




                                                 29
    Life insurance purchasers who are willing to take a significantly greater risk in return for
potentially greater returns can turn to Variable Life policies. The cash value in a variable poli-
cy is invested in securities, similar to investing in a mutual fund. And, like securities invest-
ments, this money is directly subject to market fluctuations with the policyowner/investor tak-
ing all of the risk. This is in contrast to traditional Whole Life policies, where dividends or in-
terest are paid based on the life insurance company's general investments as a whole. It also
differs from Universal Life policies, where the excess interest rate is determined by the insurer,
based upon its investment experience as a whole. For Whole and Universal Life policies, the
insurer bears most of the investment risk with only an indirect effect upon a specific
policyowners cash values.


                             THE VARIABLE DEATH BENEFIT

    The "variable" part of a Variable Life policy is the death benefit. Like other types of insur-
ance, the policy is originally written for a specific death benefit, and this is usually the mini-
mum guaranteed amount that will be paid if the insured dies. But the variable feature means the
death benefit could be greater or lesser depending on the return of the investment portion. Some
companies stipulate a minimum guaranteed amount of death benefit and some do not. There is
no guarantee, however, that there will ever be more than the original amount of insurance.

    There are two primary factors that drive Variable Life Insurance:

   THE ASSUMED INTEREST RATE
   If the policy guarantees a minimum death benefit, the cash value account operates from an
   assumed interest rate. This rate is the minimum interest the company determines the cash
   value must earn in order to cover the cost of the insurance, usually about 4% or 4 ½%. But
   this small assumed rate is not what makes the Variable policy attractive as an investment ve-
   hicle and a means to provide a greater death benefit.

   THE SEPARATE ACCOUNT
   What makes the death benefit potentially variable is what happens in the separate account.
   Under a Variable Life policy, the cash value account is referred to as the separate account,
   which is made up of the portion of the premium used to (1) pay for the insurance protection
   and (2) accumulate cash values that earn interest. Other portions of the premium are used to
   pay the various policy expenses discussed previously.

    Variable policies place the entire investment risk upon the policyowner, who decides where
the separate account funds will be invested. Insurers typically offer a variety of options; the
most basic categories are Common stocks, Bonds, and Money market instruments

   Some insurers offer very specific types of' investment accounts, such as long-term corporate
bond accounts, growth stocks or short-term U.S. Treasury bills, to name a few possibilities.
From the accounts available, the Variable Life policyowner chooses where to invest the separate


                                                   30
account funds. Generally, policyowners may divide the cash value among two or more separate
accounts if desired. Many companies allow the policyowner to switch accounts, usually with a
limit on the number of such changes permitted in any one year.

    The growth or lack of growth in the separate account is then directly attributable to the per-
formance of the financial instruments selected, just as if the policyowner had invested in those
stocks or bonds on the open market. Whenever the return on the investments exceeds the as-
sumed interest rate, the excess increases the death benefit. For example, if the investment
return has accumulated $15,000 in the separate account of a $100,000 Variable Life policy at the
time the insured dies, the death benefit is $115,000. Or assume instead, the insured does not die
until later, when the separate account investment performance has declined, reducing the former
$15,000 value to $7,000 when the insured dies. The death benefit is $107,000 instead of
$115,000.

    If the investment return is not greater than the assumed rate, the death benefit remains level
at the original face amount selected when the policy was purchased if the company has guaran-
teed a minimum death benefit.

    Each time the separate account performance rises or falls, the variable death benefit rises or
falls with it. At some point, the separate account line may remain level and so will the death
benefit line; however, the death benefit never drops below the minimum guaranteed amount. So
while the cash value might never be what the policyowner hopes for, there will always be insur-
ance protection as long as the premiums are paid.


                                      FIXED PREMIUMS

    The premium for a Variable Life policy is fixed at the beginning of the contract and remains
level during the entire policy period. (Newer forms of Variable Life, offering a flexible premium
option and known as Variable Universal Life, are discussed later.) Like Universal Life, this
premium pays any expenses or commissions and is then deposited in the separate account. The
insurer periodically adjusts the amount necessary to pay for the insurance protection out of the
account and the remainder is invested.

SINGLE PREMIUM VARIABLE LIFE

    While the usual Variable Life policies require a fixed, periodic premium payment, Single
Premium Variable Life, like its Whole Life and Universal Life counterparts, allows the deposit
of one large premium payment at the onset of the policy. The advantage, you'll recall, is that the
policyowners money goes to work earlier, rather than waiting for cash value build-up from
smaller periodic payments.

    Single premium policy death benefits must be carefully set to meet Internal Revenue Code
requirements to qualify as life insurance. A minimum amount of coverage is established, but
the insurer also sets a maximum and the policyowner may purchase life insurance in any
amount between the two. Typically, however, the maximum and amounts approaching it are



                                                  31
guaranteed only for a limited number of years, after which the policyowner may have to make
additional premium payments to maintain the higher coverage.

    Administrative fees and other charges apply to single premium Variable policies. Often,
sales loads are lower because the insurer receives a greater sum of money to invest initially and
does not incur regular expenses to handle periodic payments.

LOANS AND WITHDRAWALS

    Loans are permitted under Variable Life policies, subject to more stringent limitations than
non-variable policies. Most insurers allow loans of up to 90% of the cash value and sometimes
up to 100% after the policy has been in force for a certain length of' time - possibly 10 years.
Some companies permit no loans in the first year or two. The policyowner pays interest on the
loan.

    Insurers typically pay a lower interest rate on the cash value borrowed from a Variable Life
policy. For example, if the separate account investments resulted in 9% interest and the
policyowner has borrowed $5,000, the insurer might pay 1% less, or only 8%. on the $5,000
that represents collateral for the loan.


   The danger in borrowing from a Variable policy is that poor investment experience can
result in the value of the separate account dwindling to the point where there is not enough val-
ue to cover the insurance cost. At that point, the policy would terminate. Insurers must warn
policyowners if the separate account balance approaches that point. Such a situation could oc-
cur if both loans and interest payments were outstanding during a period of poor investment re-
turns.

    Withdrawals are also permitted, including total withdrawal-policy surrender. With partial
withdrawals, the same caveats apply concerning dwindling values in the separate account that
can cause the policy to lapse and insurance coverage to cease. Withdrawals from Variable poli-
cies are subject to restrictions and charges similar to those imposed on Universal Life policies.

REGULATION OF VARIABLE LIFE

    Because, the separate investment account contains securities, Variable Life Insurance poli-
cies are regulated in part by the Securities and Exchange Commission (SEC). The SEC requires
that potential purchasers must be provided with a prospectus, which discloses certain infor-
mation about the policy's underlying investments. In addition, insurance agents who sell Varia-
ble policies must be licensed as securities sales people and registered with the National Associa-
tion of Securities Dealers (NASD).




                                                  32
PROFESSIONAL ACCOUNT MANAGEMENT

    One of the benefits of investing in the Variable Life separate account is similar to that of in-
vesting in mutual funds: professional account management. Investment managers employed
by the insurer decide which particular securities are included in accounts made available to the
policyowner. As a result, the policyowner is not required to monitor individual securities and
make decisions about selling or buying. Instead, the professional managers make those deci-
sions. Potential purchasers of Variable Life should look at the performance of the investment
account based upon past actions of those managers, although that alone cannot predict whether
they will make good or bad investment decisions in the future.

EXCHANGE FOR FIXED INTEREST

    Insurers must allow policyowners a time-limited option to exchange a Variable policy for a
policy with a fixed interest rate. Variable policies for which the policyowner pays an ongoing
annual premium must be exchanged within 24 months of purchase. For Single Premium Varia-
ble Life policies, policyowners have only 18 months to change their minds.


                           VARIABLE LIFE REGULATIONS

     The National Association of Insurance Commissioners (NAIC) spent nearly 5 years devel-
oping “model” illustration regulations, and these regulations are in force in some form in nearly
all of the states. The purpose of these regulations were to help consumers better understand
how life insurance policies work, with particular emphasis on the differences between guaran-
teed and non-guaranteed life insurance elements.

     These new regulations are all encompassing and pertain to policies sold after 1/1/97 (or lat-
er, depending upon the state). It includes ALL forms of individual life insurance, except those
that fall under the jurisdiction of the National Association of Securities Dealers (NASD), as the
NASD provide regulations for illustrations on registered policies, better known as Variable poli-
cies. The NASD has attempted to reconcile the differences between their model legislation and
those of the NASD, but as of late, there has been no “joint” regulations issued.

     Unknown by many, but important nevertheless, Variable Life is a unique product in respect
to illustrations. It is a “registered” product, but there is NO other registered product that may
use illustrations – not stock, mutual funds, individual securities or even Variable Annuities.
They are specifically prohibited from using any projections of future values – for obvious rea-
sons. In addition, a Variable Life Insurance product must not be sold without the prospect re-
ceiving a prospectus of such an investment.

    As those in the insurance business – and many who are not specifically in the insurance
business – are aware, using projections has caused many problems in recent years. When Vari-
able Life, Universal Life and other interest-sensitive products were introduced, interest rates
were relatively high. Therefore, projections (illustrations) assumed a higher interest rate than
what has transpired. Thousands of policyholders of plans that were called “vanishing premium”



                                                   33
plans based on high interest earnings assumptions, therefore, after a period of time – as short as
7 years in some projections – the interest earnings would take care of the premium for the insur-
ance risk, therefore the insured would never have to pay another life insurance premium. Halle-
lujah!!

    Now for the bad news. Interest rates did not stay as high as projected (illustrated), so now
thousands of policyholders who thought that they would surely be enjoying their “free” insur-
ance by now –are being dunned for additional premium – many of them in the thousands of dol-
lars!! Insurance regulators did not sit still for this for long, and there are now strenuous regula-
tions regarding illustrations, and the regulations being discussed here are the among the latest in
correcting the major problems that arise because of the use of illustrations.

     However, the biggest problem with the Variable Life regulations is that the allowable in-
vestment return rate used – up to but not exceeding 12% gross – is defined by these regulations
as a constant average rate. To state it otherwise, whether the gross is 4% or 12%, the same rate
is to be applied uniformly for all years.

    According to recent published statistics, the total annual compounded return of large capital-
ization stocks in the U.S. has been 11% for the period of 1926 to 1998, or 12% from 1060-1968,
or even for the period of 1970 to 1998, it was 13.5 %. (There is an obvious lesson in investing,
but that is not for discussion here. Besides, “historical experience in no way should be relied
upon as a prediction of future performance…”)

    However, and this is a BIG however, even though the stock market of 12% returns is not a
new phenomenon, if one would take $1,000 and use a long-term average rate of a little over
11%, after 70 years there would be over $2 million in the pot! This is an illustration of the laws
of compound interest, but unfortunately, they do not apply to Variable Life Insurance.

    A Variable Life Insurance policy has a cost of insurance (COI) element that comes from the
policy funds (“disinvestment,” it is called), actually from the liquidation of sub-accounts, and
because of the cost of the net amount of risk, the growth illustrated in the paragraph above will
not occur.

     Without becoming too technical, the net amount of risk of a life insurance policy is the pure
cost of insurance, and when a person gets older, there is a greater chance of his/her dying, so
obviously the cost of insurance increases. Because the Variable Universal Life insurance plans
require that the cash value must be about 50% of the death benefit according to actuarial calcu-
lations. However (again) these types of policies fluctuate without benefit of a ceiling or a floor.
What would happen if the cash value should drop as much as 20% ? The COI charge would be
increased by a higher factor, with the end result that the policy will lapse in a few years or an
amount equal to the loss of cash value would be injected immediately into the policy.

    Again, without becoming too technical, if the actual fluctuations of the market were used in
variable Universal illustrations, it would be contrary to existing regulations.




                                                   34
    The message is that Variable Universal Life is a highly technical product (any Variable Life
product is also). Regulations are being created in an attempt to alleviate criticisms of these pol-
icies, and whether this has been accomplished or not, it is still a matter of concern.


     CONCERNS REGARDING THE SAFETY OF VARIABLE LIFE INSURANCE

     Since obviously the fact that there is a dependence on the equity returns certainly does add
an element of risk to what has always before been considered as a conservative financial in-
strument. This risk is not simply that of not achieving the projected returns, but also includes
the effect of the fluctuations in the stock market.

     A method frequently used to demonstrate these fluctuations and their effect on Variable Life
is to use the past returns of Standard and Poor’s 500. The second step is then to illustrate the
same funding & death benefits with the S&P 500 returns inverted. By using these different pat-
terns of return would, as expected, show quite different returns although the average annual re-
turn is the same. To some of the critics of Variable Life, this would indicate that it is an illegit-
imate and inappropriate cross between life insurance and mutual funds. This is incorrect be-
cause there is a significant flaw in these methods of illustrating annual returns.

     The premise that a pattern that has unequal annual returns will show a different result than
if the average were used throughout. For instance, if 10% is the average of uneven returns, the
policy results will be different than if 10% were used each year. Most illustrations for Variable
Life uses a constant assumed gross investment return, which is selected by the agent (with usu-
ally a cap of 12%) . This return, less funds fees and expenses, is used to illustrate the invest-
ment earnings on the policy cash value. If these results were graphed, this would show a
smooth curve, which ends in the targeted amount of cash value.

     However, in actuality, this would not be the result of graphing of the actual results, as there
is a difference in annual returns from the “smooth” graphic lines indicating the assumed con-
stant gross return, and the actual application of the monthly changes. Actually, while the differ-
ence in returns can easily be seen, the more significant factor is the effect of monthly charges.

     Back to basics. Life insurance policies are actually monthly vehicles and each monthly
policy anniversary (MPA) investment earnings are credited to the policy and charges against the
policy are deducted. As indicated earlier, investment earnings are credited by means of the asset
unit value (AUV) – which closely resembles the net asset value of a mutual fund.

     To reiterate, the fund manager determines the AUV by using the value of the securities in
the portfolio at close of the previous day, and divides this by the total number of outstanding
shares. Since the fluctuations of the market creates changes in the total value of the portfolio,
such changes are shown and reflected in the AUV, and is reported to the insurance company
each day. The insurer than multiplies the AUV by the number of shares owned in the policy to
determine the cash value. Fixed policy fees and expenses are then deducted from the policy
through the process of liquidating or in effect, “selling” shares at the AUV for that particular
month.



                                                   35
     The effect of changes on the AUV on the performance of the policy is by means of the net
amount of risk (NAR), which is the difference between the policy cash value and the policy
death benefit – or to put it another way, it is the amount that the insurance company would lose
in paying a death benefit under a level death benefit Universal Life policy (Option A).

     Obviously, fluctuations in the AUV results in changes in the NAR. If the MPA would hap-
pen to be the day after a significant decline in the market, the AUV would necessarily be lower,
resulting in a lower cash value. (For an Option A Universal Life policy, a lower cash value re-
sults in a higher NAR).

     Why is this important? Half of the method used to determine the cost of insurance charges
on a Universal Life policy is the NAR – the other half being mortality charges obtained from
mortality tables. As also indicated previously, the NAR multiplied by the mortality rate (per
thousand) created the cost of insurance (COI) for that particular month and is deducted from the
policy along with other fees and expenses by liquidating shares at the AUV for that month.

     Now comes the principal reason for this discourse – when market fluctuations produces a
low AUV on the MPA for that month, the NAR will increase, leading to a higher COI charge.
This will, in turn, result in more shares to be liquidated because (1) the higher COI charge, but
also (2) the shares are being liquidated at a lower AUV.

    Of course, if the market fluctuates upward, then just the opposite occurs and the NAR will
decrease which means a lower COI charge, requiring fewer shares to be liquidated at a higher
AUV. Makes sense.

     Theoretically, because of the volatility and the fluctuations in Variable Universal Life poli-
cies, the policyowner actually sells low. If there is not a premium payment, shares would have
to be sold every month with - more shares sold if the market is depressed than when the market
is high.

     When these factors are all considered, it is apparent that life insurance illustrations do not
effectively demonstrate this effect because, as stated earlier, they are usually based on constant
annual returns, and even if they were based on a fluctuating annual return which is equal to the
constant annual return, the illustration still would not reflect accurately the effect of the fluctua-
tions every month. And to make matters even worse, any illustration based on such assump-
tions would not be accurate; actually, there are innumerable monthly return patterns that could
be assumed, with each having a different outcome. This is the flaw in the illustrations that was
stated earlier in respect to using illustrations with the S&P 500 chronologically illustrated, and
then illustrated in inverse order. This method actually only uses two of the innumerable patterns
of return, and then draws a conclusion based on this very limited sample of data.

     Is there a solution to this problem? Well, yes, as originated by Gabriel R. Schiminovich
and discussed in a recent article in Life Insurance Selling. The system that produced the closest
to actual returns was produced by generating multiple patterns, each of, which was likely to
happen because they matched the variance of the domestic equity markets. This system is quite




                                                    36
complicated. For instance, a baseline illustration was run through a random return illustration
10,000 times to produce a meaningful large sample of likely results!

     A result of this study simply supports the conclusion that the fluctuation of the market cre-
ates a wide range of returns, each of which is equally likely to happen. They discovered that
two clients of identical age and health, if they purchased identical policies, funded identically on
two different days of the month, each of whom achieves the constant assumed investment re-
turns – guess what? They would likely achieve different policy results because of the fluctua-
tions of the market.

     Basically, all this proves is that the volatility of the stock market has a tremendous effect on
Variable Life Insurance, and much more than is obvious from the limited studies of the S&P re-
sults plus inversion. This does not, in any way, negate or reflect adversely on Variable Life as
an excellent financial tool.

     Further, this does not undermine or negate the usual Variable Life insurance illustration’s
value as a tool to reflect a “reasonable” expectation of the policy investment performance. The
point is that producers must be aware of the effect that the market’s fluctuations has on the per-
formance of the policy, particularly long-term. Reporting investment returns alone is certainly
not sufficient to measure the effect of the fluctuations as the actual policy values must be closely
monitored. This information must be furnished to the client on a regular basis, and if this is fur-
nished to the client regularly, both the agent and the client can rest easier.




                          CHAPTER 3 – STUDY QUESTIONS


1.     What makes the death benefit potentially variable in a Variable Life policy?
       A.      The amount of premium.
       B.      The assumed interest rate and the separate account.
       C.      The size of the insurance company.

2.     When the return on the investments in a Variable Life policy, exceeds the assumed inter-
       est rate, the excess
       A.      increases the death benefit.
       B.      decease the death benefit.
       C.      is paid to IRS in taxes.




                                                   37
3.   A Variable Life insurance policy with flexible premiums is known as
     A.     a flexible premium Whole Life policy.
     B.     an Interest-Sensitive Variable Life policy.
     C.     a Variable Universal Life policy.

4.   In order to sell Variable insurance products an insurance agent must
     A.     be bonded for $1,000,000.
     B.     be licensed as a registered representative with NASD.
     C.     forfeit their insurance license.

5.   If the accumulation of cash in the separate account of a Variable Life policy falls below
     the cost of life insurance, the policy would
     A.     terminate.
     B.     continue because it cannot happen by law.
     C.     have cash added by charging back on the agents commission.

6.   Investments in a Variable Life insurance policy are made through an account that is
     known as
     A.     Variable account.
     B.     Insurer portfolio.
     C.     Separate account.

7.   Variable Life insurance companies are regulated by
     A.     Federal Deposit Insurance Corporation.
     B.     Securities and Exchange Commission.
     C.     National Association of Insurance Commissioners.

8.   The asset unit value (AUV) of Variable Life insurance policy is determined by
     A.     using the value of the securities in the portfolio, at the close of the market and
            divided by the number of outstanding shares.
     B.     using the total portfolio of the insurance company and dividing it by the total
            number of policies in force.
     C.     using the value of the securities and dividing by the number of shareholders.




                                                38
9.      The value of a Variable Life illustration is
        A.     to reflect a “reasonable” expectation of the policy investment performance.
        B.     that it accurately demonstrates the guaranteed growth of the cash values.
        C.     that it is based upon the fact that the agent’s commission is a function of the asset
               value.

10.     The main advantage to a Single Premium Variable Life policy is,
        A.     by paying a lump sum, up front, the policy owner is guaranteed a definite death
               benefit.
        B.     the policy owner’s money goes to work earlier rather than waiting for cash value
               build-up from smaller periodic payments.
        C.     by paying lump sum, up front, the policy owner is guaranteed a specific interest
               rate over the life of the policy.


      ANSWERS TO CHAPTER THREE REVIEW QUESTIONS
      1B 2A 3C 4B 5A 6C 7B 8A 9A 10B




                                                   39
     Variable Universal Life has become an important product for financial and estate planners,
in addition to the family and business use of life insurance products. At the very least, it is
worth of a full Chapter in this text.

    Combining some of the unique features of both Universal and Variable Life, Variable Uni-
versal Life insurance permits:

        A variable and adjustable death benefit.
        Two-death benefit options (subject to the tax corridor).
        a flexible premium - both the amount and the frequency.
        a separate account with no guaranteed return.
        Policyowner control of investments in the separate account.

    These policies are subject to the same securities regulation as Variable Life policies. Fees,
policy loans and surrenders are also subject to the equivalent provisions in Variable and Univer-
sal Life policies.

      This product has been quite successful as by 1995, VUL had captured 15% of all new U.S.
premiums, a rather substantial increase since the 1980’s. From 1995 to 2000, sales results went
from 15% to 44%. However, with the stock market taking a dive, in the second quarter of 2001,
VUL premiums declined for the first time in 23 quarters and have been flat ever since. For the
first quarter of 2002, the policy count was off 24% from the first quarter of 2001.

     However, even with the news that variable sales are down, according to LIMRA VUL is the
number one life insurance product sold on annualized premiums, with a 31% market share
(down only 3% from 2000), compared to Whole Life which is 26% and up 2%, Universal Life
at 21% and up 4%, term life at 20% and down 2%, and Variable Life at 2%, down 1 %.

POLICY EXPENSES

     The pricing of Variable Universal Life can be very complex as it actually consists of many
parts, and these parts are different than in a puzzle because they can fit together in several ways.
The professional must be aware of all of the various parts and have the expertise to put them
together in a comprehensive, but understandable, presentation. Competitive pricing is very im-
portant when choosing a VUL product, and the largest expense is the cost of insurance (COI)
which is taken from the contract fund each month, as discussed earlier.

     A random check of VULs presently offered by the principal writers of these products, re-
flect that with the preferred mortality charges of many companies, at age 65 for instance, these
charges ranged from $6 to $8 annually per thousand, but there were some as high as $25.




                                                   40
     Front-load charges vary from company to company but premium taxes (3 ½% to 4%) are
pretty standard. Other charges, such as supplemental benefits, administration and premium
waiver charges do not seem to vary very much. There is much more competition for term riders
among the companies.

     The mortality and expense (M&E) charge can be tied to the client’s cash value but general-
ly is an indirect expense and is taken from the gross rate of return. While some policies charge
as much as 90 basis points for M&E, others use a reducing scale that can eventually be as low
as 20 bps.

      CONSUMER APPLICATION
      Barry has a VUL with $200,000 in a sub-account. This particular account earned 9% gross
for the year. The policy charged 90 bps for M&E, which effectively then reduced the return to
8.1%, or an expense charge of $1,800.
      Barry discovers that with another company, the M&E charge reduces to 20 bps. This would
result in a charge of only $400. It was also pointed out to Barry that these charges “come off
the top” and means that there is less cash value to be invested each year, resulting is a substan-
tial loss in later years.

VUL DURING TIMES OF DECLINE IN FINANCIAL MARKETS

     In spite of the downward spiral of VUL sales in early 2002, financial analysts predict that
VUL will climb back up and sales will move up. Many feel that this is a good time to recom-
mend VUL products to those who recognize that it is a flexible long-term investment which has
substantial tax advantages, plus it also has a death benefit. This reasoning is based upon several
factors, including:

        No other vehicle allows the policyowner, with some restrictions, to determine how
         much premium to pay and when to pay it – if at all. The policyowner must maintain
         enough cash value for the policy to pay monthly charges, but it is entirely within their
         control and they can increase or decrease to their heart’s content.
        The policyowner controls the way that their premiums are invested, and many policies
         offer more than 30 sub-accounts which are managed by professionals and recognized
         as leading investment firms, with philosophies ranging from extremely conservative to
         aggressive. They can transfer their funds between sub-accounts, and some policies of-
         fer automatic portfolio re-balancing or dollar cost averaging.
        Many VUL policies have sub-accounts that invest in a wide variety of investments,
         ranging from bonds, equity securities, money-market accounts, international equities,
         and even some allow investment in precious metal accounts. This allows the
         policyowner considerable latitude to invest in better performing accounts.
        Under tax laws, the cash value grown of a VUL is tax-deferred for as long as the
         policyowner owns the policy and investment returns are not even reportable for tax
         purposes unless more money has been withdrawn from the policy than was paid into
         it, or, of course, if the policy is surrendered. In most cases, the policyowner can bor-
         row against the policy funds on a tax-deferred basis, and can even transfer money be-




                                                  41
          tween various investment funds without having to recognize capital gains. And in ad-
          dition, policy beneficiaries can receive all death benefits free of federal income taxes.

COMPETING WITH OTHER INVESTMENT PRODUCTS

     To start with, the asset values that were assumed just a few years ago, for planning purpos-
es, are probably lower today with the result that investment portfolios cannot compete with life
insurance, in any of its forms, as the value of the portfolio is an unknown. Variable Life, and in
particular, Variable Universal Life, not only provide the investment performance, but also pro-
vides diversification, tremendous flexibility, and a guaranteed death benefit that will be there,
regardless of what the market does.

     It is readily acknowledged that fixed investments can offset market volatility, but fixed in-
vestments generally do not produce satisfactory results in time of inflation. The history of equi-
ties over a long period of time proves that the likelihood of losses diminishes while the likeli-
hood of gain increase. VUL can perform better than other investments because even during
times of poor market performance, a good advisor can help the policyowner get past the fear of
short-term losses and put them in a better position when the market increases.

    The guaranteed death benefits is not affected by poor market conditions, and even if death
occurs when the market is weak, the life insurance proceeds provide the beneficiaries with the
means to ride out the market cycle and allow them to hold onto their other investment holdings.

    Even the method of premium payment lends to good investment strategy, as by paying a
steady inflow of premiums, this creates a “dollar-cost averaging” situation which in itself is a
very effective investment strategy. This averaging strategy uses a set amount of money that is
invested at regular intervals regardless if the market is up or down. If the market is down, the
premiums buys more shares and thereby can lower the average cost per share over a long peri-
od. Down markets actually represent buying opportunities, and with the steady inflow of pre-
miums, the investor-policyowner doesn’t even need to worry about market timing.

     The wide variety of investment vehicles available to a VUL policyowner can reduce the
volatility of the market. By offering investment objectives, plus fixed amount and money mar-
ket choices, it can mimic fixed or index-based plans, or even offer a truly diversified investment
product.

     Further, while clients exchange mutual funds, go from one to another, there almost always
is a sales charge and taxes incurred. With a VUL, such internal exchanges are free from sales
charges and taxes. The flexibility of the VUL is unsurpassed.

    It is frequently pointed out by those professionals who concentrate on VUL plans, that one
merely has to imagine recommending to a client that they must liquidate stocks and mutual
funds and incur large losses in the process, to satisfy their beneficiaries needs for cash at death.




                                                   42
ALSO KNOWN AS:

   Variable Universal Life insurance policies are referred to by a number of alternate terms, in-
cluding Universal Variable, Flexible-premium Variable and (just plain) Universal Life.

AVERAGE VARIABLE UNIVERSAL LIFE PREMIUM

     According to a survey performed by LIMRA, over the past year the percentage increase in
the average VUL premium rose 21%, to $6,252 per policy. During this same period of time,
term life premiums have decreased while Whole Life premiums remained constant. (In case of
a memory lapse, please be reminded that in a variable product, such as VUL and Variable Life
products, an increase in average premium shows that more persons are using these products for
investments – a good thing.)


                    APPLICATIONS OF VARIABLE UNIVERSAL LIFE
      CONSUMER APPLICATION
      Darrell and Janet are in their mid-30’s and have two children, ages 3 and 5. They own their
home, have lower than typical consumer debt. Darrell makes $45,000 per year and Janet makes
$35,000. According to a needs analysis, it is agreed by the prospects and the agent that they re-
ally need an additional $250,000.
      They have certain priorities, including college funding for their children, and their personal
retirement secondary. They have the typical problem that so many couples with children seem
to have, with saving and investing. They both have 401(k) plans where they work and they both
contribute 3% of their income to the plans, which is the maximum.
      A Variable Universal Life policy can provide the build-up of cash values for college funds,
and then later provide supplemental retirement income. Suggestions to this couple in using
their VUL for their own particular purposes, would include:
 They could over-fund the VUL until college expenses start.
 They could then stop VUL premium payments during college years.
 Potential cash values can be used to generate funds to help pay college expenses.
 After the kids are through college, over-funding of premium can resume.
 At retirement, the potential cash values can be used to generate supplemental retirement in-
     come.

     CONSUMER APPLICATION
     John and Mary are in their mid-40’s, two children age 14 and 17, own their home and both
have good jobs. John needs around $500,000 in life insurance and Mary needs about $525,000
of life insurance. They both want to retire in 20 years and they want their children to go to col-
lege. They have 401(k) plans, but they would be insufficient to allow them to meet their needs.
Their principal needs are to obtain more life insurance and achieve their retirement goals.
 A $250,000 VUL policy for both John and Mary can be recommended.
 They may wish to over-fund these policies so that there will be more funds for retirement.
 In this case, Term life insurance can provide the additional life insurance protection.



                                                   43
     CONSUMER APPLICATION
     Waldo is age 49, with a good job. His wife, Dru, is a homemaker. Waldo makes $80,000
per year. They have 2 children, 18 and 20. A needs analysis indicates that even though Dru
could have a little more insurance on her life, the principal concern is for Dru as Waldo is un-
derinsured by $225,000, and that amount would help their children with their remaining college
expenses and would liquidate their debts. Waldo has some group and personal Term Insurance.
     It could be recommended that they purchase a $100,000 VUL policy which they over-fund
to potentially reduce the premium payment period. He could also take out a Term policy for
$125,000.

    NOTE: Variable Life for Non-qualified benefit plans is discussed in Chapter Eight, entitled
“Retirement Plans.”



        POLICY COMPARISONS OF VARIABLE LIFE & VARIABLE
                       UNIVERSAL LIFE


    Six of the life insurance companies producing a majority of the Variable Life and Variable
Universal Life plans. As discussed, the provisions of the various plans vary greatly. One of the
VUL policies is quite new and is shown as its provisions are different than most.




                                                 44
COMPARISON OF VARIABLE LIFE AND VARIABLE UNIVERSAL LIFE
.                             Co. A                         Co. B                    Co. C        .
#Riders available             6                             5                        6
Minimum issue $               25,000                 75,000-250,000 (by age)         50,000
Target/Gross Prem.$:
       Age 25                 6.39                          5.77                     6.78
       Age 35                 9.00                          7.80                     9.22
       Age 45                 16.00                         11.60                    17.40
       Age 55                 24.25                         19.10                    30.92
Minimum prem.                 none                   lower than target               Appl. for 1 yr
Curr. rate fixed acct.(%)     5.5                           6.4                      6.25
Guar. Int. Rate Fix.act.(%)   3                             4                        4
(Highest/lowest (%):)
Subaccount ann.rate           7.83/ -33.99                  2.8/ -23.93              -10.95/-28.85
Invest. Advisory fee          1.00/.39                      .90/.40                  .88/.37
Fund Operating Exp.           .095/.01                      1.1/.03                  .32/.01
Premium loading % of prem. varies 3.6 to 7.6                2.9                      6.35
No. of funds offered          31                            28                       33
M&E – Yrs 1-10 (%)            .65                           .25                      .45
     11-20                    .15                           0                        0
     20+                      0                             0                        0
Pol.Loan Int.rate (%)         8                             5                        3.25
                     st
Total Surr. Chg.-1 yr         varies                 per cent of target premium      level 120 mo.
       Renewal                0 after 10 yrs                varies            0 after 120 mo
Partial Surr. Chg.            10% 1st yr                    varies       none allowed yr1-$25 later
COI Yr 1/Yr 10
        Age 25                .26/.50                       .56/.63                  .65/.70
        Age 35                .24/.86                       .68/.78                  .60/1.20
        Age 45                .54/2.29                      1.01/1.83                .79/2.20
        Age                   55.90/5.62                    2.01/4.23                2.78/5.85
        Age 65                2.56/13.03                    7.60/10.78               6.18/13.36
Restrictions on
Transfers                     18 free per yr.               12 free per yr,          20 fund max.,
                                                            $25 thereafter           2 –fixed accts




                                                45
COMPARISON OF VARIABLE LIFE AND VARIABLE UNIVERSAL LIFE
                          (2 )
.                                Co. D                             Co. E                   Co. F         .
#Riders available                7                                 6                       7
Minimum issue $                  50,000                            100,000          50,000-250,000
Target/Gross Prem. $:
       Age 25                6.74                                 .29                      6.15
       Age 35                9.91                                 .40                      8.97
       Age 45                15.34                                .63                      13.80
       Age 55                25.01                                1.05                     22.60
Minimum prem.         lower than target                    (see above)             lower than target
Curr. rate fixed acct.(%)        6.05                              5.8                     6
Guar. Int. Rate Fix.act.(%)      3                                 4                       3
(Highest/lowest:%)
Subaccount ann.rate              1.63/ -24.96                      7.8/ -29.7              new
Invest. Advisory fee             .65/.10                           .84/.33                 new
Fund Operating Exp.              .20/0                             .02/.01                 new
Premium loading (%) of prem.2,75 –1.25                     6.6 yr 1-10, 3.6 after          new
No. of funds offered             27                                44                      43
M&E – Yrs 1-10 (%)               .50                               .90                     60bps
     11-20                       .50                               .90                     25bps
     20+                         .50                               .20                     15bps
Pol.Loan Int.rate                6% - variable                     5% fixed                3-3.5%
Total Surr. Chg.-1st yr          50% of total prem.                declining-15 year       45% level
       Renewal                   graded to 0 in 15 yrs.            varies           45% to 0 in 10 yrs
Partial Surr. Chg.               $25 of 2%                         declining 10yr proportional 10yr
COI Yr 1/Yr 10                                                                             (preferred)
        Age 25                   .077/1.05                         not available           .1013/.0370
        Age 35                   .083/.182                         not available           .1127/.0559
        Age 45                   .154/.382                         not available           .2213/.1564
        Age 55                   .323/.979                         not available           .5213/.4228
        Age 65                   .862/2.83                         not available           1.4087/.9808
Restrictions on
Transfers                 Min. $500 or balance,                    24 free per year        Unlimited -
                          free 12 trnfs per yr                     from sub-accounts       $25 after 12
                                                                                           trnfs per year.


                                                      46
ESTATE TAX REPEAL RIDER

     As anyone in the life insurance and annuity business knows by now, the estate tax laws
have been changed so that the estate tax (aka “Death Tax”) will be phased out by 2010. There
has been some concern among estate and financial planners as to whether this tax will be reen-
acted in 2011, as some believe is possible. Many insurers who offer Variable Universal Life
have recently introduced estate tax repeal riders that provide clients with additional flexibility
should the estate tax be repealed. These riders usually allow policyholders to surrender their
policies without charge if there is no federal estate taxes in 2011.


                           INTEREST SENSITIVE WHOLE LIFE

    When Interest rates rose sharply in the United States a few years ago, one of the earliest
new products insurers responded with was interest-sensitive Whole Life insurance. Other
names for this type of policy are excess interest and current assumption Whole Life. This
type of insurance is "sensitive” to current interest rates in the marketplace as reflected in various
elements of the policies.

    Interest-sensitive policies typically have a minimum guaranteed cash value based upon a
minimum guaranteed interest rate, but all policies of this type have some factors that are not
guaranteed. The specific features differ among insurers.

INDETERMINATE PREMIUMS

    Some interest- sensitive Whole Life policies have adjustable or indeterminate premiums,
which means the premium changes as interest rates change. At the onset of the policy, a premi-
um amount is set by the insurer based upon the interest rate it expects to earn, which is called
the current rate. The current rate is guaranteed only for a short period any longer than a year.

     Usually once a year, the insurer reviews the rate in light of the insurance company's finan-
cial experience and current market interest rates. The Insurer then adjusts the policy premium,
so the policyowner pays either:

        A lower premium if rates have risen (and the insurer is earning more), or
        A higher premium if rates have fallen (and the insurer is earning less), or
        The same premium if rates have not changed,

   Policies with indeterminate premiums must stipulate a maximum premium amount that will
apply no matter how poor the insurer's earnings are. This guarantee protects the policyowner
against ever having to pay more than the specified maximum premium.

REDUCTION IN DEATH BENEFIT
    Rather than requiring increased premium payments, some policies allow a reduction in the
death benefit if the policyowner prefers. In times of poor performance, however, the death ben-



                                                   47
efit could be greatly reduced, threatening the life insurance protection. On the other hand, in-
surers do not typically allow policyowners to raise the death benefit in lieu of paying a lower
premium because this action would put the insurer in the position of providing greater coverage
without evidence that the insured's health has remained stable.

FIXED PREMIUM PLANS

    An interest-sensitive Whole Life policy may have a fixed premium instead of an indetermi-
nate premium, with the "interest- sensitivity" applying to transactions in the policy's cash val-
ues. In this is the case, varying rates of interest will be credited to the cash value as interest
rates fluctuate, rather than changing the premium amount.

OTHER PROVISIONS

    Interest-sensitive Whole Life policy provisions concerning loans, surrenders and withdraw-
als are similar to the provisions for other policies discussed. More specific information about
typical life insurance policy provisions appears later in this text.


                                SECTION 1035 EXCHANGES

    With the introduction of “interest-sensitive” and Universal Life policies which allow the
Cash Values to grow at a rate based upon the level of interest paid on investments or cost-of-
living indices, the exchange of older fixed-interest Whole Life policies for the “newer” genera-
tion of policies, has become very popular. It is important that such exchange falls under the
IRS Code Section 1035, which allows for a tax-free exchange. The IRS establishes certain cri-
teria for a policy exchange to fall within Section 1035 and if the exchange does not meet these
requirements, the gain is treated as ordinary income and is taxed. These requirements are:

    1. It is an exchange of a life insurance contract for either another life insurance contract,
       an endowment contract, or an annuity contract, or
    2. It is an exchange of an annuity for another annuity contract, or
    3. It is an exchange of an endowment contract for either another endowment contract
       (provided the endowment date isn’t postponed) or for an annuity contract.

POLICY LOANS ON EXCHANGED POLICIES

    If there were a loan against the policy, this would be a routine exchange and there are no
complications if the new policy has an equivalent loan against it. However, it usually is the
case that the new policy does not have a loan against it, in which case, the IRS may determine
that that it is a taxable gain and subject to income taxes.




                                                  48
     CONSUMER APPLICATION
   Arthur has an older Whole Life insurance policy with a face amount of $100,000. He had
borrowed against it for college costs and presently the policy has a policy loan outstanding of
$25,000.
   If Arthur should die without paying off the policy loan, the beneficiary would receive
$75,000.
   Arthur’s insurance agent suggested that he exchange the policy for a Universal Life Insur-
ance policy. For the same amount of premiums that he is presently paying, Arthur can have a
$100,000 face amount policy without a policy loan.
   He exchanges the policy for a Universal Life Insurance policy. For the same amount of pre-
miums that he is presently paying, Arthur can have a $100,000 face amount policy without a
policy loan. Obviously, Arthur has gained on this exchange. This is called a “boot” in Internal
Revenue parlance.
   The IRS Code states that if other property were received as part of an otherwise tax-free ex-
change, any gain contained in the exchanged property must be recognized up to the fair market
value of the “boot.” The loan that disappeared in this transaction is the “boot.”
   According to the IRS Code, the receipt of boot will first result in a reduction of the policy-
holder’s basis in the new policy, and the gain will be taxable only if the “fair market value” ex-
ceeds the basis in the exchanged policy.
   Arthur’s basis is the total amount of premiums that he has paid into his old policy; in this
case he had paid a total of $20,000 in premium. This leaves a total “boot” of $5,000. There-
fore, Arthur would have to pay tax on an ordinary income basis on the $5,000.
   Arthur’s agent had a couple of solutions:
(1)      Arthur could borrow the $25,000 from the bank to pay off the loan. Then, when the
         loan is paid off, the exchange can be made without incurring any taxable “boot.” Then
         Arthur can take out a policy loan on the new policy to pay off the bank. While this
         looks simple, the agent warns Arthur that it must be handled very carefully, because if
         it looks like part of a “plan,” the IRS may disallow the maneuver and he would still
         have to pay taxes on the $5,000.
(2)      Or, the agent says, Arthur can exchange it for a policy with a smaller face amount. Ar-
         thur would therefore have a policy with no loan outstanding, but with a reduced face
         amount. There can be problems with this solution, also.
         The Cash Value that is transferred into the new policy may violate the cash value accu-
mulation or guideline premium/cash value corridor for life insurance policies. The agent would
have to submit this information to his home office to see if this would be a taxable distribution.
(This is a technical calculation and outside of the purview of this discussion),]
         Also, Arthur could end up with not enough face amount to take care of his needs. He
may have to purchase other insurance to make up the difference.
    Arthur was rather disturbed over all of the “technicalities” that had arisen, however the
agent pointed out to him that he still would be better off, as his old policy allowed his cash val-
ue to grow only at 3% per year, and by allowing his cash value to grow at the present interest
rates, and to grow tax-free, plus the advantages that he would have by using a more “modern”
type of policy in his estate planning, he is still “way ahead of the game.”




                                                  49
                                                    Table of Policy Features

     This table summarizes many of the primary features of the life insurance policies:

     Table of Policy Features
                                                                    Cash Value/               Securities
     Type               Death Benefit         Premiums               Interest Rate            Regulation

     Whole life or           Fixed           - Level                     Guaranteed rate      No
     Limited Pay Life                        - Relatively high           Relatively low

     Universal Life - Adjustable by          - Relatively high,          Low guaranteed       No
                      policyowner within       but flexible              rate plus variable
                      specified limits       - May be raised,            excess rate, not
                    - Two options              lowered or skipped        guaranteed
                      available                                          (current
                                                                         interest rate)

     Variable Life   - Variable              - Level                 - Variable rate          Yes
                     - Guaranteed            - Relatively high       - Not guaranteed
                       minimum benefit                               - Policyowner's risk

     Variable       - Variable                Relatively high,       - Variable rate          Yes
     Universal Life - Adjustable              but flexible           - Not guaranteed
                    - Guaranteed              May be skipped         - policyowners risk
                      minimum benefit

     Interest-          Fixed, but subject   - Relatively high       - May vary               No
     Sensitive          to change in         - May be fixed or       - Current rate
     Whole Life         certain situations     indeterminate           guaranteed for
                                             - Maximum specified       short periods

     Term               Fixed                - Relatively low          None                   No
                                               initially
                                             -Increase as insured ages,
                                             upon renewal




                                     CHAPTER 4 – STUDY QUESTIONS


1.       Under present tax laws the cash value growth of a Variable Universal Life is
         A.          taxed each ear, the same as a savings account.
         B.          tax deferred until the future unless more money is withdrawn than deposited.
         C.          treated as capital gains and taxed accordingly.




                                                                    50
2.   The greatest expense incurred, by the insurer, for a Variable Universal Life policy is
     A.     commissions paid.
     B.     underwriting and policy.
     C.     cost of term insurance.

3.   The basic difference between a Variable Life and a Variable Universal Life is
     A.     the Variable Universal Life is not regulated by NASD or SEC.
     B.     generally the premiums paid into a Variable Life are level and into a Variable
            Universal Life and be flexible.
     C.     the Variable Life has a guaranteed death benefit and the Variable Universal Life
            does not.

4.   Variable Universal Life insurance provides
     A.     flexibility.
     B.     for a fixed monthly premium.
     C.     for a separate account with a guarantee return.


5.   Estate tax Repeal Rider is
     A.     a rider on Family policies that covers estate taxes that family members might
            have to pay.
     B.     a rider on a 20 year Decreasing Term policy that allows the owner to reinstate the
            policy after 20 years.
     C.     use in the event the estate tax is phased out by 2010.

6.   Interest sensitive Whole Life policies
     A.     provide for a current rate of interest throughout the life of the policy.
     B.     are also known as excess interest and current assumption “Whole Life”.
     C.     do not have a minimum guaranteed cash value.

7.   One of the requirements for a 1035 exchange is
     A.     to exchange a Term policy for an Annuity.
     B.     to exchange an Annuity for another Annuity.
     C.     to exchange a Whole Life policy for a Term policy.




                                                51
8.      The Variable Universal Life policy is recommended to sell in either a “Bull” or a “Bear”
        market because
        A.     the financial backbone of the Variable Universal Life policy is “Junk Bonds” and
               since their performance is guaranteed it is a good buy.
        B.     the fluctuations of the stock market do not have any influence on the Variable
               Universal Life policy.
        C.     the fluctuations of the stock market can work to the benefit of the owner.

9.      Some interest sensitive Whole Life policies have “indeterminate premiums” which
        means
        A.     the premium amount is set by the insurer at onset of the policy based on expected
               earnings.
        B.     the insurer sends a policy notice once a year and charges the owner a rate that re-
               flects an interest rate and profit.
        C.     the death benefit changes as the insurer earns more or less interest.

10.     One of the benefits of a Variable Universal Life policy is
        A.     a fixed rate of return.
        B.     the guaranteed death benefit is not affected by poor stock market performance.
        C.     a guaranteed separate account.



      ANSWERS TO CHAPTER FOUR REVIEW QUESTIONS
      1B 2C 3B 4A 5C 6B 7B 8C 9A 10B




                                                  52
     This discussion pertains to many of the features and provisions commonly found in all types
of life insurance policies. As rules and regulations governing life insurance change frequently,
many of these provisions were standardized by law and apply wherever insurance transactions
take place. Some of the provisions that are not applicable, or seldom used, in financial planning
are not discussed.


                                    LAPSE PROTECTION

    Many policies include an additional feature that helps prevent an insurance policy from ac-
cidentally lapsing. The automatic premium loan provision allows the insurance company to
use part of the cash value to pay the premium when the policyowner fails to do so within the
grace period, providing there is sufficient cash value. The knowledge of this provision is useful
to a financial planner when life insurance is used for various reasons within a financial plan.

    The "automatic" part of this provision means the insurer will automatically use the premium
loan feature to keep the policy in force. It does not mean this provision is automatically includ-
ed in every cash value life insurance contract. Typically, the insured must request the automatic
premium loan provision in the insurance application.

    This transaction is treated as a loan to the policyowner. The insurer expects to be repaid and
the policyowner pays interest on the amount used. If the loan is not repaid before the insured
dies, amount of the policy loan will be deducted from the death benefit.


                               BENEFICIARY DESIGNATIONS

    The use and designation of Beneficiaries in life insurance is very similar to that of a Trust
Beneficiary. The proper usage of Beneficiary designations is of utmost importance, as a care-
less or unknowing designations can completely destroy the planning objectives, and at a time
when there would be no remedial actions that can be taken as the primary bequeathed and des-
ignator of the beneficiaries is no longer alive to correct the errors.

PRIMARY AND CONTINGENT

    Those designated to receive the death benefits or proceeds of a life insurance policy when
the insured dies are the beneficiaries. The insured or the policyowner chooses who will be
named beneficiaries.

     The primary beneficiary is the person or organization legally entitled to receive the pro-
ceeds at death. Primary or Class I beneficiaries are always first in line to receive the death bene-
fit.




                                                   53
    If the primary beneficiary should die before the insured dies, the death benefit is paid to the
contingent or Class II beneficiary. In this case, receiving the death benefits is contingent upon
the prior death of the primary beneficiary.

    Neither primary nor contingent beneficiaries must be a single individual. For example, a
woman might name both her husband and her children as primary beneficiaries or her mother
and father. Or this same woman could name her husband as primary beneficiary and her chil-
dren as contingent, or possibly, her parents and her children as contingent beneficiaries.

    In fact, beneficiaries need not be individuals at all - organizations or estates may also be des-
ignated. A man might name his wife as primary beneficiary and his alma mater as contingent
beneficiary. There are many possibilities.

REVOCABLE OR IRREVOCABLE DESIGNATIONS

    Unless otherwise stated, beneficiary designations are always revocable, which means they
can be changed. This is the most common and most practical way to designate beneficiaries
because irrevocable beneficiary remains unchanged forever regardless of any changes in cir-
cumstances. An irrevocable beneficiary in essence becomes a co-owner to the policy and must
consent to all policy transactions such as taking out policy loans or changing contingent benefi-
ciaries. The only way this type of designation may be changed is if the irrevocable beneficiary
expressly agrees in writing to give up this right.

CLASS DESIGNATION

    As stated previously, a person might name children as beneficiaries. Rather than naming
each child individually, parents may name children as a class; for example: "Shared equally
among all children born from the marriage of the insured to J. B. Ashe, including adopted chil-
dren." In this case, the class designation ensures that any children born after the policy is issued
will benefit. The class designation also avoids confusion if a child dies before the insured and
the insured fails to change the designation.

    Others besides children could be named as a class. For instance: “All of the insured's sib-
lings.” “All of the insured's siblings' children.” “All of the insured's grandchildren,” etc. Again,
there are many possibilities.

PER CAPITA AND PER STIRPES DESIGNATIONS

    When two or more individuals are named as either Class I or Class II beneficiaries, one or
more might die before the insured, raising questions about how the policy proceeds should be
divided among the living beneficiaries. There are two different ways a beneficiary designation
might be handled to account for this situation.

    A per capita designation is used to indicate that any remaining beneficiaries share all of the
proceeds equally. The legal term per capita, derived from Latin, literally means –“by the heads
or polls" and is translated to refer to "each person." For example, the insured names his four



                                                   54
sisters to share equally as primary beneficiaries of his $100,000 policy. If all four are living
when the insured dies, each person receives $25,000. But if two of the sisters die before the
insured does, when the insured dies, each person still living receives $50,000 - the two remain-
ing sisters in this example.

    A different arrangement applies under a per stirpes designation. Per stirpes, literally, "by
roots or branches,” legally refers to a progression through the branch of a particular family
member. For the situation described in the preceding paragraph the two living sisters would re-
ceive $25,000 each as originally planned. But the remaining two shares of $25,000 each would
pass on to the heirs of each of the deceased sisters, to each sister's "branch" of the family, rather
than being divided between the two living sisters.

MINORS AS BENEFICIARIES

    Typically, it is not a good idea to name minors as beneficiaries since minors are not legally
recognized as competent to handle financial transactions. If an insured insists on naming mi-
nors, the insurer might require that a trust be established to hold the policy proceeds until the
minors are adults. Alternately, the insurer could arrange to hold the proceeds, pay interest, and
disburse the proceeds plus interest when the minors reach adulthood.

ESTATES AS BENEFICIARIES

    An insured may name their estate as the beneficiary. This is the least favorable type of ben-
eficiary designation for several reasons. If the policy proceeds go into the estate, they increase
the size of the estate, which could in turn increase estate taxes that become due when the in-
sured dies. In addition, if the insured failed to leave a will, the executor of the estate would
have no way of knowing how the insured really wanted the policy proceeds distributed. And
even if a will existed, indicating how to distribute proceeds, probate court actions can take
months to complete. Life insurance proceeds that go into an estate are also more vulnerable to
attachment from the deceased person's creditors.

SPENDTHRIFT CLAUSE

    A spendthrift clause included in some life insurance policies is intended to protect policy
proceeds from creditors by establishing a trust to receive the death benefit. Under this ar-
rangement, the policy proceeds are paid out as periodic income rather than in a lump sum. The
payout could be arranged as a fixed payment for as long as the money lasts or for a fixed period
of time. The proceeds are then usually protected from creditors until the terms of the trust have
been fulfilled. While this is the intent, the extent of the protection varies from state to state.

    While some state laws protect the entire death benefit as long as it is paid in installments,
others allow only a portion of each fixed payment to the beneficiary to be protected by a spend-
thrift trust. For example, the law might require that if the beneficiary receives more than "X"
number of dollars per month under the trust, creditors might pursue any additional amounts. In
other states, the income is protected only while it is in the insurer's possession; after a payment




                                                    55
is made to the beneficiary, the money is no longer protected. A financial planner will want to
learn how spendthrift clause trusts are handled in the states where they do business.

UNIFORM SIMULTANEOUS DEATH ACT

    The unhappy possibility of family members dying at the same time or nearly at the same
time can cause complications in beneficiary designations. Since it is fairly common for a
spouse and/or children to be named as beneficiaries, logically there is concern as to what hap-
pens, for example, if the insured and her husband, the primary beneficiary, are killed in the same
accident? The following Consumer Application illustrates the difficulties.

    CONSUMER APPLICATION
    Anna has a life insurance policy, with her husband Donald, as the primary beneficiary. The
couple has no children. Anna's sister Nattalie is the contingent beneficiary. Anna and Donald
are involved in an automobile accident; both are pronounced dead upon arrival at a nearby hos-
pital. The question arises: Did Anna die first, making the policy proceeds payable to Donald, or
did Donald die first, making the proceeds from Anna's policy payable to Nattalie?
    If Donald lived longer than Anna, the policy proceeds would be paid into his estate and dis-
tributed according to his will. If Donald, the primary beneficiary, died before Anna, Nattalie
would receive the proceeds as the contingent beneficiary.

    Recognizing this problem, most states have adopted the Uniform Simultaneous Death Act,
which assumes that the primary beneficiary died before the insured. As a result, the policy pro-
ceeds are paid to the contingent beneficiary. This is true only when there is no evidence that the
primary beneficiary did, in fact, outlive the insured.

    CONSUMER APPLICATION
    Dominic was married to Angela, named as primary beneficiary on a life policy, with sister-
in-law, Stephanie, as contingent beneficiary.
    The emergency personnel who accompanied Dominic in the ambulance after a car accident,
attested that he had vital signs up to the time they arrived at the hospital. On the other hand, no
one in the ambulance with Angela believed she was alive during the trip to the hospital. In this
case, there is evidence that Dominic did outlive Angela, so the policy proceeds would be paid
into his estate rather than going to the contingent beneficiary, Stephanie.

COMMON DISASTER PROVISION

    Another way to mitigate the problem is by including a common disaster provision in the
beneficiary designation. A typical provision would stipulate that in situations where there is se-
rious injury to both the insured and the primary beneficiary in a single event, the policy pro-
ceeds are held in trust for a specified period of time, often from one to three months. If the pri-
mary beneficiary is alive after the specified period expires, the primary beneficiary receives the
death benefit. Otherwise, proceeds go to the contingent beneficiary. This provision might also
be called a survival clause or similar term.




                                                   56
    Still another option is to arrange the policy so proceeds are paid as periodic income to the
primary beneficiary as long as he or she lives. Upon the primary beneficiary's death, the re-
maining policy proceeds are paid to the contingent beneficiary. Insurers will work closely with
insureds to see that the designation is worded to provide protection for the beneficiaries as pre-
cisely as the insured desires.

DIVIDENDS

    Whether or not a life insurance policy pays dividends depends upon the type of policy.
When an insurer makes more profit than anticipated, certain policies the company issues might
share in that surplus. Any such share is called a dividend. The source of the surplus is savings
the insurer realizes by reduced operating expenses, better mortality experience than expected
and/or higher investment returns than predicted.

PARTICIPATING AND NON-PARTICIPATING POLICIES

    Not all policies share in a company’s surplus. Those that do are called participating or
"par" policies. Those that do not are called non-participating or "non-par" policies. Partici-
pating policies might be either term or cash value insurance, but dividends on term policies are
typically quite small.

    Participating policies generally have slightly higher premiums than non-par policies. Alt-
hough dividends are not guaranteed to be paid, the higher premiums can help improve the sur-
plus picture. When the policyowner has an outstanding policy loan from the cash value, the pol-
icy usually receives a lower dividend than policies without outstanding loans. The courts have
ruled that a dividend is legally an overpayment of premium that is returned to the policyholder.

DIVIDEND PAYMENT OPTIONS

    The owner of a participating policy may choose how the dividends are paid - which divi-
dend payment option to choose from among those the insurer offers. Six basic options are dis-
cussed in the following paragraphs, but few companies will offer all six.

     Cash Dividend: Policyowners may choose to take cash dividends. Whenever the insur-
      er pays a dividend, the policyowner receives a check from the insurance company.

     Premium Reduction: Dividends may be used to help pay the next premium. Under the
      premium reduction option, the amount of the dividend is deducted from the premium
      so the policyowner pays less the next time a premium is due. Since the amount of the
      reduction depends upon the amount of the dividend, the normal premium is required
      when no dividend is paid.



     Paid-Up Policy: By using both dividends and the accrued interest on cash values, the
      policyowner might be able to have a paid-up policy. That is, both dividends and inter-



                                                  57
          est are used to pay future premiums. This option requires a large policy paying large
          dividends and earning significant interest. Some policies are purposely written to do
          just this and the premium is sometimes termed "vanishing premium.” A caution is in or-
          der, though, since dividends are not guaranteed. If the insurer's experience is much
          worse than anticipated, the policyowner may have to keep paying premiums. In addi-
          tion, the premiums required in the first years of the policy are typically higher than poli-
          cies that do not include this feature.

        Paid-Up Additions: Alternately, dividends could be used to purchase paid-up addi-
         tions to the policy. These are small additional amounts of Whole Life insurance that are
         added to the existing policy without evidence of insurability and with no additional
         premium required in the future for the additions. This use of dividends is essentially the
         purchase of small amounts of single-premium cash value life insurance.

        Accumulation at Interest: Leaving dividends with the insurance company allows them
         to accumulate at interest. The accumulated dividends and interest are then added to
         the death benefit, so a $100,000 policy, in which dividends 'accumulated at interest total
         $2,000, would result in death proceeds of $102,000. While the dividends themselves are
         not taxable because they're considered a return of excess premium paid by the
         policyowner, the interest is taxed under this option.

        One-Year Term Insurance: Dividends may also be used to purchase one-year Term
         Insurance. The amount of Term Insurance that may be purchased is whatever the divi-
         dend will buy at the insured's current age, up to the cash value of the policy. If part of
         the dividend remains after the term purchase, it is usually left with the insurer to accu-
         mulate at interest. No proof of insurability is typically required under this option.

    Remember, not all of these options are available from every insurance company. In addi-
tion, while policyowners normally select a dividend option when the policy is issued, they usu-
ally may switch to another option if desired.


       CONSUMER APPLICATION
        A policyowner has an outstanding policy loan of $5,000, for which he is paying 7% inter-
est.
     The insurer assumes a dividend interest rate of 10%. The dividend that is due to be paid is
$500.
    Since the $5,000 loaned to the policyowner is not available to earn the assumed rate of 10%,
the insurer earns only the 7% interest paid by the borrower - 3%, less than assumed. Three per-
cent of $5,000 is $150, so it ($150) is subtracted from the dividend paid. Instead of receiving
the full $500 dividend, this policyowner receives only $350 because of the outstanding loan.


                                        THE CASH VALUE




                                                     58
    Cash Surrender: The policyowner may receive the cash surrender value of the policy.
This involves withdrawing the entire cash value and surrendering or terminating the policy. The
insurance company deducts any outstanding loans, interest on loans and unpaid premiums be-
fore paying the cash value to the policyowner.

        Cash value policies include tables showing the cash surrender value for every year the
policy is in force and that is the basis for the amount due the policyowner. However, a Universal
Life policy has only a minimum cash value guarantee and a variable policy has no guarantee at
all. These policies might include an illustration of potential cash values based upon assumed
rates, but, unlike the tables in traditional policies, there is no guarantee that those potential val-
ues will be available at any given time.

    Paid-Up Insurance: Another nonforfeiture option is to use the cash value to buy paid-up
insurance. This provides a reduced amount of cash value life insurance for which the
policyowner never pays another premium. The paid-up policy is the same type of insurance as
the basic policy from which the cash value is being used. No riders or other provisions added to
the original policy are included. Cash values accumulate in the paid-up policy and the policy
earns interest. If the original was a participating policy, the paid-up policy will also earn divi-
dends.

    The amount of the death benefit for the paid-up policy depends upon how much coverage
the cash value will buy. Any outstanding loans and interest are deducted first and the insured's
attained age is used to determine the cost. Administrative expenses will be small because it costs
insurers very little to provide a paid-up policy from cash values.

    Extended Term Insurance: Finally, the policyowner may use cash values to purchase ex-
tended Term Insurance. In this case, the death benefit is the same as the original policy (unless
a loan is outstanding) and the “extended term" is the number of years and days of coverage that
can be purchased with the available cash value at the insured's attained age. Policies that have
guaranteed cash values include a table showing how long the term will be, based upon these
factors.

    If there is an unpaid policy loan, the insurance company deducts the amount of the loan and
any interest due from both the cash value and the death benefit amount before determining the
length of the extended term. For example, assume the original policy has a $100, 000 death
benefit, a cash value of $20,000 and an outstanding loan with interest of $5,575. The death
benefit of the extended term policy will be $94,425 and the cash value used to purchase the pol-
icy will be $14,425.

    The outstanding amounts are deducted from possibilities, both the cash value and the death
benefit to protect the insurance company. If the insured should die soon after opting for the ex-
tended Term Insurance and before repaying the policy loan, the insurer would have lost the loan
amount completely since there is no longer any cash value as collateral.

    If a policyowner simply stops paying premiums and does not choose a nonforfeiture option,
insurers automatically set up the extended Term Insurance unless the policy also includes the



                                                    59
automatic premium loan provision described earlier. This nonforfeiture option provides the
most insurance protection for the cash value available.


                                  SETTLEMENT OPTIONS

     Settlement options are the choices either the insured or the beneficiary makes about how
the death benefit will be paid. Most companies offer all of the options presented in this section.

LUMP SUM

    Typically, death benefits are paid in one lump sum and this is the “default” option.

INTEREST OPTION

     The face amount of the death benefit (or the “principal”), is left with the insurer to be in-
vested and earn interest, which is then paid to the beneficiary at a predetermined period of time.
The policyowner may stipulate the frequency, which usually may be changed by the beneficiary.

    The interest only settlement option may also provide that the beneficiary may withdraw all
or part of the principal amount at some point. Policies may also be written so the beneficiary
may not withdraw any of the principal, in which case:

        The principal is paid to the estate of the now deceased beneficiary.
        The principal is paid to any contingent beneficiary of the original insured.

    The first possibility is more typical because the money belongs to the primary beneficiary,
now dead, so it goes into his or her estate. This happens if no alternate arrangement was made
when the beneficiaries were designated. The second possibility occurs only if arranged for orig-
inally. And, the original arrangement might have been that the contingent beneficiary also re-
ceives interest only rather than the principal amount. But, unless specified otherwise, at this
point the principal would be paid in a lump sum either to the primary beneficiary's estate or to
the contingent beneficiary.

FIXED AMOUNT

    This settlement option permits the death benefit to be distributed in more than one pay-
ment of a fixed amount that is either originally specified by the policyowner or selected by the
beneficiary and may be made annually, semi-annually, quarterly or monthly. The portion of the
death benefit not yet paid draws interest while the insurer controls it.




                                                  60
FIXED PERIOD OPTION

    Rather than a fixed amount, benefits might be paid for a fixed period. If an insured wants
to be certain the beneficiary has at least some income for a certain period of time, this is better
than the fixed amount option. Interest is paid on the retained principal. The amount of each
payment depends upon the original death benefit amount, interest earned on the decreasing
principal, the length of the fixed period and the frequency of each payment.

LIFE INCOME OPTION

    The life income option pays the death benefit and it provides the beneficiaries an income for
their lifetime. This option involves the purchase of an annuity contract designed to provide life-
time income. The primary advantage of this option is the guaranteed lifetime income.


                                   JUVENILE INSURANCE

     Insurance that covers the lives of minor children is often called juvenile insurance for iden-
tification purposes. The coverages and provisions for policies written on adult lives are essen-
tially the same for children, whether the policy is term or cash value life insurance.

   Financial advisors disagree about the need for life insurance covering a child's life. Oppo-
nents cite two major reasons for not buying life insurance for children:

1. The chances of children dying while young are relatively small.

    2. Children do not earn income upon which the family relies for day to day living, so their
deaths have no significant financial impact.

   Without contesting the validity of those arguments, proponents stress these advantages of
purchasing life insurance for the child:

    1. Because life insurance rates are considerably lower for a young healthy child, juvenile
insurance offers the opportunity to buy more insurance for less money.

2. Many people need life insurance as adults, but not everyone remains insurable into adult-
   hood, when deteriorated health could affect the ability to buy life insurance. Juvenile cash
   value policies ensure that at least some insurance is in place when the child becomes an
   adult.

3. Like any other cash value policy, a juvenile policy will build cash values that can be used in
   the future, perhaps as a low-interest loan to pay for the child's education.




                                                   61
JUMPING JUVENILE

    A "jumping juvenile" policy, which might also be called a junior estate builder, covers
the child with a death benefit that is initially small. When the child reaches age 21, the death
benefit then jumps to a greater face value - usually five times the initial amount.

     A juvenile policy often has a payor rider attached. As discussed earlier, this rider obligates
the insurer to cover the premiums if the person paying for a child's policy becomes disabled or
dies.


                                  BUSINESS PROTECTION

     A professional and effective planner must be knowledgeable about all aspects of an indi-
vidual’s personal and business life. While financial planning is usually more of a personal mat-
ter, many of those who require planning for their retirement and the handling of their estate are
in business, either self-employed, or in business with others. Life Insurance is ideally suited for
an effective tool in buy/sell agreements and corporate stock redemption plans.

     The need for business insurance arises because the death of people who are vital to the op-
eration of a business can have far reaching effects, including the death of the business itself.

     CUSTOMER APPLICATION
     Maggie Southerland and Grace Jones were long-time friends and the co-owners of a suc-
cessful 10 year-old retail business. When Grace was tragically killed in a car accident, Maggie
suffered a double loss: first, the death of her dear friend and second, the loss of her business.
Why her business? While Grace's husband and daughter both wanted Grace's business to con-
tinue after her death, they were forced, for financial reasons, to use Grace's share of the business
income, causing the store to close.
     Neither of Grace's survivors was equipped to contribute financially to the business nor were
they equipped by training or personality to help run the business. Seeing the financial problems
her friend's family was having, Maggie immediately began sharing profits with them and at-
tempting to add to that amount to buy Grace's half of the business from her heirs. These kind
and thoughtful actions unfortunately resulted in cash flow problems for the business and finally,
the financial burden forced Maggie to go out of business altogether. Maggie's loss was rooted in
the lack of capital to purchase Grace's half ownership from the survivors when Grace died un-
expectedly. This loss could have been avoided entirely if Maggie and Grace had executed a
buy/sell Agreement.


                               THE BUY/SELL AGREEMENT

    Buy/sell agreements funded with life insurance provide an immediate source of money for
a surviving business partner to buy the deceased person's business interest with no interruption
in the business. Life insurance policies used for this purpose are also called business continua-



                                                   62
tion insurance because they help the business to continue as usual even after a very important
contributor dies.

    A buy/sell agreement for a partnership would stipulate that any surviving partners would
purchase the portion of a business owned by a deceased partner. Included in the agreement is
the exact purchase price of the deceased person's interest in the business or a specific formula
for determining its market value. The agreement must also include a guaranteed method to en-
sure the money is available when it is needed. Life insurance is the perfect method to guarantee
availability of the money and can be used with either of the two types of buy/sell agreements
described below


                               THE CROSS-PURCHASE PLAN

    One type of buy/sell agreement is a cross-purchase plan. Under this arrangement, each
partner purchases a separate life insurance policy on every other partner's life for a sufficient
amount to buy a share of the partner's interest at death. In the case of Maggie and Grace as dis-
cussed above, Maggie would purchase a policy on Grace's life and Maggie would purchase a
policy on Grace’s life.

    If Maggie and Grace had a third partner, Terry, Maggie would buy two policies - one on
Grace's life, one on Terry's. Terry would buy two policies, on Maggie and Grace's lives, and
Maggie would own policies on Terry and Grace's lives. Each partner buys separate policies.
When Grace was killed in the previous scenario, both Maggie and Terry would have had the life
insurance proceeds from their individual policies to purchase Grace's interest from her family.


                                 ENTITY PURCHASE PLAN

    Another type of buy/sell agreement, the entity purchase plan, arranges for the partnership
(the entity) itself to own the life insurance policy on each partner. For example, assume that the
business partnership of Maggie, Terry and Grace is called MTG Enterprises. MTG Enterprises
as an entity purchases three separate policies - one on the life of each partner. When Maggie
dies, the policy proceeds are paid to MTG rather than to Grace and Terry individually. MTG
then uses the proceeds to buy Maggie's interest from her heirs.

BUY/SELL AGREEMENT WITH A CLOSELY HELD CORPORATION

    When a business is a closely held corporation rather than a partnership, a similar life insur-
ance-funded buy/sell agreement can be established. Closely held corporations are much like
partnerships, but because they are incorporated, they have stockholders rather than partners. In
a closely held corporation the stock is held "closely” by a select group of people rather than be-
ing made available for public sale.




                                                  63
    It is not unusual for the stockholders and owners of a closely held corporation to be just a
few people who serve in many different positions as employees and directors. Often, just one
person holds the majority of the stock.



     CONSUMER APPLICATION
     Clyde Cardwell is the founder and principal stockholder of CC Manufacturing, Inc. There
are only two other stockholders, CC's vice presidents, Ty Falani and Moses Shadeeq. Clyde's
death could have disastrous financial consequences for the surviving stockholders of CC Manu-
facturing, especially if Clyde's heirs are not actively working in the business nor interested in
doing so. At Clyde's death, Ty and Moses probably would want to continue running the busi-
ness but Clyde's family might want to receive cash for Clyde's stock and get out of the business.
If they were to sell Clyde's majority share of the stock to an outsider, Ty and Moses could find
themselves in an unfavorable business relationship.
     Using life insurance, a buy/sell agreement can be developed to provide funds for either the
corporation as an entity or the individual stockholders, under a cross-purchase plan, to buy the
deceased stockholder's stock. This is known as a partial stock redemption and because these
redemption provisions are found in Section 303 of the Internal Revenue Code, this is often
called Section 303 redemption. Under an entity plan. CC Manufacturing would use the policy
it owns on Clyde's life to redeem his majority stock from the family at a predetermined price
and the family would be obligated to sell the stock to the corporation. Or, with a cross-purchase
plan, both Ty and Moses would use the insurance proceeds from their individual policies on
Clyde's life to purchase the stock on the same basis.



    A buy/sell agreement funded by a life insurance policy that is certain to pay in the event of
death is a guaranteed way to ensure that the remaining owners will be able to continue operating
their business. The surviving owners purchase the deceased person's business interest at a pre-
determined price and the deceased's heirs know they will receive a fair payment for that interest
and be freed from the burden of any business-related financial responsibilities.

   Buy/sell agreements are complex legal documents that require the services not only of a
competent life insurance agent, but also of the business owner's accountant and lawyer.

                                   KEY MAN INSURANCE

    Another well-known use of business-related insurance is life insurance written on the life of
a key employee, who is someone vital to the successful operation of a business. A key employ-
ee might be one of the owners, but it could also be a non-owner employee without whose
unique credentials the company could quickly experience financial problems.




                                                  64
    CONSUMER APPLICATION
    e-Base Computer Systems, a closely held privately owned company, designs technical com-
puter programs for industrial machinery manufacturers. Two years ago they hired Ralph as a
programmer, and during his tenure with the company, he had personally been responsible for a
system that doubled the income of e-Base. Because of financing commitments they could not
make him a shareholder or partner at this time, but they gave him a compensation package that
gave him all that he wanted. However, he was almost irreplaceable with the firm. Therefore,
the company purchased “Key Man” insurance on Ralph, with the company paying the premi-
ums, and also named as beneficiary. The face amount was what they expected to have to pay
for a replacement if Ralph died. (They also took out a disability income key man insurance pol-
icy, in case Ralph becomes disabled and unable to work).

    Because a life insurance buyer must have an insurable interest in the life of the insured per-
son, the most important criterion for key employee insurance is that the employee's death would
result in economic loss to the employer.

    Unlike other insurance-funded business arrangements, key employee insurance requires
nothing but a life insurance policy that names the employee as the insured and the business or
employer as the policyowner/ beneficiary. The employer pays the premium and receives the
death benefit if the employee dies.

    Employers who want to provide a death benefit for the key employee's survivors may add a
Term Insurance rider for this purpose. If the key employee dies, the base policy's proceeds are
paid to the employer as described above and an additional amount of insurance stipulated in the
rider is paid to the employee's heirs.

        NOTE: See discussion of Employee Benefit Plans, Split Dollar Plans, Non-
qualified Deferred Compensation Plans, and Supplemental Executive Retirement Plans.
Also, note discussion of Variable Life in Non-Qualified Business Plans.




                                                  65
                      CHAPTER 5 – STUDY QUESTIONS


1.   The automatic premium loan provision allows the insurance company to
     A.     take out a loan against an insurance policy and buy additional insurance.
     B.     take out a loan against the policy to pay a premium that if not paid would lapse
            the policy.
     C.     take out a loan against the policy to pay a mortgage payment.

2.   Which of the following named beneficiaries would be the first to receive the death bene-
     fits?
     A.     Primary beneficiary.
     B.     Contingent beneficiary.
     C.     The insureds son if the insureds spouse dies before the insured.

3.   The ”spendthrift” clause is a clause
     A.     in an insurance policy, to protect death benefit proceeds from creditors, by pay-
            ing out periodic payments rather than a lump sum.
     B.     that requires the insurer to monitor where the death benefits are spent.
     C.     to make sure that all creditors are paid upon the death of the insured.

4.   When the beneficiary designation is worded that all beneficiaries are to share the pro-
     ceeds equally it is know as
     A.     irrevocable.
     B.     revocable.
     C.     per capita distribution.

5.   In a buy-sell partnership agreement, when each partner owns a life insurance policy on
     the life of each of the other partners it is known as
     A.     a partnership trust.
     B.     an Entity plan.
     C.     a cross purchase plan.




                                               66
6.    Dividends from participating insurance policies may be paid out as follows
      A.     sent directly to the owner’s bank to pay on his/her mortgage.
      B.     added to the cash value of the policy.
      C.     paid out in cash.

7.    What is the provision, in a life insurance policy, that explains how the death benefits are
      to be paid to the beneficiary?
      A.     Modes of payment.
      B.     Non-forfeiture option.
      C.     Settlement option.

8.    When a business is the owner and beneficiary of a life insurance policy on the life of an
      important person in the company, the policy is know as
      A.     Stock Redemption plan.
      B.     Key Person insurance.
      C.     Split Dollar insurance.

9.    Most states have adopted a law, which clarifies the sequence of death in the case of two
      people dying in a common accident and not having proof of who died first. This law is
      called
      A.     Uniform Simultaneous Death Act.
      B.     Uniform Disaster Provision.
      C.     Contingent beneficiary.

10.   In the dividend option where dividends are allowed to accrue at interest, when the policy
      owner dies the beneficiary must
      A.     pay taxes on the dividends.
      B.     pay taxes on the interest earned.
      C.     receive the dividends in cash, and then return the cash to the insurance company
             to earn interest.


ANSWERS TO CHAPTER FIVE REVIEW QUESTIONS
1B 2A 3A 4C 5C 6C 7C 8B 9A 10B




                                                 67
                                WHAT ARE ANNUITIES?

      Annuities are particularly important in any type of planning, whether financial or estate, as
they are designed to pay the insured a regular income over a specified number of years. Annui-
ties protect against the annuity-holder from “living too long.” In addition to providing income,
most annuities have some sort of death benefit – a benefit not available by other types of in-
vestments. By assuring continued payments for a specified or unlimited number of years, annu-
ities guarantee that the insured will not deplete his or her source of income. Although annuities
have been around for years, in recent years annuities’ income growth is indexed according to the
growth or decline of an outside fund, such as Standard and Poor’s 500, or some other indexing
method. This allows the annuitant’s annuity value to fluctuate with the state of the economy,
making it most competitive with other forms of investments, such as stocks, bonds, mutual
funds, etc.

     It is assumed that those using this text are already familiar with the concept of annuities,
however in order to better understand the more complicated interest-sensitive types of annuities
and their usage, a brief review of the basics of annuities should be helpful.

     The time period over which the insurance company promises to provide income varies by
type of contract is logically called the Annuity Period. The contract may specify an exact
number of years or the individual’s lifetime (an unspecified number).

    The person who purchases the annuity is the owner. The person who received payments
from the annuity is the annuitant. The annuitant may or may not be the contract owner.

     Annuities may be written on an individual, joint or group basis. The most common is the
individual annuity that is usually purchased for retirement purposes. The “Joint and Survivor”
annuity is also a common form for married persons. With this type of annuity, there are two
persons insured and payments are guaranteed to continue to the surviving spouse upon the oth-
er’s death. Annuity payments can be either the same or different amount, usually designated as
a percentage of the original amount (discussed in more detail later). Group annuities are gener-
ally part of a group pension or similar employee benefit plan.


                                    PAYING OF BENEFITS

    There are two basic types of annuities in regards to when benefits start (when the annuity
“annuitizes”).




                                                  68
IMMEDIATE ANNUITY
    With an immediate annuity, annuity payments will commence after a predetermined “peri-
od.” The period can be one year, for instance, in which case the first benefit payment will be
one year after the purchase of the immediate annuity. Payments can be monthly, quarterly,
semi-annual or annual. If period is one month, annuity payments start one month after pur-
chase.

DEFERRED ANNUITY
      With annuitization, the payment period is scheduled to begin at some future date. The pe-
riod when the contract annuitizes, is called the maturity date. Conversely, for definition purpos-
es, the period prior to the maturity date is called the accumulation period. Further, the period
following the maturity date during which payments are made is the liquidation or distribution
period.

     If death occurs before the annuitization period as stated in the contract, the cash value paid
to the annuitant’s beneficiary would equal the amount of premiums paid in. However, most
contacts provide for payment to the beneficiary of at least the amounts paid in - plus interest and
regardless of sales charges.

     The purchaser of a Deferred Annuity is permitted to alter the date that payments are sched-
uled to begin but within certain conditions that are plainly stated in the annuity.


                                    PREMIUM PAYMENTS

     The specific premium amount depends on several factors, primarily the length of the guar-
anteed benefit payment period. The “Straight life” (discussed later) annuity offers maximum
income per dollar of outlay. Obviously, the reason for this is that some annuitants will die
prematurely, or in the early part of the annuitization, thereby restricting the total amount of pay-
out. Period certain and refund options provide less income per dollar of outlay, as the element
of mortality does not enter the equation.

     The interest the company earns on investments is an important factor in determining annui-
ty premiums. The higher the interest, the more income per dollar of outlay. During the discus-
sion of Variable and Equity Index Annuities, the effect of the company’s investment portfolio is
extremely important. Obviously, the higher the investment return the lower the premiums to the
annuitants.

    The third factor is the expenses of the insurer. If the insurer has high expenses (such as
high commissions and overrides), the higher premium to the policyholder. In other words, the
lower the expenses, the lower the premiums paid to the insurer that is required by the insurer to
pay all claims and satisfy their stockholders.




                                                   69
     CONSUMER APPLICATION
     Bertrand, age 66, and his wife, Louise; also age 66, talk to their insurance agent about the
purchase of an annuity that will pay $1,000 to each of them for his/her lifetime. Since Bertrand
is a CPA, he has an interest on how the premiums are calculated. Their agent refers to his com-
pany’s actuarial department, who offers the following explanation:

     The Insurance company assumes an earned interest rate of 8% on the investments that they
purchase using the premiums paid by the insured.
     Bertrand’s single premium cost would be $9088. Louise’s premium would be $8890.
     Difference in premium would be $198. Therefore $198 would be liquidated the first year
(one-year difference in ages).
     8% of $9088 = $727.04.
     Added to the one year cost difference ($198) would be $925.04.
     Since the company promises to pay $1,000, the company would be $74.96 short.
     This (annuity) concept may be difficult for people used to Certificates of Deposit and other
savings vehicles to comprehend. As an insurance product, annuities are calculated on the partic-
ipation of many people. Thus, when they start receiving annuity payments, those funds will
come from a pool of funds that provides this income to those who live long enough to receive it.
The $74.26 represents the insurance benefit that annuitants that survive to age 66 would receive,
based on calculations on the number of annuitants that are likely to die that year. Therefore, the
death benefit to surviving annuitants will grow larger each year during the liquidation period. If
the annuitant lives long enough, both principal and interest eventually will be exhausted, and
entire payment will come from the insurance benefit.


     Single Premium immediate annuity premiums are paid when the contract is signed, hence
the term “lump sum payments.” The funds for the payment of premiums can come from a vari-
ety of sources such as Employee profit-sharing plan, Savings Accounts, cash value of life insur-
ance policy or sale of home or property, etc.

    In today’s market, many annuities are purchased as the result of an IRA, 401(k) or 403(b)
rollover. When this is done, it is extremely important that it be a “Section 1035” exchange, i.e.
that it not be a taxable exchange unless, for some reason, the customer wants to pay taxes on the
amount of the rollover at that time. The insurance company will furnish the papers that must be
executed for such a rollover to exist and as discussed elsewhere in this text, the funds must be
automatically transferred to the new annuity.

     Periodic Level Premiums is a typical payment method of Deferred annuities. The annui-
tant pays equal premium amounts at regular intervals, until the benefits are scheduled to begin.
Some individuals choose this option, as it is similar to making deposits into a regular savings
type account.

     Periodic Flexible Premiums is a premium payment method that is more “in tune” with to-
day’s investment world. The annuitant pays the premiums over a period of time, until they are
paid off. Since the premiums are flexible, they appeal to those who want flexibility in the tim-
ing and amount of premium payments and is particularly attractive to those who want a program


                                                 70
in which they can vary the amounts they save each year. This also appeals to those who earn
commissions, or other types of irregular income such as actors, fruit-truck drivers, artists, etc.,
not to mention families with growing children. As long as the annuity remains in effect, funds
will continue to accrue interest. The principal disadvantage is that the actual amount of annuity
benefit cannot be determined in advance, which may be essential in financial planning.


                                    BENEFIT PAYMENTS

ANNUITY CERTAIN (PERIOD CERTAIN)

     An Annuity Certain specified the number of benefits payments of a set amount. This option
will guarantee a minimum amount that the insurance company will pay on an annuity. The an-
nuity has a Death Benefit that provides for payment to be made to the designated beneficiary
upon the annuitant’s death and will continue as long as the beneficiary lives. In effect, this an-
nuity says that it will pay the benefits remaining of the period certain to the beneficiary. How-
ever, if the annuitant should survive the period certain, then the annuity performs as a Life An-
nuity.

    CONSUMER APPLICATION
    Cecil dies 3 years after taking out an Annuity with a 5-year period certain. The Annuity
Company will continue to make payments to his beneficiary for next two years. Insurance
companies usually pay the present value of the remaining payments in a lump sum, so Cecil’s
beneficiary will receive 2 annual payments
    If Cecil had survived the first five years of annuitization (liquidation period), the annuity
would have continued to be paid out in the normal manner, ceasing upon the annuitant’s death.

LIFE ANNUITIES (STRAIGHT LIFE ANNUITIES)

     The most common type of annuity is the simple “Straight Life Annuity” which provides for
guaranteed periodic payments that terminate upon the death of the annuitant. Once the annui-
tant dies, the contract is fulfilled and no payments are made. This type of annuity does not
guarantee that the annuitant will receive payments equal to the amount paid as premiums on the
contract. If the annuitant lives a long time, they will recover more than all of the premiums they
have paid; if they die soon after annuitization, the insurance company will only pay the benefits
up until the time of death.

      In the event the annuitant dies during the accumulation period (i.e. the time that payments
are being made on the annuity, but prior to annuitization) proceeds will revert to the beneficiary,
or if none is named, to the estate. Because this limits potential payouts, it will provide a higher
return than other plans.

    The Straight Life Annuity provides the maximum income per dollar of outlay.




                                                   71
LIFE INCOME WITH PERIOD CERTAIN

     The Life Income with Period Certain (probably named by a dyslexic Actuary…) guarantees
that annuity payments to a beneficiary will be made for a specific number (or certain period) of
years, even if the annuitant dies before the end of this period. Payments to the annuitant will
continue as long as he or she lives.


LIFE INCOME WITH REFUND ANNUITY

     The Life Income with Refund type of Annuity states that in event of the annuitant’s death,
the company will pay an amount at least equal to the total dollars paid in as premiums. The
company will continue to pay the guaranteed amount of monthly income for as long as the an-
nuitant lives.

    There are two types of this annuity:
      1.      Cash Refund: The Company agrees that if the annuitant dies, it will refund in
              cash the difference between the income that annuitant received and the amount
              that was paid in premiums plus interest earned.

       2.      Installment Refund: The Company agrees to continue to make payments to the
               beneficiary until the total of the payments made to the annuitant and to the bene-
               ficiary equals the amount the owner paid for the annuity plus the interest earned.
               The longer the payout is to continue after the annuitant’s death, the smaller will
               be the periodic payments.

        NOTE: Annuities with refund options pay annuitants lower amounts of income than do
comparable contracts without them. The refund option represents an extra benefit for the con-
tract owner and an extra cost for the company.

TEMPORARY LIFE ANNUITY

      The Temporary Life Annuity is a “combination” plan. Annuity payments will be made un-
til either (a) the end of a pre-determined number of years, or (b) until the death of the annuitant,
whichever comes first.


                        JOINT AND SURVIVOR ANNUITIES

     Under this arrangement, two people are insured, usually husband and wife. Beginning on
the date set in the contract, payments are paid to the annuitants. Payments are guaranteed to
continue to the surviving spouse upon the other spouse’s death. Depending on the terms, the
continuing payments will either be in the same amount as when both annuitants were alive, or
be reduced.




                                                   72
   Two types are commonly used.

       1. Joint and 2/3 survivor, the surviving spouse receives two thirds of the income paid to
           the original annuitant.
       2. Joint and one-half survivor, surviving spouse receives half of the income.

     Obviously, the premiums are higher than those for life income annuities are since the like-
lihood of a long annuity payment period is greater when more than one life is covered.


                                 VARIABLE ANNUITIES

    The first Variable Annuity was the College Retirement & Equities Fund (CREF), designed
by Teachers Annuity and Insurance Association. Since that time it has grown into one of the
most successful and heavily used insurance product in financial planning.

      One of the earliest deviations from traditional fixed annuities was the Variable Annuity,
which offers the potential for a greater rate of return if the annuity owner is willing to take a
greater investment risk. Fixed annuity premiums are deposited in the insurance company's gen-
eral investment account so that every annuity buyer's funds are commingled and the insurance
company takes the risk on the investments it makes as a whole. With a Variable Annuity, how-
ever, premiums are invested separately, with the buyer assuming all of the investment risk.


                                 THE SEPARATE ACCOUNT

     Premiums deposited in a Variable Annuity go into a separate account where they are invest-
ed in a variety of securities, similar to investing in a mutual fund. Because Variable Annuity
premiums are used to buy securities, they are subject to fluctuating market conditions, resulting
in a variable rate of return that depends upon the performance of those securities. There are no
guarantees about the value of the annuity at any given time since the value depends upon the
separate account performance. Not even the principal amount invested by the annuity owner is
guaranteed, which means it could be diminished or lost entirely.

     Insurance companies continue to add optional types of investment portfolios for Variable
Annuity buyers to choose from. Typically, investors may choose from such securities as com-
mon stocks, bond funds, U.S. government securities, short-term money market instruments and
others depending upon their investment needs. For example, the insurer might offer different
funds whose separate goals are long-term growth, capital preservation, high yields, or some
combination. The annuity buyer may switch investments, if desired, subject to any insurer lim-
its on the number of times changes may be made.

     Historically, over many years, the markets rise - and fall periodically, but generally provide
an average long-term rate of return that is greater than fixed rates. However, regardless of past
performance, it is important to note again that absolutely no guarantees are made about the per-
formance of the Variable Annuity separate account.


                                                  73
                       SECURITIES AND INSURANCE REGULATION

     Because the separate account is invested in securities, Variable Annuities are regulated in
part by the Securities and Exchange Commission (SEC) and in part by state insurance depart-
ments. The SEC requires that potential purchasers of Variable Annuities must be provided with
a prospectus that discloses certain information about the underlying investments. This is the
same regulation that applies to all securities Investments, such as mutual funds.

     Agents who sell Variable Annuities must be licensed as securities sales people and regis-
tered as brokers with the National Association of Securities Dealers (NASD).


                  THE VALUE OF THE FUND: ACCUMULATION UNITS

     Funds invested in a Variable Annuity separate account are referred to as Accumulation
Units. Rather than buying a certain number of stocks or having a specific dollar value, the buy-
er purchases "units" based upon the dollars invested and the total value of the stocks on the day
of purchase.
     A formula is used to determine the value of one Accumulation Unit:

         Separate Account Value                           = Accumulation
        Total of All Accumulation Units .                   Unit Value


     As an example: The insurance company-managed separate account value is $5 million and
all of the investors own a total of one million Accumulation Units. Therefore, using the above
formula, dividing the $5 million account value by one million total Accumulation Units results
in a value of $5 per accumulation-unit

          $5,000,000       =         $5
           1,000,000

     Therefore, a Variable Annuity buyer who invests $1,000 when the value of each Accumula-
tion Unit is $5, can purchase 200 Accumulation Units: ($1,000 / $5 = 200)

     Because the $5,000,000 account value can change daily according to market conditions, the
value of this Variable Annuity could be higher or lower than $1,000 as early as the next day.
For example, if the market took a nosedive and dropped to $4,000,000, with everything else re-
maining equal, the Accumulation Unit value would now be $4. This investment value is now
$800 ($4 x 200 Accumulation Units) instead of $1,000.

    Conversely, if the market improves markedly to where the separate account value is
$6,000,000, and everything else remains equal, this investment value grows to $1,200. Obvi-
ously, this is a simplistic illustration of how the values fluctuate, as realistically, within a short


                                                     74
period of time the values would fluctuate much more modestly and the total Accumulation Units
would change as other Variable Annuity Units are purchased.

     Note that while the value of the investment changed, the number of Accumulation Units the
individual purchased (200), did not change. The investor will never have fewer Accumulation
Units than the number purchased, although the value of those units changes in response to mar-
ket fluctuations.

     Every time investors make additional annuity payments, they buy more Accumulation
Units based upon the value of one unit at that time. Using the same example, if investor would
then pay $1,000 to the insurance company, the value of the separate account has risen and so has
the total Accumulation Units owned by all investors.

               $8,000,000
                2,000,000          =              $4

               Annuity Premium                         $1,000        =     250 units
               Accumulation Unit Value

      At this point the investor purchases 250 additional Accumulation Units with the same dol-
lars that previously purchased 200 units, although at this purchase each unit is worth less. This
investor now owns 450 Accumulation Units and will always own at least that many units re-
gardless of their value.

     Because of the variability that characterizes these annuities, a similar mathematical compu-
tation occurs when the liquidation phase begins, as discussed later.


                            LOADING AND OTHER CHARGES

     Loading is an addition to the pure cost of insurance that reflects agent’s commissions, pre-
mium taxes, administrative costs associated with the acquisition of new business, and other con-
tingencies. The previous examples do not show the effect of loading (as part of the cost to the
consumer of a Variable Annuity) on the amount of money that actually goes to work for the in-
vestor, nor of other charges imposed by the insurer.

      The Variable Annuity has, in many cases, a death benefit which is payable to the heirs, and
is, at least, equal to the amount of money invested into the Variable Annuity. This insurance
guarantee will cost approximately 0.6% more in fees than a similar investment without this
guarantee. In addition, most charge annual account fees from $30 to $40, which also diminish
the investor’s total return. Loading and fees are not returned to the customer and do not con-
tribute to the investment value of the Variable Annuity.

    Immediate Variable Annuity fees vary by company, but one survey indicated that they ap-
proximate 1.8%. By comparison, some mutual funds will only charge 0.3 percent.




                                                  75
                            IMMEDIATE VARIABLE ANNUITIES

    While most Variable Annuities are deferred annuities, the Immediate Variable Annuity has
emerged as an interesting vehicle for some investors.

      When an immediate Variable Annuity is purchased, the customer pays a lump sum to an in-
surance company and immediately starts receiving monthly payment. The payments will rise as
fall, just as with a deferred Variable Annuity. And, comparing the immediate Variable Annuity
to immediate fixed annuities, some investors like the idea of receiving different amounts each
month, depending upon the performance of the stock market. It is generally believed that in-
vestments in the stock market will always beat inflation, therefore an immediate Variable An-
nuity will provide inflation protection that a fixed immediate annuity will not do.

     People who are approaching retirement and have a large sum of money, are the best cus-
tomers for this type of Variable Annuity which has have been around for several years, but only
within the past 2 years have they grown in popularity. The reason, some experts believe, for the
increased interest, is that older “baby-boomers” are willing to take on some risk, probably be-
cause the baby-boomer generation simply have not been saving enough, plus there is concern as
to whether the Social Security program will continue when they reach retirement age.

     However, most financial planners do not recommend an immediate Variable Annuity if the
customer is not of retirement age. It is much less expensive for younger persons to maximize
their 401(k) plans first. Actually, it may be cheaper for the person retiring with a substantial
401(k) to simply roll over the money into an IRA. It could also be rolled over to a mutual fund
for less expense; however, the security of the financial strength of the insurer is not present.

     While some investors are “queasy” about the Variable Annuity’s unfettered payouts –
which is appealing to some, as stated earlier – some immediate Variable Annuities guarantee
that monthly payments will never fall below a certain percentage (such as 80%) of the first
payment received. As an example, if the first payment of the immediate Variable Annuity was
$1,000, the annuitant would never receive less than $800. Please note, however, as mentioned
various times in this text, for this “safety feature” there is a price. There is always a trade-off as
where an annuity offers such a guarantee, as an example, an 80% guarantee would have a higher
fee, such as 1.4%, while without the guarantee, the fee would be closer to .55 per cent.

     Some insurance companies do not offer such “safety” features, because reinsurance com-
panies have declined to reinsure this business (reinsures provide financial assistance to insurers
by providing cash reserves) because they are afraid that they will have to pay large unanticipat-
ed sums if clients live beyond their life expectancy by 20 or 30 years.




                                                    76
               COMPANY-MANAGED VS. SELF-DIRECTED ACCOUNTS,

      One of the benefits of a Variable Annuity is management of the account by professionals
when the separate account is company-managed. With a company-managed account, profes-
sional investment managers employed by the insurer decide which particular securities are in-
cluded in the accounts made available to the investor. Again, this is similar to mutual fund in-
vestment management. As a result, the annuity owner is not required to monitor individual secu-
rities and decide whether to buy or sell.

      For investors who have the time, temperament and desire, a self-directed annuity account
might be appealing. Experienced investors can personally choose their investment portfolios
and decide how much of each premium will be allocated to the available investment funds. The
investor typically may make changes in investment strategies during both the accumulation and
liquidation phases. Although the annuity buyer bears the risk of any Variable Annuity,
self-directed annuities can be even riskier if the investor does not have the knowledge and abil-
ity to follow the stock market carefully and consistently.

     Interestingly, since the market took a dive, there is an increased interest in annuities and
one reason stressed frequently, according to many large annuity producers, is the desire of the
annuitants to have their funds managed by experienced professionals.

                              OPTIONS AVAILABLE AT DEATH

     The Death Benefit option was briefly considered in the discussion of loading and fees,
above. As a matter of practice (and of law in some jurisdictions) deferred annuities provide
some type of death benefit when the owner dies before liquidation begins. Variable Annuities
create a special situation because account values can fluctuate violently enough to erase any
death benefit provided by traditional means – as illustrated by the volatility of the stockmarket
in recent years. Therefore, insurers have developed innovative optional death benefit provisions
in order to guarantee minimum death benefits and take into consideration the potential increas-
es.

RATCHETED OR STEP-UP DEATH BENEFIT

     A ratcheted or step-up death benefit is an increase in the guaranteed "floor," which is the
account value, provided the value of the investments has increased. The increase could occur
every five years or at whatever interval the insurance company specifies. If death occurs, the
survivors would receive the greater of two amounts: (1) the accumulated cash value (typically
premiums paid plus separate account earnings) or (2) the increased value that last went into ef-
fect before the annuity buyer died. Under this option, the increase is tied directly to the perfor-
mance of the underlying investments in the separate account.




                                                   77
DEATH BENEFIT ADJUSTMENT

    The Death Benefit Adjustment is similar to the step-up death benefit. Under this arrange-
ment, at the end of the surrender charge period, the annuity owner may adjust the benefit to
match what will be, (it is hoped) the increased value of the account. Again, any increase in
death benefits is tied to the separate account performance.

ANNUALLY INCREASING DEATH BENEFIT

      A third death benefit option is more concrete than the ones previously discussed. The an-
nually Increasing Death Benefit specifies a percentage by which the death benefit increases each
year (e.g. by 5% of the years premiums), with an overall cap of 200%. This is tied only to the
amount of premiums paid, not to the performance of the Variable Annuity separate account. At
death, the survivors may choose to receive the account value if it is greater than the death bene-
fit provided by this option.

     Insurers who offer any of these options typically make them part of the standard Variable
Annuity with no additional premium required. Where appropriate, additional costs to the insur-
er are built into the premium, but for the most part, the annuity buyer is expected to live to the
liquidation phase, so annuity death benefit costs are not usually a big risk for the insurance
company.


                             FIXED AND VARIABLE PAYOUTS

FIXED PAYMENTS

    When the liquidation phase begins the insurer starts paying income to the annuitant on a
regular basis. The total cash value accumulated for the amount of the lump sum with a single
premium payment is annuitized by the insurer using established procedures that consider:

        The annuitant's age-and hence, life expectancy.
        Frequency of each income payment.
        Interest or account earnings that will continue to be paid on the diminishing annuity
         principal amount during the liquidation period.
        Guarantees the insurer has made (or not made) about the length of time income
         payments will continue. In some annuities, provisions are made to make payments
         to the survivors after the annuitant dies. Obviously, guarantees such as this require
         each income payment to be smaller to make certain the accumulated funds last long
         enough.

    The age consideration involves the annuitant's age when the liquidation phase begins. For
example, an annuitant that wants to begin receiving lifetime income at age 55 will receive
smaller payments than one who waits until age 65. In the former case, the insurer makes a
commitment to pay lifetime income for what is assumed will be a longer period.



                                                  78
     As discussed earlier, since some states use “Unisex” ratings, premiums would be the same
for male and female. From all of the factors considered (as discussed earlier), the insurer arrives
at a certain "fixed" dollar amount of income the annuitant will receive every time an annuity
payment is made.

VARIABLE PAYMENTS

      In their original concept of Variable Annuities, one of the "variable” parts of Variable An-
nuities was the amount of each income payment. However, many annuitants were unhappy with
the uncertainty of each payment amount, so insurers now permit payments from Variable Annui-
ties to be determined in the same way as fixed annuity payments - each payment remains con-
stant during the liquidation phase. The amount is based upon the value of the annuity when liq-
uidation begins. Therefore, at the liquidation phase, the only remaining "variable" in the Varia-
ble Annuity is the interest rate, or earnings, paid on the remaining principal. While most annui-
tants (about 90% currently) prefer this type of payout, insurers will make variable fluctuat-
ing-amount payouts if the annuitant desires.

VARIABLE ANNUITY UNITS

     Under the original variable payment method, Variable Annuities require a different means
to determine the payout. When the liquidation phase begins, the insurer uses the number of Ac-
cumulation Units to arrive at a number of Annuity Units. Annuity Units are an accounting
measure representing a fixed number of payout units rather than a fixed number of dollars. The
determination of the exact number of Annuity Units resulting from the annuity’s accumulation
value, is as follows:

    First, the insurer determines the dollar value of the accumulation account by multiplying
    the number of Accumulation Units times the value of each. (This is the same calculation
    used to determine value during the accumulation period.) If the value of each unit is, for
    example, $5 and the annuitant has 50,000 Accumulation Units, the value is $250,000.

    Then, using annuity tables that consider such things as age, sex (where permitted), the in-
    sured’s guarantees and any transaction charges or loading, the insurer then determines the
    dollar amount that will be paid per $1,000. For example, assume the payment will be made
    monthly and the tables indicate a payment of $10 for every $1, 000 of value. The annuitant
    in the example has $250,000 or "250 thousands" - $10 times 250 equals a monthly payment
    of $2,500, which is the amount the annuitant will receive for the first payment. Once the
    number of Annuity Units has been determined, that number remains the same during the
    entire payout phase. However, the value of each annuity unit varies according to the per-
    formance of the investments in the separate account. This means the amount of each pay-
    ment can vary. Sounds complicated? Keep reading…

    In the previous example, the value of each annuity unit was $5. Dividing the $2,500 pay-
ment by $5 results in the number of Annuity Units - 500 in this case. From this point forward,




                                                  79
the monthly payment is equal to 500 Annuity Units times the value per unit at the time the pay-
ment is made.

      Using the same example, if, during the next month, the value per unit has dropped from $5
to $4, then the monthly will be ($4 times 500) Annuity Units or $2,000. Later during the annui-
tant's lifetime if the value rises to $7, it would result in a monthly payment of $3,500. Through-
out the “liquidation period” fluctuations continue as the separate account investments fluctuate.

RISK

     Fixed annuities have been perceived as essentially risk-free in terms of safety of the princi-
pal amount invested. The primary risk associated with fixed annuities was inflation risk - the
possible loss of purchasing power resulting from high inflation. Variable Annuities, on the other
hand, greatly increase the investment risk to the annuity owner with the hope of offsetting the
inflation risk. Need it be said again?? “The higher the risk, the greater the reward.”

     Insurance company annuities have on occasion, been compared negatively to bank savings
instruments in regard to safety of principal since bank deposits are protected by deposit insur-
ance and annuities are not. However, careful selection of the insurance company that provides
the annuity virtually eliminates the question of financial soundness.

     In addition, many states have guaranty funds or associations that basically serve the same
purpose as bank deposit insurance. If an insurer becomes insolvent, guaranty funds provide the
means to continue servicing the insolvent company's policyowners, including annuity owners.
Funding comes from assessments all insurers in the state are required to pay. In some cases,
guaranty laws apply only to insurers domiciled in the state, while others cover any insurer doing
business in the state. Still, to be fair, the FDIC that guarantees up to $100,000 per person for
investments in bank CD’s, is funded by the Federal Government that applies anywhere in the
U.S.

     As for risks involving future income, only an annuity can guarantee a lifetime income
stream to the buyer. For example, money deposited in a savings account and withdrawn period-
ically during retirement can run out eventually. But the annuity buyer can be guaranteed life-
time income - even if the annuitant is still alive when the original principal and interest amounts
are depleted.


                  EARNINGS, GUARANTEED OR NOT GUARANTEED

     While both fixed and Variable Annuities are capable of earning a competitive rate of return,
Variable Annuities, in particular, provide greater opportunity to earn a higher rate of return on
investments in the separate account - but, of course, earnings may fluctuate during the life of the
annuity. Interest rate guarantees vary widely among insurers, providing a broad range of op-
tions. Careful shoppers will also look at the investment management track records of compa-
nies offering Variable Annuities. While past performance is no guarantee of effective future ac-




                                                  80
count management, investors can identify companies whose annuity returns have increased over
time.

    And, as frequently stated, not only have annuity interest rates become competitive with oth-
er investment products, but annuities also enjoy deferral of income taxation on earnings. Re-
turns on bank products and securities are taxed as current income in the year they are paid to the
investor. Even Variable Annuities, with their reliance upon securities to determine income, are
eligible for tax-deferred interest.

    A particular advantage that a non-qualified Variable Annuity has over mutual funds in this
present market environment is the fact that there are no capital gain taxes within the Variable
Annuity accounts. The ability to transfer funds between subaccounts with taxation is a huge
benefit because many mutual fund investors have become very frustrated by the capital gains
tax bills that they receive at the end of the year when they watched their mutual funds only de-
cline in value! Mutual fund representatives have had to do a lot of explaining. True, variable
subaccounts have decreased also during this period of time, but the annuitant was able to avoid
intermediate taxation and still have the ability to adjust within the subaccounts.

     Because Variable Annuities offer a fixed account among the investment choices is a distinct
advantage over mutual funds. This fixed and guaranteed fund provides comfort to many inves-
tors during this time of market fluctuations. Even those who normally invest in the variable
stock and bond funds and are long-term investors, since they can ride out the volatility of the
market in a fixed environment, and to do so all within one product, are more-and-more being
attracted to Variable Annuities.

LIQUIDITY

     Since annuities are intended to be long-term investments, penalties are assessed under cer-
tain circumstances if the owner withdraws all or part of the annuity's value. These charges can
be substantial in some situations.

    Typically, the annuity owner can withdraw 10% during the first year, with an additional
10% increase each year until the final year of the annuity term. As an example, with a 7-year
annuity period, the first year 10% could be withdrawn without penalty, the second year it would
be 20%, 30% the third year, etc., until the end of the accumulation (annuity) period.

     Some of the plans offer surrender-free withdrawals for terminal illness, for confinement in
nursing homes, and other similar situations.


                          TAXATION OF VARIABLE ANNUITIES

     Variable Annuities are generally a tax-favored investment product when purchased by an
individual on a non-qualified basis. When purchased as part of a qualified retirement plan, such
as an IRA, 401(k),TSA-403(b), or Deferred Compensation Plan – 457, they are taxed under the
special tax provisions governing that qualified retirement plan.



                                                  81
    The Taxpayer Relief Act of 1997 brought two key changes that can affect Variable Annuities
as to their marketability.

   1. Long-term capital gains rates were pared to a maximum of 20%. Those who own in-
      vestments outside of tax-deferred accounts and meet the 18-month holding-period re-
      quirement, face a much lower tax burden on any gain realized. On the other hand, in-
      vestment income from a Variable Annuity is taxed at the ordinary income rate, which in
      many cases is higher than the top capital-gains rate.

   2. The Roth IRA was created. It works much like a tax-favored retirement account that
      mimics a Variable Annuity. The customer puts money into the account and investment
      earnings are not taxed unless the money is withdrawn too early. The funds can be shifted
      between investment vehicles without tax consequences as long as the funds stay in the
      IRA.

      In a Roth IRA, as long as the money stays in the IRA for at least 5 years, and it is not
      withdrawn before retirement; the funds are withdrawn tax-free. If, conversely, the money
      was put into a Variable Annuity, the annuitant would pay tax at the ordinary income tax
      rate at retirement. (Also there are restrictions for Roth IRA – single income must be be-
      low $95,000, or $150,000 married filing jointly.) Since there are no restrictions as to in-
      come for a Variable Annuity, if a person made too much money to contribute to a Roth
      IRA and trades too actively to enjoy the long-term capital gains rate, a Variable Annuity
      would be the way to go.


                              USING A VARIABLE ANNUITY?

     The Variable Annuity has proven that it is a formidable financial planning tool and with its
“sister” annuity, the Equity Index Annuity (discussed later) has grown significantly in usage for
estate and financial planning purposes. Some of those applications are:

        Since some state laws Variable Annuities allow protection from certain creditors,
         those who are contemplating entering a nursing home are interested.

        Those who are concerned about unexpected events, since some products offer sur-
         render-free withdrawals for terminal illness, nursing home confinement, and other
         similar situations.

        Individuals who wish to reinvest dividends and capital gains are interested as any
         growth in account value avoids current taxation and 1099’s.

        For those who transfer their funds between investment options, funds within the
         Variable Annuity can be transferred tax-free and helps to avoid sales charges.




                                                  82
        Those investors who are knowledgeable about investments and who are concerned
         that “what goes up, must come down,” especially the deterioration of assets passed
         to a beneficiary in a down market, appreciate the stepped-up death benefits that
         provide a stop-loss for beneficiary protection.

        Variable Annuities (and especially, Equity Index Annuities) often offer guarantees
         through a fixed account, which allows annuitants to change their financial objec-
         tives because of unease of the financial markets.

        If a person wants to establish a charitable remainder trust, the Variable Annuity al-
         lows trust-donor “income control.”

        Those who are concerned about estate planning may use Variable Annuities as they
         may avoid probate as well as its costs and the loss of privacy.


     CONSUMER APPLICATION
     Loren is 42 years old and has just inherited $25,000, which he wants to invest for the fu-
ture, so he purchases a Variable Annuity. The annuity returns 7% after subtracting a manage-
ment fee and other expenses, which include a mortality fee that guarantees that when Loren
dies, the Variable Annuity will not be less than $25,000.
     20 years later, when Loren reaches age 62 and is concerned about retirement funds; the
$25,000 has now grown to $97,000, an increase of $72,000. This amount ($72,000) is consid-
ered regular income and not as a capital gain. Depending upon the tax laws at that time, it is
possible that Loren’s taxes may be higher than if the money had been invested in a mutual fund
if capital gains taxes are lower than taxes on regular income. It would probably be best for Lor-
en to take a series of payments, instead of a lump-sum payment, which would spread the taxes
out over the payment period.
     If the stock market should collapse after Loren has had the Variable Annuity for about 3
years, unfortunately Loren would have to pay a sizeable penalty for early withdrawal should he
desire to do so. However, since a Variable Annuity should be purchased as a long-term invest-
ment, over the 20-year period, the market should probably also go up again.

     CONSUMER APPLICATION
     Chris and Bertha are in there 70’s and received $100,000 from the sale of the estate of Ber-
tha’s sister. They have been retired for several years and really do not need additional retire-
ment funds. They contact their agent, Lambert, who is an insurance agent and registered repre-
sentative. They told Lambert that they wanted as much of this money available as possible in
case of an emergency. Also, they wanted as much money available as possible to the survivor
when one of them died.
     Lambert recommended a Variable Annuity because of the tax-deferral features and because
of the growth of the stock market. Lambert had to search the market in order to find the “right”
Variable Annuity, i.e. an annuity that provided the best returns and still allowed an easy “way
out” in case of an emergency. He found a product with a 1.25% insurance and administrative
                                                                   (Continued next page)



                                                 83
     charge. The product had a death benefit, which was equal to the highest account value the
contract had ever reached. It also allowed for early withdrawal for certain situations, nursing
home confinements, terminal illness, divorce and disability. It also had a death benefit feature
that resets the contract value each anniversary, and then arrives at a guaranteed amount at age
81.
     He used an optional death benefit which pays 15% of the annual contract growth as an es-
tate benefit which means that the surviving spouse can have the money if they so desire, or it
can be kept in the contract if they do not need the money immediately.
     Under this option, the surviving spouse would incur no income taxes, and the taxes can be
deferred throughout his/her lifetime. This amount is added to the contract value and if not paid
out, it will continue to grow, in effect increasing the size of the estate. On an annuity of
$100,000, over 10 years this $15,000 would grow into nearly $30,000 (at continued growth of
7% which would be far surpassed if the stock market continues to grow at the rate it has over
the past 10 years) which could be used to help pay taxes if this money is needed, or it can be
passed to the heirs.


                                  ENHANCED ANNUITIES

     A recently innovation of annuities and in particular immediate annuities, is the “enhanced”
annuity, also known as a “substandard” annuity. The theory is that if a person’s health is such
that they would be declined or heavily rated for life insurance, then an annuity issued to such a
person would provide higher payouts - or require smaller deposits to achieve the same results.
In effect, since added mortality increases the cost for life insurance, therefore it follows that
added mortality should increase the payout for annuities.

     Should payouts to healthy annuitants be subsidized by the increased mortality (and reduced
longevity) of the insured? There is another element of “unfairness” – as assets increase with
age, so do issues of deteriorating health. An annuity is designed specifically to provide the
guaranteed income that the annuitant cannot outlive.

     Annuities have been used for structured settlements, and in many cases, the annuities are
underwritten using an age rate-up method of increasing payments. About 6 years ago, a health
questionnaire was introduced in the U.S., an approach used in England several years previously.
Smoking is the most important question as it is the largest single mortality factor. Some appli-
cations only have a the smoking question as the only question asked.

    In England, the companies use a lifestyle questionnaire and this has been adopted by some
U.S. companies. These other underwriting factors include marital status, geographic location,
occupation, socio-economic status, etc.

     What types of annuities are used? The limited experience indicates that the unbundling of
various types of annuities is important. Some companies are packaging these annuities with
long-term care or critical illness benefits, some of the newer Variable Annuities in this market
have an enhanced earnings benefit that provides additional payouts to cover taxes and other in-
cidental needs.


                                                  84
     Annuitization is infrequent – according to LIMRA, in 2000, 2.1% of fixed and .06 of Vari-
able Annuities were annuitized. Therefore, annuities are very much a growth product, and in-
novations such as the enhanced annuities, can be expected in the future, and should be wel-
comed.

WHAT IS HAPPENING TO ANNUITIES TODAY?

      Annuities pay an important part in financial planning, and have been an integral part of this
process for many years. Recently there has been a change in the use and marketability of annui-
ties, driven by the economy, the low interest rates, and the “bullish” stock market. Surveys have
been made by various publications and organizations in respect to what has happened to the an-
nuity market and the popularity of annuities in financial planning.

     If the economy were different, for instance if inflation was 2%, interest rates on “risk-free”
investments such as CD’s were around 8%, and the stock market would go down as much as
going up, then investment choices would be different. In recent years, this would probably in-
dicate an excellent market for fixed annuities. But today, this is not the case.

     One large brokerage firm that specializes in annuities in a Life Insurance Selling article
discussed their experience in the changing annuity market. Their experience parallels those of
other annuity brokerage firms and is worth discussing in this context.

     In 1992, the annuity brokerage business was nearly totally the traditional fixed deferred an-
nuities with one year guaranteed interest rates. In the second half of 1999, these types of annui-
ties had fallen to where they were only about 25% of their total brokerage annuity premium.

      The reason that the number of fixed annuities have decreased is because interest rates have
been going down since about 1982, and that downward interest rates continued from 1992 to
1998, with a sign of some increase in 1999 and early 2000, but dropping drastically since. As
interest rates moved down, bond prices moved up, and insurance companies were induced to
sell their bonds so as to realize the gains and to invest in other obligations as required by regula-
tory authorities.

     Renewal interest rates on one year guaranteed annuity rates were realigned to reflect new
lower bond interest rates. It was customary for annuities to renew at or near the present (cur-
rent) interest rates, which were consistently lower. Annuitants that had a 9% return on their an-
nuities, found themselves with 5% returns and were not happy. Some agents were quite unhap-
py also, as they had expected that the fixed deferred annuities would at least maintain their orig-
inal base rate renewal levels. Where customers expected that returns would not drop to these
levels, their agents found themselves losing business and losing “face” among their customers.

    One large brokerage firm has gone from nearly 100% fixed deferred annuities less than 10
years ago, to only 25% one-year guaranteed rate annuities, 30% long-term guaranteed annuities,
8% single-premium immediate annuities, and 37% equity index annuities.




                                                   85
     The long-term guarantee annuities feature interest rate guarantees that run from 5 to 10
years, usually with an option to surrender without penalty at the end of the interest-guarantee
period. This changes the design of the fixed annuity to where it is much more palatable now.
Since these 5 - 10 year rate guarantees are often higher than one-year base rate guarantees, this
product is increasing in market share.

     The single premium immediate annuities are becoming more popular, for whatever reason.
While there seems to be nothing totally specific about the attractiveness of this product, it is felt
that the general trend towards fully guaranteed annuities is increasing for a variety of reasons.
(This was discussed early in this text)

     The Equity Index Annuities has been explored in detail in this text, and the brokers are all
excited about this new product and predict a solid place in financial planning.




                          CHAPTER 6 – STUDY QUESTIONS


1.     The “Annuity Period” is
       A.      the time period, over which the insurance company agrees to pay income.
       B.      the time period, in which the annuitant deposits money into the annuity.
       C.      the time period that the insurance company guarantees a death benefit.

2.     In a Deferred Annuity, the period following the maturity date is called
       A.      the accumulation period.
       B.      the annuitization date.
       C.      the liquidation or distribution period.

3.     The type of an annuity, that provides for guaranteed payments that terminate upon the
       death of the annuitant is known as
       A.      Life Income with Period Certain.
       B.      Life Income with Refund.
       C.      Straight life.




4.     With a Variable Annuity


                                                   86
       A.     the value of the annuity is guaranteed.
       B.     the principle invested by the annuity owner is guaranteed, but not the rate of re-
              turn.
       C.     premiums are deposited in a separate account.

5.     The main advantage of a non-qualified Variable Annuity over a mutual fund is
       A.     the cash principal in the Variable Annuity is protected by FDIC and mutual funds
              are not.
       B.     the interest earned is tax deferred.
       C.     The interest earned in a Variable Annuity is always higher than in mutual funds.

6.     The major advantage of a Roth IRA over a standard IRA is?
       A.     The money deposited accumulate tax-free and the deposits are tax deductible.
       B.     The money in the Roth IRA can be taken out, at any time, without any penalty.
       C.     The money taken out, upon retirement, after 59 ½, is received tax-free.

7.     Susan buys an immediate Variable Annuity with 10 years certain. She receives $500 per
       month for 7 years and dies. Her beneficiary will receive
       A.     $30,000.
       B.     $18,000.
       C.     an undetermined amount.

8. A Joint and Survivor Annuity will be paid out to
       A.     two different people.
       B.     two people, both receiving the same amount.
       C.     the beneficiaries of the two people in monthly installments.

9. The value of an accumulation unit, in an Variable Annuity, can be determined by
       A.     multiplying the monthly premium by the number of months of payment.
       B.     adding the annual premium paid to the number of years paid.
       C.     dividing the separate account value by the total of all accumulation units.




10. What is the main purpose of an annuity?


                                                     87
A.   to provide tax-free income for the life of the annuitant.
B.   to provide financial protection against outliving assets.
C.   to provide a tax shelter during the growth period of a person’s income production
     years.


ANSWERS TO CHAPTER TEN REVIEW QUESTIONS
1A 2C 3C 4C 5B 6C 7C 8A 9C 10B




                                            88
                                        BACKGROUND

     The Equity Index Annuity (EIA) is not only a new product; it is a somewhat complicated
and unusual policy. It is an insurance product that determines the annuity payments by the use
of an index “geared” to the fluctuations of the stock market. It is still considered as “insurance”
and not as security, therefore an insurance-only agent can market the plan, and a securities li-
cense is not needed (although it is may be recommended as described later). This explanation
of the product is not only for informational purposes, but may help to keep the product out of
the regulation of the Securities and Exchange Commission because of misuse or misrepresenta-
tion by insurance agents.


            The Equity Index Annuity is NOT a security, and should never be directly
                               compared to a security (stock, bond, etc.)

     This product offers a unique planning opportunity for financial planners. However, there
are many provisions and elements of this new product and many new options and changes are
introduced with regularity.

     Terminology is important with this product, as because it is a new product; it has intro-
duced new words and new definitions of existing words into the vocabulary of the financial
community. As with many new products, it is extremely important that terminology be com-
pletely understood.


                                          WHAT IS IT?

     An Equity Index Annuity is, simply put a fixed deferred annuity. It is not only a new type
of annuity, it is not a security, it is not a Variable Annuity – it is a fixed deferred annuity with all
of the guarantees and features.


          The biggest difference between an EIA and a “regular” fixed deferred annuity”
is how interest is credited to the contract.

     Traditionally on a fixed annuity, the interest rate credited to the annuity is based on existing
and current interest rates which is guaranteed by the insurance company and is guaranteed pay-
able for the term of the annuity. Since most fixed annuities use a one-year period, they are re-
newed for another year, one year at a time. While it may have a guaranteed interest rate of, typ-
ically, 3 percent, it will use current rates each year, but never less than the guaranteed rate.




                                                     89
     With an EIA, the interest rate is based on a formula linked to an independent stock market
index – usually Standard & Poor’s Composite Stock Price Index (S&P 500). So, to summarize:
an Equity Index Annuity is a fixed deferred annuity that uses an external index that reflects the
fluctuations of the stock market to determine the interest earned.

    The EIA is not a security, indexed mutual fund, nor an investment in the stock market, nor
a Variable Annuity; it is also NOT a substitute for any of these investment vehicles. However:


  The conservation of the principal of the Equity Index Annuity is GUARANTEED!
    (Blaring of trumpets, rolling of drums, resounding applause of thousands of investors….)

     It is a fixed annuity. A fixed annuity protects the annuitant from the risk of losing their in-
vested money (principal) because of the vagaries of the stock market. This is the safety factor
that has made fixed annuities attractive throughout the years and which are then used for “safe”
investments that will not be accessed for a period of years. Remember also, as stressed
throughout this text, risk and return work in tandem – as the risk increases, the return increases.
Therefore, the security of a fixed annuity would indicate that the return would be provided at a
low rate of return.

     With an EIA, the investor is provided with an opportunity to share in increasing rates be-
cause of increasing values in the stock market, and still do so with a guarantee that the principal
will not be touched. It can be used to provide the annuitant with a steady stream of income, and
can be used to supplement other income like Social Security, pension plans and income from
savings.


                                  HISTORY OF THE EIA

     The EIA was introduced first in the late 1980’s but not marketed successfully. Neither the
product nor the company is still in existence. In 1994 two companies reintroduced the Equity
Index Annuity. In 1996, $1.4 billion in premium was sold, in 1997, it went to $3.5 billion, and
in 1998, it was $5 billion. Today, there are more than 80 different products from more than 40
companies.

    As this product is dissected in this text, the question will usually arise as to why there are
so many and varied forms of EIA’s. There are a variety of reasons that are the result of experi-
ence of the market, the marketing effort, the customer’s viewpoint, and the home office con-
cerns.

     There are a variety of means used by insurance companies to measure the movement of the
index used by the company, and each method is responsible for some form of variation. Since
the assets of the insurance company “guarantee” the returns, including the guarantee of the
“minimum,” the portfolio containing the reserves for these products must mirror or closely imi-



                                                   90
tate the index at any particular time. As experience in persistency, for instance, becomes more
valid, the length of time that the assets must be invested becomes more apparent.

      This is a new product and any new product is the result of the “best guess” of the marketing
staff, the investment and underwriting philosophy of the carrier, and the product creation by the
actuaries based on their assumptions. Rarely has any insurance product (or most any product)
been so perfect when first introduced that no changes were necessary later.

     Although rarely discussed publicly, there is continued concern by the insurance companies
as to whether the product will be considered as a “security” by the SEC, which would require
much additional administration, compensation methods, securities licensing of their sales people
and the general headaches connected with dual regulation – the State Department of Insurance,
and the Federal Government’s Securities and Exchange Commission.

     Probably the most significant changes come as a result of input from the marketing area. If
the product does not sell, all of the expertise and expense available is of no consequence. The
customer tells the agent/financial planner as to what they want and what they need, plus any
reason that they do NOT want to purchase the product.

     Then, of course, arguably as important as marketing input, is the actual fluctuation of the
market. As noted later in this text, the various types operate best when the market is performing
in a particular manner. When this product was first introduced the stock market and other in-
vestments were behaving much differently than they are today. As to what appealed to a certain
class of customer at that time is probably much different today.

      Competition plays an important role in developing types of EIA’s, as it does in the devel-
opment and revision of all products. Since two companies introduced the plan in its present
basic form, and that has expanded to around 40 companies now, it is self-evident that competi-
tion was involved. It should be pointed out that any time an insurance company introduces a
new product, it must go through a lengthy period of approval by various Departments of Insur-
ance, and during this period of time it cannot make any changes of any type. If it does make
even minor changes in most cases, it will have to resubmit the plan for approval all over again,
causing another delay. In the meantime, another company can create a “better” plan and submit
it to another Department.


                                    WHY INDEXING?

    Indexing is nearly as old as the stock market. The government uses the Consumer Price
Index (CPI) which is a method of measuring goods and services, which is used by the govern-
ment and industries to measure inflation.

    Some of the most brilliant of actions seem so elementary in retrospect that one must won-
der why no one else had thought of it before. In the mid 1970’s, a company that markets mutual
funds, decided to “index” the mutual fund by buying the same stocks as the Standard & Poor’s
500. Other mutual funds followed, as later did banks and financial institutions that offer finan-


                                                  91
cial products. While actually the Standard & Poor’s 500 Index is an “index,” it is also an indus-
try guideline that measures stock prices of 500 leaders in their particular industries. Therefore,
to “mirror” the index, invest in the same 500 companies.

    The Dow Jones Industrial Average is another “index” that tracks the activity of 30 “blue-
chip” companies. It is important to note that both Dow Jones and S&P 500 are “averaging” in-
dexes, e.g. they use the average stock value for their index. S&P’s 500 uses a “weighted” aver-
age which is believed to more accurately reflect the action of their stocks over a period of time.

     Indexing is popular because, for instance, an investor in a mutual fund that tracks the S&P
500 can feel secure knowing that the “best” stocks in the market comprise the portfolio of which
he is a part owner. While most mutual funds are “managed,” there are those that are not man-
aged because they so closely follow the S&P or DJ indexes. Many pension fund managers use
these indexed stocks as it automatically creates diversity in the market.

     One other factor, that is not of much importance at this time but could become more im-
portant in the future, is that historically the stock market has outperformed the inflation rate (as
well as most other types of investments). Therefore, an indexed product should provide a
“hedge” against inflation.


                                   THE TRUST FACTOR

     One of the problems with fixed annuities is that the insurance company makes the invest-
ments that will determine the annuity’s return. In effect, the insurer is telling its customer that
he/she should “trust me to make the best investments on your behalf.” Remember that deferred
annuities are annual products, and the interest rate used during any one period is the result of the
insurance company’s declaring what interest rate it will use. Also, if the customer does not like
the interest rate at the end of any year, there is a surrender charge that can be quite severe in the
early years of the annuity. Therefore, the annuitant cannot decide that they can make more
money just by following the S&P or Dow Jones, cash out their annuity and invest it otherwise –
without paying a large penalty.

     With an EIA, there is no “trust me” factor. The annuity is indexed and moves according to
the fluctuations of the market. Some EIA’s have some restrictions by making their plans subject
to changes in the participation rates or “caps” during the limited liquidity years.

     Indexed annuities are different from indexed mutual funds in one primary and substantial
reason. With a mutual fund, if the index should take a dive, the monetary risk is with the holder
of mutual fund shares. With an indexed annuity, however, the insurance company is the one
that is at risk, as the annuitant does not lose his/her principal. This is guaranteed by the as-
sets of the insurance company (and in most states, backed by guarantee funds also).




                                                   92
                                 MARKETING THE EIA

     In the early 1990’s, EIA’s were introduced to the securities market through national stock
brokerage firms, independent broker-dealer firms and regional brokerage firms. The national
stock brokerage firms have not been very successful in marketing the EIA’s, as they have tradi-
tionally marketed investments with a risk factor and they have not actively marketed products
with limited risk. The sale of EIA’s by these firms is increasing but not significantly. The inde-
pendent broker-dealers have embraced this product however, as they usually take more of a pro-
fessional financial planning approach with their customers and they recognized early how the
EIA could be an integral part of their client’s portfolio. They have produced a large portion of
EIA sales.

      This product was a natural to life insurance agents who are accustomed to selling fixed an-
nuities and life insurance that provides for safety of principal and interest rate guarantees. At
last they can offer an Equity Index Annuity that is an insurance product and they do not have to
go through the licensing routine of a securities dealer (although a recent survey indicated that
nearly 80% of those agents who have sold EIA’s, are registered representatives). They can now
actually offer their customers an opportunity to participate in greater growth in their annuities
without the risk of losing their principal. Agents, as can be expected, are the largest marketers
of the EIA product.

     Banks have been interested in the EIA and bank sales have grown consistently. Many feel
that banks will become a major marketing source as bank customers are perceived as conserva-
tive in their investments, and are not comfortable with risk products. With the guarantee of no
market risk, they should be perfect for bank annuity customers.


                         SEC REGULATION/NON-REGULATION

     Most of the EIA’s marketed today are not considered as security products and actually fit a
heretofore vacant area between fixed annuities (insurance products) and Variable Annuities (se-
curity product). The few EIA’s that are registered are structured differently than the annuity
type of EIA. The registered EIA must be sold with a prospectus and the agent must hold a
NASD Series 6 or 7 license. Some states may require that the agent also pass the Series 63 ex-
amination.

      Without going into detail as to the appropriate government regulations that determine what
is a security product as opposed to an insurance product, basically in order not to be classified
as a security, it must meet the following conditions:
      1. The product must be issued by an insurance company.
      2. The insurer must assume the investment risk. The contract’s value must not vary
         with investment experience, a minimum rate of interest is credited to the contract, and
         the current interest rate must be declared in advance and not modified more than once a
         year.


                                                  93
    3. It must not be marketed as a security or sold (primarily) as an investment. There
       are substantial marketing requirements, such as it must be accurately described, both the
       investment and the insurance contract, and the long-term retirement or income security
       features of the contract must be emphasized.

    It should be noted that under government regulations as summarized in (2) above, the EIA
does definitely qualify as an insurance product because it declares the interest rate in advance.

     It would be fair to ask why some insurance companies have registered their EIA versions.
Probably, their sales force is mostly registered representatives who are used to selling Variable
Annuities and other securities. Also, a registered product allows the salespeople to emphasize
the product’s investment aspects.

     It should be recognized that the S.E.C. could at any time decide that the product is a securi-
ty and the agents must be registered representatives. Even though the best legal minds in the
business maintain that such a decision would be contrary to the law, it could be costly and use-
less to appeal any such decision. Companies are still relying on the legal opinions of their at-
torneys and are treating the EIA as an insurance-only product.


                      PROVISIONS OF EQUITY INDEX ANNUITIES


                An Equity Index Annuity is a Retirement Savings product.
      The following discussion of provisions, features and uniqueness of the Equity Index Annui-
ty does not cover all of the variations that are available on the market today. This product, still
in its infancy, has already undergone changes and will undoubtedly undergo more in the future.
Certain features are basic to all of the plans, and will be discussed in some detail.

     The most significant and principal difference between the EIA and other annuity products
is simply that the interest credited to these accounts is based on a market index. The index used
in most EIA products is based on the Standard & Poor’s 500 because:

     The S&P 500 is widely quoted and understood.
     It measures the changes in the prices of 500 stocks, which represent at least 70% of the
      equity market in the U.S., therefore it is an excellent indicator of the overall stock mar-
      ket movements.
     The S&P 500 stocks are traded on the New York Stock Exchange, the American Stock
      Exchange and the National Association of Securities Dealers Automated Quotation Sys-
      tem. They represent different economic sectors, divided into various industry groups
      and are linked to excess of $600 billion in public and institutional funds.
     The S&P 500 is a “market-value” index, i.e. each company’s value is determined by
      multiplying the number of shares outstanding times the stock price. It is a “weighted”
      index, which means that each company’s “influence” on its performance is directly
      proportional to its market value.


                                                  94
                                  CALCULATION OF YIELD

     To calculate the yield that changes in the index’s value, the formula is like that used to de-
termine the changes in value of mutual funds, i.e. the value of the index at the end of the period
measured, less the value of the index at the beginning of the period – divided by the value of
the index at the beginning of the period.

     Example: If the value of the S&P is 1000 on Jan. 1 1999 and 1200 on Dec. 31, 1999, the
yield for 1999 would be 20%. (1200 less 1000 = 200) divided by 1000 = .20

    2d example: if the value of the S&P dropped by 50 points, then (950 less 1000) divided by
1000 equals a minus .05 or negative 5 percent.

    S&P 500 index is reported daily in the Wall Street Journal, USA Today and many other
newspapers. The index is reported by the following:
    HIGH: The highest average price the 500 reported during the day reported.
    LOW: The lowest average price the 500 reported during the day reported.
    CLOSE: The index value at the end of the trading day.
    NET CHANGE: The change in the index for that day.
    FROM DEC. 31: The change in the index from December 31 of the previous year.
    % CHANGE: The change in the index from Dec. 31 previous year reported in percentages.

    There are a few indexed annuities that use other indexes, in particular foreign stocks. By
doing so, the annuitant can participate in the returns of overseas securities.

     As discussed earlier in this text, the Dow Jones Industrial Average, the Dow Jones Trans-
portation Average, and the Dow Jones Utility Average are considered as the leading indicators
of the stock market movement. Therefore it should be no surprise to discover that some compa-
nies are using the Dow Jones Indexes for EIA’s instead of the S&P 500.

     Which is the best? The Dow Jones Industrial Average (DJIA) is weighted by price, as op-
posed to market value of the S&P 500. This means that within the DJIA, the high-priced stocks
carry more weight than those lower-priced stocks. Therefore, a 3 or 4 % change in the price of
a $100 share will have more of an impact on the DJIA than the same change in the S&P 500.

     Using the S&P 500 as an index, a change in the price of a stock is multiplied by the number
of outstanding stock. Therefore, a change of 3 – 4% in the price of a stock with a small market
value will have a much smaller impact than a comparable price of a stock with a large market
value.




                                                   95
     While other indexes may appear, the key point is that it is very necessary to keep the pro-
cess simple. Since the S&P 500 and the DJIA are both well known and well regarded, and
somewhat understood by the majority of potential customers, there is little chance that any other
indexes will have much of an effect.


            DETERMINING INTEREST RATES - METHODS OF INDEXING

      Most investors are familiar with indexed mutual funds, but that has little to do with index-
ing of Equity Index Annuities. With mutual funds the fund itself purchases stock that comprise
the index. With EIAs, there can be – and is – a variety of indexing methods. In today’s rapidly
changing financial environment, there can be methods that are beneficial if the market goes up,
or if it goes down, or if it stays the same, if it goes up and down over a short period of time, etc.

     Some of the new products have new methods of indexing, but traditionally (if you can have
a “tradition” for a 6-year old product) there are six variations and will be discussed in detail.
These are point-to-point, high water mark (look back), annual reset, low water mark, multi-year
reset and digital. The other features of the EIA, such as floors, caps, participation rates/margins,
and averaging, may work together with the methods of indexing.

POINT-TO-POINT

     The simplest indexing method is the point-to-point method. The beginning “point” is the
beginning date of the contract, i.e. the day that the premium deposit is made. The end “point” is
the last day of the contract’s initial term. The difference in the index value between the two
points is the amount of interest that will be credited to the annuity. For the mathematically
minded, the formula is simply: The “Beginning Point” is subtracted from the “End Point,” and
the result is divided by the Beginning Point.

     Example: For simplicity purposes, assume a 5 year EIA with 100% participation and the
S&P 500 index is at 1000. Initial premium deposit is $10,000. At the end of the initial term, the
index stood at 1500. Therefore, subtracting 1000 from 1500 is 500. 500 divided by 1000 is .50
or 59%. The full 50% would be credited (100% participation) and the credited interest would
be $5,000 (50% of $10,000)

     If the market “went south,” the minimum rate would still be 3%. This is discussed later in
this section. This would be true of any of the methods of indexing used.

      Some have expressed concern that if the market should “soar to exhilarating heights” dur-
ing the term of the annuity, but then falls off just before the end of the annuity, the annuitant
doesn’t receive the benefits of the increases since only the beginning and ending points are
used. The movement of the market during the annuity term does have an effect, though, as the
last (end) point would almost certainly be higher if the trend during the annuity period was con-
tinual gains.




                                                    96
     The Point-to-Point method of indexing is good in bullish markets, but is very dependent
upon a single end point. A little bad timing at the end could wipe out the result of several up-
ward years. Another criticisms leveled against this method is that at the end of the second year,
or even later years, an annuitant has no way of knowing how much her annuity value will in-
crease. This has been referred to as the lack of “instant gratification.” This is similar to the ad-
vice of financial “experts” in the stock market, whereby they tell investors, “Don’t look at your
stock returns every single day.” Much easier said than done. It is human nature to want to
know your financial standing at any particular time, or at least be able to approximate it.

     Vesting, as discussed later, and an averaging technique, serves to alleviate these problems.
For instance, vesting means that at the end of each year, a certain percentage of the account val-
ue will be “vested” and credited to the account, subject to participation rates and surrender
charges.


           Point-to-Point products work best in an upward or bullish market.
HIGH WATER MARK METHOD

     The “high-water mark” method is a popular indexing methods, and is used heavily by one
of the companies who “started” the modern Equity Index Annuity. Many agents consider this
method as the method that they would like in their “ideal” EIA.

    As in the point-to-point system, this method uses two points in time: the beginning point is
when the premium is deposited into the annuity. The other point is not an “end” point, but is a
point during the annuity period when the index value was the highest. The mechanics are the
same as the point-to-point method, except that the “high” points substitutes for the “end” point.

     This method satisfies the “instant gratification” problem as the contract holder knows that
the value has been locked in when they reach that point. Therefore, even if the market index
declines, it will not have the same negative effect that the point-to-point method has. It should
be noted, however, that most plans using the high-water mark method, use the contract-year-end
results, so even if the index has climbed to record highs during the year, and then dropped
somewhat at the end of the contract year, the interest will be credited according to the year end
index.

     It will be noted in this discussion, that on occasion, certain provisions of an EIA will be
more conservative in order to allow more liberal provisions elsewhere in the contract. This is
one of those situations. A product using the High Water Mark method normally has a lower par-
ticipation rate. The reason is that the cost to the insurer in investing to compensate for this fea-
ture is much higher than in other products.


The High-Water Mark method performs best in a market that peaks early during the
            contract period, and then declines for the rest of the contract period.



                                                   97
ANNUAL RESET METHOD

     This is also a method that appears on agent’s “wish lists” as it can be very powerful if the
market is right. Simply put, instead of the index covering the annuity period as a single entity, it
allows the experience of each year to stand on its own. If it were a 7-year annuity, there would
be a new calculation at the end of each year. In effect, it measures the changes in the index with
a series of beginning & ending points. Most new plans now (2001) use this method.

     Mathematically, the formula is the same as the point-to-point, but it is performed at the end
of each year. If the “end point” minus the “beginning point” is negative at any year, then the
index is zero for that year.

     This type of method suits the Equity Index Annuity perfectly in a lot of ways. If the market
goes up, the annuitant participates through the index method. However, if the market drops, the
annuity will show a zero interest contribution for that year. (This is where the “floor” comes in,
which is usually “zero” in most contracts). However, and it is a big “however,” the next year
the annuitant can start over. Historically, the stock market usually performs the best after it has
reached a substantial low. Talk about timing!! The annuitant participates in the “good” years
and “just goes along for the ride” during the “bad” years.

     As good as this product is, there are still a couple of drawbacks. Nothing is perfect. One
factor is that it is confusing to the ordinary investor, inasmuch as the contract extends over sev-
eral years but the method operates on an annual basis.

     The annual reset design is expensive for the insurer. Since the formulas differ each year,
not only the investment costs are high, but also so are the administrative costs. Therefore
(trade-off time again) this method usually has the lowest participation rates of any EIA plans.

     Perhaps the greatest handicap of the annual reset method is that the interest credited to the
account each year is compounded. Certainly the compounding of interest into the product de-
sign would appeal to clients. However, since this method is very expensive for insurers, some
insurers do not include a compounding feature. Some companies do allow compounding but
include a “cap” (described later) which limits the amount of interest credited in any inter-
crediting period.


Annual resent annuities work best in a market that is highly volatile over the contract
    term, and performs the worst if the market is steadily rising and has low volatility.

LOW WATER MARK METHOD

     Forget the “low” terminology as this method can produce good yields. Under this method
the “end point” is the last day of the contract term. The beginning point is the contract anniver-
sary date when the index reached its lowest value. The mathematical formula would be “Earn-
ing Point minus the Lowest Point, divided by the Lowest Point.”



                                                   98
    The thing that should be emphasized is that the lower the starting point, the higher the in-
dex will become. This method works well in many different environments, however:


  The Low-Water Mark method works best in a market that takes a deep dive in the
 early part of the contract term, then rise throughout the rest of the contract term. It will
  not do well if the market declines early and does not recover during the contract term


DIGITAL METHOD

     This is another method renowned for its simplicity. This method credits a particular rate of
return every year that that index is positive; and credits another particular rate of return every
year that the index is negative (usually zero). As an example, if the particular rate of return is
15% and zero (-0-) when the index is negative, either one or the other, hence the “on and off”
connotation. Generally the rate of return for years when the index is positive will continue
throughout the policy duration and will not change for the policy duration.

     The index is evaluated each year. In comparison to the annual reset method, if there is an
upswing in the index performance after a downswing, the annual reset method allows for a sub-
stantial increase in the interest credited to the contract for that year. However, if the contract
uses the digital method, then the “upswing” would be restricted to whatever the contract states.

     The “trade-off” for the digital method pertains to the interest compounding. Contracts us-
ing the digital method may allow for compounding or not, but those that allow for compounding
may have a lower rate of interest than those that do not allow compounding.


The Digital Method works best in a modestly rising market, and does not work well if
                 the market is alternating large upswings with downturns –
                           especially if the downturns are small.

MULTI-YEAR RESET

     The Multi-year Reset method operates much like the Annual Reset method, except that the
rate is based on the result of more-than-one year (takes a larger “bite”). For instance, if the con-
tract term were 10 years, the Multi-year Reset Method would be calculated every two years (or
more – in any event it is always less than the contract duration). At the end of each period, a
new beginning reset period is determined and another multi-year period will start.

    The formula is the typical Ending Period minus the Beginning Period value, divided by the
Beginning Period Value. However for the life of the contract, it would apply at the end of each
term. Using the 2-year example able, that would mean that it would be “reset” every two-year.

     If the index performance is positive during any multi-year period, the participation rate is
applied to determine interest earnings for the contract. Conversely, if the performance of the


                                                   99
index is negative during any multi-year period, no interest is credited to the contract, but also no
interest is lost.

    If the contract allows compounding of the interest, the results of each multi-year period are
multiplied together to determine the total amount of the end-of-term interest. If the contract al-
lows for simple interest, then the results of each multi-year period is added together.


Multi-year resent contracts works well in a rather modestly capricious market, partic-
ularly if the upsurges and the downswing parallel the contract’s reset points. It performs
                   worst in a market that is rising steadily and smoothly.

AVERAGING

     Some persons believe that “averaging” is a method of calculating indexed returns. Not
true. Averaging is incorporated into many indexing methods however. Averaging is used so
that the experience of a single day cannot be used as the starting point or ending point in index-
ing. In April 2000, the markets all took huge losses, including the S&P 500. What if a contract
just happened to have an end-date on the day of the crash!

     Averaging is accomplished by taking the closing index prices over a pre-determined num-
ber of days, adding them together and then multiplying by the number of days. It can be per-
formed the same way by using months or quarters, but usually it is days.

    An averaged point can be either the end point or the beginning point, but usually it is the
end point, and is usually averaged during the last year of a point-to-point contract.

     Averaging accomplishes what shock absorbers do to the ride of a car – it levels out the
bumps and holes. Years when the stock market rises during a year, and then declines toward the
end of the year, the averaging will produce excellent results. However, if the stock prices rise
steadily during the year, the return will be halved.

     For the mathematically inclined: if the contract has a 7-year term, and averaging is used
during the last year, the last year’s average would be: 1st Quarter+2d Quarter+3rd Quarter+4th
Quarter, the total divided by 4. Just like in the 4th grade.


             WHAT’S OUT THERE? SUMMARY OF PRESENT PRODUCTS

     While there is some disparity in recent surveys, the following percentages are nearly accu-
rate and can show the usage of various features.




                                                  100
TYPES OF PREMIUMS
      Single Premium                                          68%
      Flexible Premium                                        32%

METHODS OF INDEXING
     Annual Reset                                             50%
     Point-to-point                                           33%
     High Water Mark                                          16%
     Others                                                    1%

FEATURES AS GAUGED BY USE IN CURRENT PRODUCTS
     Participation Rate                                       65%
     Margin only                                               7%
     Margin and Participation Rate                             3%
     Cap with Participation Rate                              25%
     Participation &/or Margins that can change               33%
     Averaging                                                60%
     Vesting                                                  20%
     Specified Surrender Charges                              85%
     Surrender Charges not specified                          15%

INTEREST CALCULATION
      Compound                                                85%
      Simple                                                  10%
      Not applicable                                           5%

     If Free Withdrawal privileges are available, more than half use a percentage of the indexed
value; about 15% use a percentage of premium; around 15% have no privilege for withdrawal
and the remainder have some other sort of calculation.


                                 THE PURPOSE OF THE EIA

      Remembering that an EIA is a form of deferred annuity, it is used as a deferred annuity, i.e.
it is generally used for long-term investments and for long –term accumulation of funds, There-
fore, retirement is an example of what the annuity was designed to do. Funds accumulate on a
tax-deferred basis, which is probably one of the most used feature that is sold in recommending
annuities for financial planning.

    Further, an annuity has many options available when the annuity is “annuitized.” If the life
income option is chosen, the income cannot be outlived – guaranteed.

    The Equity Index Annuity has some further features that recommend it for financial plan-
ning. Because the EIA is an (attractive) alternate to other, much riskier, investments, it provides
an opportunity to “beat” the rate of inflation and to do so without market risk, while offering a



                                                  101
potential for higher market returns. As most investors know, or are made aware of, over a peri-
od of time, investments in equities out-performs the rate of inflation, and have done so better
than fixed-interest investments such as Treasury bills and Bonds.

      Until the EIA was introduced, if an investor wanted to offset the effects of inflation on their
personal retirement savings, there was no vehicle or easy way to do so. Some investors refused
to take the market risk at all, and invested only in guaranteed products. Even though there is no
guarantee as to how the market will perform in the future (or even in the next 15 minutes!), the
EIA offers the customer the potential to receive a rate of return that is higher than the rate of in-
flation. A survey of mutual fund investors showed that 27 percent of investors in mutual funds
were very cautious about taking any risk and would avoid any investments that might be con-
strued as “risky” in any sense.

     Some investors, super cautious, believe that they will be better off with their Certificates of
Deposits (CDs). Maybe, but probably not. The Federal Deposit Insurance Corp. (FDIC) in-
sures any bank CD balances of $100,000. Investors have actually experienced losses where
they had CDs for amounts exceeding $100,000. Conversely, losses on annuities have only had
one loss, and those annuitants did not lose their principal, only the expected return for one year.

      In addition, annuities almost always carry higher interest earning rates than CDs, and – this
is of utmost importance – because their earnings are tax deferred, they actually earn even more
because with good planning, their marginal tax rate will be less when they annuitize (so they
pay less taxes) then during the accumulation period.

    One note of caution when EIA’s are used for an IRA. The contract period must coincide
with or be earlier than, the date that the annuitant turns age 70 ½, or severe tax penalties will
occur. This pertains to any IRA, regardless of the type of funding.

     When discussing an EIA with a customer, as indicated earlier in this text but should be re-
peated again for emphasis, an EIA should never be directly compared to a registered security.
(In those instances where the EIA is a registered product, then this would not apply). Any at-
tempt to promote the EIA as a “superior” product can have negative implications. Presenting a
non-registered EIA as if it were a security is a violation of the Securities laws. However, as
good as this sounds and as accurate as the statement is, there will be times when a potential cus-
tomer who is familiar with mutual funds &/or other investments, will demand some sort of
comparison. Not to provide a comparison under these circumstances could make it appear that
the agent is “hiding something,” or he/she is simply not well versed in the product.

      How to handle, how to handle?? It is recommended by those with experience in this prod-
uct, and by companies who are very sensitive to the dividing line between insurance and securi-
ties, that:


                    Reinforce how the EIA DIFFERS from a security.


                                                   102
    To reiterate: A registered security product participates fully in both market gains and
market losses. The amount of the investment (principal) is not guaranteed and they can
be purchased for either short-term or long-term investing. EIAs, however, are purchased
by consumers primarily for the purpose of accumulating savings for their retirement


                                          DIVIDENDS

     The S&P 500 and nearly all other listed indexes are called “price” indexes, meaning that
they reflect only the price of the stocks in the indexes and do not reflect any dividends or rein-
vesting of dividends. Therefore, EIA’s that use the S&P 500 index will not reflect dividends. At
one time dividends accounted for 2 to 4 % of the stocks annual returns, but it dropped to a little
over 1% of the total return after about 1995. Therefore since dividend yields are lower than
they had been before, it would indicate that they will not have any long-term impact on the
market performance.

      It should be fully understood by the marketer and by the consumer, that buying an EIA that
is linked to the S&P 500 is not the same as purchasing stocks in the S&P 500. This does not
mean that the EIA is an “inferior product,” but is just one of the items that the purchaser of an
EIA gives up as a trade-off to eliminate the market risk.

     Since there is a separate S&P index that does reflect dividends, there are a handful of EIA
products that have been designed to include dividends. As will be emphasized in this text, there
are only 100 pennies in a dollar, so there will be a trade-off by the EIA having a lower participa-
tion rate as explained later.


                                    GUARANTEED RATE

     All EIA’s have a guaranteed minimum interest rate, usually 3%. Why so low? Insurance
products are subject to “non-forfeiture” laws, which specify the minimum interest rate that must
be attributed to a policyholder upon the “forfeiture” of the policy, usually annuitization or sur-
render. The non-forfeiture provision is a function of state regulations and there may be some
differences, however 3% is considered as the “standard.” Fixed annuities normally apply the
guaranteed minimum interest rate to the entire premium deposit each year. If the insurer de-
clares a higher interest rate, then that rate would apply, but in no circumstances would it be
more than 3%.

    At the end of the contract’s term, the contract holder will receive the greater of: (1) the
guaranteed minimum value of the contract, or (2) the indexed value.




                                                  103
                                  TIME LENGTH OF THE EIA

    The term that is used to define the time length of an EIA is the “Initial Accumulation
Term.” This can vary anywhere from one year to 15 years, but the usual period is 5 to 7 years.
The initial accumulation term has two functions.
    (1) the length of time that the indexed rate of return is applied to the contract, and
    (2) it the length of the surrender period during which surrender charges apply.

     At the end of the contract period, there is a “window” of (usually) 30 to 45 days for the an-
nuitant to determine if they want to annuitize (cash-out) the annuity, full or partial withdrawal of
the funds, or renew the contract for another term. If no choice is made, some companies will
automatically transfer the funds into a fixed annuity. Others may simply renew the contract for
another term.


               HOW MUCH IS SUBJECT TO INTEREST PARTICIPATION

     First, it should be pointed out that premiums for EIA’s are in most cases, single premiums,
with typical minimum payment of $5,000 or more. However, some companies are allowing ad-
ditional premium payments, usually in amounts of $50 to $500. This is important to know as
customers may question as to why, since they have made a large payment, they are initially only
going to receive credit for part of the amount. Secondly, participation rates may differ accord-
ing to the date that a payment is made.

     Another rather unique design of the EIA is the “Participation” rate. This is simply the per-
centage of the premium deposit and annuity value that will be applied (credited) to the contract.
“Participation” comes from the fact that it determines what percent the contract “participates” in
the contract’s indexed return.

     In order to determine the actual interest rate applied to the contract, the first step is to de-
termine the yield of the index used. Then the participation rate (percent) is multiplied by the
participation rate to determine the amount of interest to be credited.

     CONSUMER APPLICATION
     Archie purchased an Equity Index Annuity a year ago with a participation rate of 90%.
This particular annuity uses the S&P 500 index. The S&P 500 rose 10% during the first con-
tract year. Therefore the interest rate applied to the contract would be 9% (.10 x .09).

     Participation rates can range from 20% to over 100%. One company uses 100% of the av-
erage of the daily closing prices during the year. The participation rate depends upon the fea-
tures of the product, i.e. generally if the participation rate is low, the contract has more liberal
features in other areas. Of course it also depends upon the insurer’s internal indexes and cost
allocations.



                                                    104
     A higher participation rate does not necessarily mean that it will result in higher interest
crediting, as will be explained later. Also, most EIA contracts will use the same participation
rate throughout the contract term, but some contracts will change participation rates annually.

     The fact that the EIA collects its premium usually in a rather large lump sum, but the entire
amount immediately “reduces” in value (in most plans) can cause questions in the minds of the
customer (and the marketer, the first time they see this). One of the reasons is that most insur-
ance regulations allow an insurer to collect a 10% “load” on an annuity for administrative pur-
poses. While this is factual, it is of little interest to the consumer.

    There are two reasons that can be explained to the customer:

    (1st)      At the guaranteed rate of 3%, for instance, a $10,000 premium deposit will start
      exceeding $10,000 in value after about 3 ½ years. If the “math” is done, over $11,000
      will be credited to the account after 7 years.

    (2nd)      And most importantly, this product should not be sold to anyone that will have
      immediate liquidity needs, or needed on an on-going basis, or will need to surrender the
      contract prior to the contract term. It cannot be emphasized enough:


Equity Index Annuities are designed for long-term investing, and should not be sold to
                 those with immediate or continuing liquidity requirements

     An “alternative” to the participation rate is the “Margin” (also known as the ”spread”) used
on some contracts. The “margin” is subtracted from the indexed yield (instead of being multi-
plied as with the participation rate). For instance, the margin rate on a contract may be 5%. If
the indexed yield is 10%, then the interest rate credited to the EIA would be 5% (.10 - .05).

     The question as to, which is best for the client, frequently arises when discussing margins
and participation rates. Mathematically, different assumptions will produce different results be-
cause the two are not mathematically comparable. Basically, when indexed rates are low, then
the participation rates may produce better results, and conversely, when the indexed rates are
high, the margin may produce better results. There may be more technical answers but simply
put, “it just all depends,” as one is not comparing apples-to-apples.

    Margins may be used for any EIA product, but are most commonly used with annual reset
products.

                                              CAPS

     Some – not all – EIA’s have a “CAP” or limit on the amount of indexed interest that can be
applied to the contract during a certain period, regardless of how high the indexes may go. As
an example, a contract may have a cap of 12%. If the market-oriented index soars to 15% in
one year, the maximum that will be attributed that year, would be 12%.



                                                  105
     How is this explained? The actual and true reason for the cap is that it protects the insurer
against “wild fluctuations” or very substantial index increases. Therefore the insurer is able to
offer other attractive features, without which they would not be able to do so.

      One large broker who sells a substantial amount of EIA’s, and whose remarks have been
seconded by many other marketers, in a recent survey by Life Insurance Selling,” stated, in ef-
fect that his chief concern for both buyers and sellers of EIA’s, is the cap on returns. “Inferior
products” (his terminology) that cap returns have cost annuitants millions in lost gains. This is
particularly noticeable during 1998 for instance, when the indexed rates would have almost al-
ways created returns in excess of 20%. An annuitant at that time would have been losing 6%.

    Caps may be applied to any indexing method, but they are generally found on annual reset
contracts.

                                          THE FLOOR

     The floor is the minimum amount of indexed interest that will be credited to a contract in
any one year or over several years and applies only to those contracts that determine index in-
terest annually or multi-year. In most contracts, this amount is –0- (zero), which means that if
the index drops, there will be no interest credited. But this doesn’t mean that the customer’s
account value will lose, it will just remain the same as the previous year.

     Example: Participation percentage is 80%. The first year the indexed percentage is 10%,
therefore 8% is credited. Second year the index drops to 5%, 4% is credited. The next year the
bottom drops out and the index drops to a minus 15%. In that case –0- would be credited. The
fourth year however, if the index yield increases back up to 5%, 4% would be credited for that
year.

     The Floor should not be confused with the guaranteed minimum interest rate. The guaran-
teed minimum interest rate determines the worth of the contract that will be received by the con-
tract owner at the end of the contract term if the indexed amount accumulations are less than the
minimum interest rate. The floor is the worse scenario with respect to the amount of index
linked interest credited in any particular year or years.


                                VESTING AND SURRENDER

    There are two provisions that address early withdrawal of funds, either partially or totally.

     “Vesting” allows for partial withdrawals or surrenders and operates much like a pension
fund’s “vesting.” A specified percent each year of the account value at the end of each year is
available from the total contract’s value. For instance, many EIA’s that have this feature allow
for an increasing percentage of the cumulative interest credited. If the contract term is 5 years,
for example, the percentages may start at 20% the first year, and increase by 20% increments
until 100% of the amount is vested in the 5th year.




                                                  106
      The purpose of this feature is to protect the insurer from early contract surrenders. An in-
surance company invests in financial markets that closely approximate the EIA’s that it markets.
If a number of EIA’s terminate early, this means that the insurer will have to cash-in some of its
investments to meet the demand for cash because of contract surrenders. An early termination
of investments always is expensive as most financial products have some sort of protection
against early termination, or it could occur when the market was down, resulting in the sale of
investments at a substantial loss.

     Mathematically, the beginning year account value is increased by the interest that is credit-
ed to the contract. The vesting percentage is applied to that amount to determine the amount
vested.

      Surrender charges of EIA’s differ from surrender charges of other fixed annuities. Usually
if there is a vesting provision, there are no surrender charges. Otherwise, they have a schedule
that declines over the number of years the contract is held.

     Early surrender of an EIA can mean that the annuitant loses not only the surrender charge,
but can lose the interest credited to the account that year. For instance, if the policy anniversary
date is June 1, and the contract is surrendered May 1, the amount that is tendered may be based
on the previous year’s account value. If there had been a substantial increase in the index for
the 11 months prior to surrender, this could mean more of a loss than anticipated.


                                     ANNUITIZATION

     The principal purpose of an annuity is to guarantee an income stream after retirement to
supplement other retirement income, such as Social Security, pension plans and other invest-
ments. Through the accumulation of funds, the annuitization of an EIA operates just like any
other annuity. The insurance company assumes an interest rate that considers the annuitant’s
age, sex and anticipated longevity and whether single or joint annuity.

      Once the values are annuitized, the amount of the monthly (or other mode) payments will
remain the same. Some insurance companies are attempting to create a product that will index
the annuity payments and it is anticipated that both immediate and deferred annuities will offer
this feature.

     The comparison of risk of various planning and investment products can be illustrated by
the following:




                                                  107
                              Relationship of Return And Risk
                                                                                         (High)

                                                                                 Commodities
                                                                                       Options
    R                                                                   Limited Partnerships
                                                            Individual Stocks
    E                                                 Corporate Bonds
                                                Mutual Funds
    T                                      Money Market Funds
                                        Variable Life Insurance
    U                                   Variable Annuities
               Equity Index Annuities
                        Savings Bonds
    R               Savings Accounts
                  Life insurance
    N         Fixed Annuities-(fixed rate)
            Government Bonds
          Certificates of Deposits
         Checking Accounts
         (Low)
                                                 RISK
     The top of this illustration shows those investments normally considered to be “High Risk.”
The bottom shows those which are normally considered to be “Low to No Risk.” Following the
point made earlier in this text, this illustrates again that the higher the return, the higher the risk.
The top 3 (Commodities, Options and Limited Partnerships) are considered High Risk, the next
lower 6 investments are considered as Medium risks and the bottom 7 are considered as Low to
No Risk. An attempt is made to “rank” them in order as to the risk, but some may differ as to
the order. For instance, while a Certificate of Deposit is guaranteed by the FDIC for up to
$100,000, a CD for $250,000 would not be as “safe.” In respect to Government Bonds, this re-
fers to all “governments” that issue bonds, and on occasion a municipality has had to default on
its bonds. So whether a products guaranteed by a “government” is safer than that guaranteed by
an insurance company, may be argued any way.



                                                    108
     The idea of this illustration is to show that the EIA as an investment is a secure investment,
but even though it is first and foremost, a Fixed Annuity, with all the safety thereto, it can be
legitimately shown as higher in return and lower in risk than almost any other product. The EIA
“breaks the mold” in investment products, as shown in this illustration, and that, of course, is
the attractiveness of the product.

     The following Comparisons of EIA’s presents information on the principal EIA sold by six
of the top 21 companies marketing such products. The names of the companies are not shown
as these charts are for comparison purposes only.



                    COMPARISON OF EQUITY INDEX ANNUITIES
    .                                                 Co. A          Co. B
    No. EIAs offered                      4                          2
    SPDA or FPDA                          SPDA_12 Yr                 FPDA
    Free partial withdrawals:             Yes-after 1 yr             Yes after 1yr
    Index values for free part. withdrawal No                        Yes
                                                 st
    Surrender charges                     15% 1 5yr, then            17.5% decr. to
                                          decr. to 0 in 6 yrs        0 in 16 yrs
    Waivers Nur.Home, Nur.Care,Conf.      None                       Confinement waiver
                                                 st
    Min. Guaranteed. Cont. value.         75% 1 yr prem              75% of prem pd yr
                                          +87.5% of prem after
                                          1st yr-partial surrender
    Guarantee Base                        Accumulated @ 3%           75% of prem. pd
    Guaranteed Min. int. rate             3%                         3% yr 1, varies 2+ yr
    Index vehicle                         S&P500                     S&P500, Merrill Lynch
                                                                     US Master Bond Index
    Indexing method                       Ann.Reset, mo. Averaging   Annual ratchet (S&P)
                                                                     Pt. to Pt. (Bond Acct)
    Cap on annual earnings                Yes, 10% ann. Earnings     Yes, 20% average index
                                                                     Annual growth rate, 10%
                                                                     Guar. Renewal yrs
    Current participation rate            100% guaranteed, not       100% Guar. Adjust annual
                                          Adjustable
    12-mo. participation rate             100% over 12 mo.           100% over 12 months
    Potential gains                       recognized, lockedin       recognized, lockedin,
                                          & credited annually        & credited annually
    Margin or point spread                No                         Yes, 1.5% asset exp. Chg
                                                                     Year 1, 5% Mx. Guar. Renew.



                                                         109
                COMPARISON OF EQUITY INDEX ANNUITIES

.                                              Co. C               Co. D
No. EIAs offered                      5                            3
SPDA or FPDA                          SPDA – 8 yrs                 SPDA, 7 or 9 yrs
Free partial withdrawals:             Yes, after 1 yr              Yes,each yr,1 per yr
                                      Up to 10% of prem
Index values for free part. withdrawal No                          No
Surrender charges                     Level 9% for 8 yrs           10-0% in 10 yrs
                                      From pol.date.& ea renewal
Waivers Nur.Home, Nur.Care,Conf.      None                         Nurs.Hm.,Term Ill.
Min. Guaranteed. Cont. value.         90% gtd. Base                90% of prem @3%
Guarantee Base                        90%                          90% of prem
Guaranteed Min. int. rate             3%                           3%
Index vehicle                         S&P 500                      S&P 500
Indexing method                       Annual ratchet               Pt. to Pt. Averaging,
                                                                   w/final 52 weeks av.
Cap on annual earnings                No                           No
Current participation rate            100%                         80% on 9 yr,
                                                                   75% on 7 yr. Gtd.
12-mo. participation rate             95% yr 1, 100% after         80% to 100% (varies)
Potential gains                       recognized, lockedin,        accessed only at end of
                                      Credited annually            Indexed Option period
Margin or point spread                No                           No




                                                    110
                COMPARISON OF EQUITY INDEX ANNUITIES
.                                           Co. E                             Co. F

No. EIAs offered                            6                                 6
SPDA or FPDA                                FPDA 10 yrs              `        FPDA – 15 yrs
Free partial withdrawals:                   Yes, after 1 yr.                  Yes, after 1 yr, 10% of
                                            10% of acc. Value,                accumulation value.
                                            one per year                      one per year
Index values for free part. withdrawal      Yes                               Yes
Surrender charges                           10-0% over 10 yrs                 20% to 0% - 20 yrs.
Waivers Nur.Home, Nur.Care,Conf.            Death or Nur.Home        Surrender charges waived
                                            Rider                             after 30 days in
                                                                              Nursing home or hospital
Min. Guaranteed. Cont. value.               3% of 90% prem                    75% of 1st yr premium,
Guarantee Base                              90% of prem.                      87.5% of prem.yrs.2+
Guaranteed Min. int. rate                   3%                                3%
Index vehicle                               S&P 500                           S&P 500
Indexing method                             Annual ratchet                    Annual ratchet
Cap on annual earnings                      Yes, Cap is 11% now               No
Current participation rate                  75%w/no average                   100% 1st yr, adjusted
                                            Annually                          annually
12-mo. participation rate                   70% 5 mos, then 80%               90% 1st yr, then 100%
Potential gains                             recognized, locked in             recognized, locked in
                                            Credited annually                 Credited annually
                                                                              On anniversary date
Margin or point spread                      No                                No




The Maximum-Minimum age for plans from 21 major companies have minimum age of 0, maximum age of
70 to 90, with one company at age 88.
Minimum premium from these 21 plans is usually $2,000, some at $5,000, one company at $50 per month.
Maximum premium are either $500,000 or $1,000,000.
Surrender values are most often determined by accumulation value less surrender charges.




                                                  111
                         THE EIA IN A VOLATILE MARKET

     Various insurance industry publications, as well as released from insurance companies and
brokers that specialize in EIAs, have discussed the EIA from the marketing viewpoint. Many of
those that have written articles or contributed to surveys, etc., are professional financial planners
so their opinions are well worth reviewing. (For purposes of simplicity, the marketing person-
nel will be referred to as “agents” or “producers,” even though input is from companies and reg-
istered representatives).


                                         THE MARKET

     Over the past several years, the economy and the stock market have performed like roller-
coasters. At this time, (2002), the market is down and a total recovery appears to be quite some
distance in the future. Investment vehicles have performed well at times, and not-so-well at
other times, and it is fair to say that not all of them have worked well over the changing eco-
nomic climate. EIAs have performed as designed, by offering more choices and at the same
time, making guarantees and showing a potential for growth.

     EIAs and fixed and Variable Annuities, all are appropriate for those who are looking for tax
deferral, avoiding probate, privacy and a guaranteed income that the annuitant cannot outlive.
Particularly at this time, those who want the potential of larger gains than available under a
fixed annuity and also wants to avoid the downside of the possibility of losing the principal that
can occur with a Variable Annuity. Those that at the present time are the most interested in
EIAs are those who are familiar with the stock market and may also have mutual funds, stocks,
bonds or other types of equity products.

     Especially for those people in or near retirement who want to protect their principal and
hedge against inflation, the EIA is a good option. For those who have a longer period of time
available to recover from a market downturn and are willing to invest over a longer period, a
Variable Annuity may serve just as well.

     Because of the relative newness of the product, there have been a lot of changes since in-
troduction. There are more indexing options available, more riders, more flexibility, more dis-
tribution options, many more duration period.




                                                  112
     CONSUMER APPLICATION
     Bertha is a 77 year old widow whose income is derived from Social Security, a mutual
fund, and several CD’s in a local bank.
     The mutual fund had decreased in value by about 1/3 over the past two years and what was
then a value of $350,000, is now around $235,000. She has $200,000 in CD’s which are paying
2.5% interest at the present time. Bertha is very concerned about her principal in the mutual
fund and felt that the principal could not go lower without causing her considerable financial
difficulties.
     By moving her assets from the mutual fund and from the CD accounts, to an Equity Index
Annuity, she was able to increase her income substantially, she has the potential for higher gains
in the future and gives her a hedge against inflation. Her principal is guaranteed not to go lower
and also avoids probate at her death.

     Generally, the EIA has been recommended to those clients who want to improve their re-
turn on investments, compared with a CD, for example. Some clients have done well with other
investments and now want to save their gains for retirement and still “participate” in the market
without the attending risk of other investments. Other potential customers are bondholders,
charities with money in other “safe” investments and those with under-performing annuities, or
those with no surrender charges on their annuities.

     One successful producer of EIAs states, “The only situation in which I do not recommend
the EIA is when a customer is looking for a fixed income.” The usual purchaser is over 50 and
has over $100,000 to invest. One common characteristic of EIA prospects appears to be those
persons who have identified a part (or all) of their investment portfolio that they do not want to
expose to risk, but still wants an alternative to fixed interest investments.

      Another highly successful broker maintains that “almost everyone” is a potential EIA cus-
tomer. There is a new category of “super-wealthy” individuals who do not want to lose their
money, but still wants to participate in the Bull market when it reappears. These people believe
in long-term gain potential but still want to lock in past gains. Those prospects, who have iden-
tified “safe money” as part of their savings plan, are “naturals” for EIA’s.

     Perhaps because so many producers are also registered representatives, several profession-
als have stated that the EIA should not be presented to the prospect as an alternative to investing
in the market itself. They inform their prospects that the EIA is “different money” as it fills dif-
ferent needs, and is in a classification all of its own or risk-based products and solutions. The
consumer, who is uncomfortable with money invested directly in the stock market and
inVariable Annuities and mutual funds, may be an excellent prospect for EIA’s.

     In some fashion or other, most producers classify prospects into one of the following cate-
gories:

    1. Those with money or designated savings or insurance plans that they want to protect
       with products that are conservative and use guarantees for both the downside and the
       upside fluctuations.


                                                  113
     2. Those that have money gained from the stock market over the past 10 - 12 years, but
        are nervous about the long term and want to move some of their money into guaranteed
        products.

     3. Investors who don’t think that the present bull market will continue and want to move
        their 401(k) or 403(b) accounts into EIAs.

     4. Baby-boomers, who have 20 years or more to save for retirement, but want to diversify
        their plan with a guaranteed alternative. They may not have much faith in their being a
        Social Security “floor” for their retirement income.




                         CHAPTER 7 – STUDY QUESTIONS


1.     The difference between an Equity Indexed Deferred Annuity and a regular Fixed De-
       ferred Annuity is the
       A.      amount of commission that is paid.
       B.      regular annuity is an insurance product and the EIA is not.
       C.      method in which the interest is credited to the account.

2.     The most commonly used index to determine the interest rate credited in an Equity In-
       dexed Annuity is
       A.      Dow Jones industrial average.
       B.      Standard & Poor’s 500 index.
       C.      Adjustable Rate Mortgage (ARM) index.

3.     The main difference between an indexed annuity and an indexed mutual fund is the
       A.      indexed mutual fund is guaranteed to perform at the rate of the index and the an-
               nuity is not.
       B.      indexed annuity is guaranteed by the assets of the insurance company not to lose
               the original principal and the mutual fund is not.
       C.      indexed annuity is regulated by the Securities & Exchange Commission and the
               mutual fund is regulated by the state insurance department.




                                                 114
4.   The simplest method of indexing is know as
     A.     Averaging.
     B.     Multi-year reset.
     C.     Point-to-Point.

5.   The High Water Mark indexing method performs best when the
     A.     market peaks early during the beginning of the contract and declines during the
            rest of the contract.
     B.     market is highly volatile over the contract term.
     C.     market takes a deep dive in the early part of the contract term then rises during
            the balance of the contract.

6.   The main purpose of an EIA, considering it is a deferred annuity, is
     A.     for retirement.
     B.     short term stock market investment.
     C.     to provide funds for the payment of estate taxes.

7.   When an EIA is used as the funding for an IRA, what should be a note of caution?
     A.     Not to over fund.
     B.     The contract period must coincide with IRA rules concerning annuitization prior
            to age 50 ½ or after 70 1/2.
     C.     Not to under fund.

8.   The Equity Indexed Annuity
     A.     is issued by an insurance company.
     B.     is a security product.
     C.     is the same as a Fixed Deferred annuity.

9.   Comparing the performance of a CD which pays 3% interest to an indexed annuity that
     guarantees 3%, which product should show a better return in the long run?
     A.     the CD.
     B.     both would return the same.
     C.     the EIA.




                                              115
10.   A registered security product
      A.     participates fully in stock market gains and losses.
      B.     is sold by insurance agents.
      C.     guarantees a profit on the investment.


ANSWERS TO CHAPTER SEVEN REVIEW QUESTIONS
1C 2B 3B 4C 5A 6A 7B 8A 9C 10A




                                               116
    Annuities are used for individuals and corporations to provide group benefits. Regardless
of what the purpose of the annuity is to be, there are certain considerations that should be kept
in mind.

                    LONG TERM INVESTMENT STRATEGIES

     As a general rule, annuities should be considered part of a long-term investment strategy
rather than as a short-term liquid savings account. One of the primary benefits of annuities—
the tax-deferral on interest — applies only as long as the funds deposited in the annuity are not
withdrawn. When the tax consequences are discussed later in this text, it becomes apparent that
the Internal Revenue Service tax penalties can be quite severe. In addition, the insurance com-
pany imposes its own penalties in the form of surrender charges or interest rate adjustments
when annuity funds are withdrawn under certain circumstances.

     The exception to the long-term investment strategy is the use of a single premium immedi-
ate annuity, as discussed in a previous section, to begin providing income payments as soon as
possible. In this case, of course, the purpose is to pay an immediate stream of income, not to
build up funds for the future.

     For the most part, however, annuities are purchased with flexible premiums in order to de-
fer the income return until some future date and to reap the tax benefits in the meantime. Annui-
tants who adhere to the long-term strategy are thus “rewarded” and annuitants that do not are
penalized. At the same time, the flexibility and withdrawal privileges of newer annuities are
more sensitive to changing financial circumstances, so that annuity owners who encounter large,
unexpected immediate financial needs are able to access their annuity funds to some extent.

     Variable Annuities and Equity Index Annuities, especially, are best perceived as long-term
investments. Like the stock market, the securities that underlie a Variable Annuity have in the
past, generally performed well over the long term in spite of some significant downturns from
time to time.

      Historically, a mix of securities, such as those that are investments for Variable Annuities
and mutual funds has been profitable over an extended period of time. The key to using annui-
ties successfully and for the purpose to which they are designed, is avoiding the temptation to
withdraw from the investment during temporary downturns in the market.




                                                  117
                QUALIFIED AND NON-QUALIFIED ANNUITIES

    NOTE: The recently passed tax bill, Economic Growth and Tax Relief Reconciliation
Act of 2001, changed dramatically the taxation of life and health insurance, particular in
the areas of employee benefit plans, and in particular, the 401(k), pension and profit-
sharing plan. These limitations and provisions will be the presented in italicized style as
applicable to the subject under discussion.

     The Act provides that its provisions and amendments do not apply to taxable, plan, or limi-
tation years beginning after December 31, 2010, and that the Internal Revenue Code and
ERISA shall be applied to such years as if the Act had not been enacted.

      Annuities may be written as either qualified or nonqualified contracts. “Qualified” means
the annuity is established and maintained according to Internal Revenue Service rules that per-
mit a tax deduction for the premiums paid. This means no current income tax is required on the
portion of income used to pay premiums for a qualified annuity. Nonqualified annuity premi-
ums, on the other hand, are paid for with after-tax dollars, which means contributions is not tax
deductible.

      In the survey of the 21 EIAs discussed above, the Minimum/maximum age varied with
some companies as to whether the plan was qualified or non-qualified and in some cases, the
minimum and maximum premium. The maximum premium in those policies are usually equal
to the maximum allowable contribution to an IRA.

      The only qualified annuities available for most individuals are those used to fund Individ-
ual Retirement Accounts (IRAs). For corporations and other business entities, group annuities
designed to fund employee or other group retirement plans may also be qualified. In both indi-
vidual and group situations, the annuities must be designed for and operate under stringent IRS
qualification guidelines.

      While most insurance companies offer both qualified and nonqualified annuities, some do
not. Of the various types of annuities offered by a single insurer, some types may be written
only as qualified plans while others may be written only as nonqualified annuities. Some may
restrict their qualified annuity offerings to certain uses, such as for IRAs or for 403(b) organiza-
tions, discussed later.


                       INDIVIDUAL RETIREMENT ANNUITY (IRA)

    Individual Retirement Annuities (IRAs) which are established on an individual basis, allow
wage earners to make independent contributions to their own retirement plans. Either a fixed or
Variable Annuity may be used. An IRA is always a flexible premium deferred annuity. IRAs
provide a limited tax deduction for the individual’s contribution as well as interest accumulation



                                                  118
on a tax-deferred basis. Instruments other than annuities may be used to establish individual
retirement accounts, but this discussion is limited to annuities used for this purpose.

     Originally, the purpose of an IRA was to offer retirement savings incentives to people not
included in a corporate or employer-sponsored plan. This is still the primary use for an IRA,
but some people who are covered by employer plans may establish tax-deductible IRAs as well.

      A popular use for an individual annuity is as a rollover IRA to receive money from a com-
pany-sponsored pension or profit sharing plan. Individuals who leave an employer take with
them any such monies in which they are fully vested—which means they own 100% of their
share of the plan. To protect themselves from adverse tax consequences, they must have the
funds immediately reinvested in another tax-favored plan. A rollover IRA provides this protec-
tion.

     At one time, individuals could have possession of such funds for 60 days before rolling the
funds into another plan. However, by federal law, to avoid all penalties the corporate plan pro-
ceeds must be paid from the former employer’s plan directly into another instrument. If the in-
dividual chooses to have a check made payable to him or herself while deciding where to re-
invest the money, the employer is required by law to withhold 20% and send it to the IRS.

     Further information regarding the regulations regarding rollover into IRA’s, etc., are dis-
cussed elsewhere in this text. A point to remember specifically is that if the entire amount,
which includes the 20% that is “earmarked” for the government, is not rolled over within 60
days; there are dire tax consequences. A rollover IRA that is used properly keeps the funds in-
tact and retains the tax-deferral benefits on the pension funds.


    A “Roth IRA” will be discussed in detail elsewhere in this text. An annuity may be used to
fund a Roth IRA, the difference being as to when taxes must be paid on the investment income.

                        NONQUALIFIED INDIVIDUAL ANNUITIES

    Unless an individual annuity is used to fund an IRA, it is nonqualified. While premium
deposits to a nonqualified annuity are not tax deductible, interest earnings are tax deferred and
enjoy all of the other advantages as discussed in this text.

     In addition, nonqualified individual annuities are not subject to the strict contribution limi-
tations of an IRA. As a result, individuals may deposit much more cash into a nonqualified an-
nuity each year than they are permitted to deposit into an IRA. For many people, the flexibility,
the potential for depositing greater sums for retirement savings and the relatively fewer Internal
Revenue Code requirements and limitations on nonqualified annuities add up to a better choice
than an IRA.




                                                  119
                         ANNUITIES FOR SENIOR AGE GROUPS

    With the burgeoning senior population who control a large percentage of financial assets
and savings dollars, the insurers have developed annuities with their needs in mind, leading to
what has been called, “the senior industry.”

FEATURES AND OPTIONS

     Typically nonqualified, annuities geared to senior needs have many of the same features of
other flexible premium or single premium deferred annuities already discussed. The seniors
have free withdrawal privileges and a nursing home withdrawal or bailout feature, which is typ-
ically included automatically for this group of people. In addition, the senior age annuity owner
is generally permitted to annuitize at anytime, without paying surrender or withdrawal charges
and begin receiving income payments regularly, as discussed in the sections regarding variable
and equity-indexed annuities.

     Interest rates are as competitive on senior-directed annuities as on other annuities, although
rates may be graded downward at the upper age range. Current declared rates are guaranteed
for a limited time, after which a new renewal rate goes into effect.

    The death benefits have been outlined previously, and it is apparent that some of the death
benefit options are geared towards the older annuitants.


                     GROUP/BUSINESS-OWNED ANNUITIES

     Taxation drives the Retirement plans more than any other single factor. Taxation of the
various retirement plans will be discussed in another section of this text, but will be briefly and
broadly discussed here. The use of annuities specifically as a funding mechanism requires more
mention during this discussion of annuities.

KEOGH PLANS (HR 10)

      Those who are self-employed, whether as sole proprietors or as business partners, may es-
tablish retirement plans for themselves (under a law named for the congressman – Keogh - who
introduced it). They receive beneficial tax deferrals provided they qualify under the Internal
Revenue Code. However, there are some features that should be highlighted in discussing annu-
ities specifically.

    In addition to covering the self-employed person, Keogh plans must also cover some em-
ployees as stipulated in the law, while other employees, such as certain part-timers, may be ex-
cluded. The plan must have a funding formula that doesn’t discriminate unfairly among em-
ployees who are required to be covered, specifically not penalizing lower-paid employees while



                                                  120
providing an unfairly greater benefit for highly paid employees. Laws limit the amount that
may be contributed to a Keogh plan.

     Self-employed individuals who contribute to a Keogh plan may take a business tax deduc-
tion for contributions made for themselves and for employees. The contributions and interest
earned are not taxed as current income. These amounts are taxed when they are paid out as re-
tirement income or otherwise withdrawn. Employees may make their own personal contribu-
tions to the Keogh plan. While these voluntary contributions are not tax deductible to the em-
ployees, they do accumulate and earn interest on a tax-deferred basis, with tax payable on the
interest only when funds are withdrawn.

     Annuities may be used to fund Keogh plan benefits as either a defined benefit plan or a de-
fined contribution plan. (Also, see discussion under Qualified Pension Plan section)

DEFINED BENEFIT PLAN

     As the name implies, a defined benefit plan is one that specifies or defines the amount of
the benefit that will be paid at retirement. When the plan is established, a formula is included
for determining the benefit amount. Contributions to the plan are then made in order to provide
that predetermined benefit.

      Qualified Defined Benefit Plan Limits: The Act increases the dollar limit on annual bene-
fits from $140,000 to $160,000, subject to future indexing in $5,000 increments, in accordance
with current law. The limits for early and late retirement are also made more generous: the dol-
lar limit is reduced only if benefits start before age 62, while the limit is increased if benefits
start after age 65. Effective for years ending after December 31, 2001.

     Notice of Significant Reduction in Benefit Accruals: The Act amends the Internal Reve-
nue Code to require the administrator of a defined benefit pension plan or a money purchase
pension plan to give advance written notice of a plan amendment that provides for a significant
reduction in the rate of future benefit accrual. Unlike the requirement under current law, the
new notice requirement also applies to any elimination or reduction of an early retirement bene-
fit or retirement-type subsidy. The notice must include sufficient information to allow partici-
pants to understand the effect of the amendment and must be provided within a reasonable time
before the effective date of the amendment. A plan administrator that fails to comply with the
notice requirement is subject to an excise tax. The Act also amends ERISA § 204(h) to provide
that a plan amendment may not significantly reduce the rate of future benefit accrual in the
event of an egregious failure by the plan administrator to comply with a notice requirement that
is similar to the notice requirement in the Code. Effective for plan amendments taking effect on
or after the date of enactment; however, the period for providing any required notice will not
end before the last day of the 3-month period following the date of enactment. A good faith
standard of compliance applies before the issuance of Treasury regulations.




                                                 121
DEFINED CONTRIBUTION PLAN

     A defined contribution plan specifies a formula for the amount of the contribution that
will be made, rather than the amount of the benefit to be paid at retirement. The law stipulates a
maximum amount that may be contributed. While the future benefit amount is unknown, it can
be estimated at various points based upon the participant’s length of service, amounts actually
contributed, and the estimated and actual earnings on contributions.

     • Qualified Defined Contribution Plan Dollar Limit: The dollar limit on annual contribu-
tions is increased from $35,000 to $40,000, with more rapid future indexing (in $1,000 incre-
ments rather than the current $5,000 increments). Effective for years beginning after December
31, 2001.

    • Qualified Defined Contribution Plan Percentage Limit: The Act increases from 25% to
100% the percentage-of-compensation limit on annual contributions. Effective for years begin-
ning after December 31, 2001.

CORPORATE PENSION AND PROFIT SHARING PLANS

    Annuities may also be used to fund corporate pension and profit sharing plans. While
Keoghs are designed for self-employed persons, these plans are aimed at retirement for people
employed by corporations. Like Keogh plans, these corporate plans must meet strictly written
requirements to be considered “qualified” for special tax treatment.

     A corporate pension plan may be either a defined contribution or a defined benefit plan. By
law, pension plans must be established specifically to pay retirement benefits to employees.
Contributions are paid by the employer on behalf of employees, subject to very detailed nondis-
crimination requirements regarding lower-paid and highly-compensated employees.

     Pension plans must conform to a formula for determining the amount of contributions or
the amount of benefits.

     Corporate profit sharing plans, which are designed to share actual company profits with
employees, are more flexible in terms of how contributions are made. Some plans have a for-
mula to determine what portion of profits will be distributed to employee accounts, while others
do not. Even when no formula exists, non-discrimination controls must be in place to ensure
individual employee contributions will be made fairly.

    • Qualified Plan Compensation Limit: The limit on eligible compensation is increased
from $170,000 to $200,000, with future indexing in $5,000 increments (rather than the current
$10,000 increments). Effective for years beginning after December 31, 2001.




                                                 122
GROUP DEFERRED ANNUITY

     A group deferred annuity is one option available to corporations for funding defined benefit
or defined contribution plans. Each year, the employer uses the contribution to purchase a sin-
gle premium deferred annuity for each employee included in the plan. After many years, the
employee receives the benefits from all annuities purchased on his other behalf.

     Group deferred annuity plans have been popular because, first, they guarantee income
since they are provided by an insurance company with the same guarantees any other annuity
enjoys; and second, the insurer takes responsibility for all of the administrative details. As new
forms of funding have been developed, however, group deferred annuities have become less
popular with larger businesses, although many smaller businesses still find them attractive.

GROUP DEPOSIT ADMINISTRATION CONTRACT

     A more popular way to use annuities for retirement funding is through a group deposit ad-
ministration contract. Under this arrangement, funds deposited with the insurer are not allocat-
ed for individual annuities, but instead, provide a pool that the insurer invests as a whole. The
employer may choose investments providing a fixed rate, equity investments with variable rates,
or a combination. Typically, a group deposit administration plan allows the employer to move
funds between investment accounts from time to time to capitalize on changes in the market.

      Under this type of plan, no annuity exists for an individual employee until the employee re-
tires. The insurance company transfers funds from the pool of money to purchase a single pre-
mium immediate annuity for the employee, beginning retirement income payments at that time.

401(K) PLANS

     Corporations that have a qualified profit sharing plan in place may use annuities to offer
employees another type of qualified plan popularly called 401(k) plans in reference to a section
of the Internal Revenue Code. This will be discussed in detail elsewhere in this text. Again, the
usage of annuities for 401(k) plans have been briefly discussed in the chapter on annuities, but
some salient points regarding annuities are discussed here for emphasis.

     Under 401 (k), employee participation must be optional. Whether the income to be de-
ferred is actually a salary reduction or included additional compensation such as bonuses, the
individual must be able to choose whether to take the cash when earned and be taxed as usual,
or defer receiving the salary or bonus, and therefore defer taxation, until sometime in the future.

     One of the primary advantages of a 401(k) plan from the employer’s point of view is that
the contribution is essentially made with the employee’s money, rather than from an employer
contribution over and above regular salary or bonuses paid. At first glance, a 401(k) might ap-
pear less advantageous for the employee since that person’s current salary will be smaller or a
bonus will not be received currently. However, the employee not only has the benefit of tax de-




                                                  123
ferral on accumulations, but also avoids paying federal income taxes on salary and bonuses de-
ferred. Some state and local governments also defer income taxes for 401(k) funds.

     A 401(k) plan is subject to many of the same rules as other qualified plans, plus additional
rules unique to the 401(k). A fairly low maximum amount may be deferred into a 401(k) plan
annually. The specific amount is indexed for inflation, so it changes periodically. This upper
limit is the total deferral permitted for all CODAs (Cash or Deferred Arrangements) in which an
employee may be eligible to participate. Under certain circumstances, employees could be in-
volved in more than one deferral arrangement, and the total maximum is specified by law. As a
result, participants must be careful to coordinate how much is deferred into each plan or face
penalties for paying in more than the maximum.


     • §401(k) Dollar Limit: The limit on § 401(k) contributions is increased from $10,500 to
$11,000 in 2002. Beginning in 2003, the limit is increased in $1,000 annual increments until the
limit reaches $15,000 in 2006, with future indexing in $500 increments. Similar changes are
made to the limits on contributions to § 403(b) annuities, § 457(b) plans, and other elective
plans.

     Hardship Withdrawals: The Treasury is directed to revise its regulations to reduce from 12
to 6 months the period during which an employee's contributions must be suspended following a
hardship withdrawal. The regulations are to be effective after December 31, 2001. In addition,
no hardship distribution is an eligible rollover distribution (even if the distribution is not subject
to § 401 (k) restrictions), effective after December 31, 2001.


     • Catch-Up Contributions to Qualified Plans: An additional increase in the dollar limit on
§401(k) contributions and other pre-tax elective contributions allows individuals age 50 or old-
er to make catch-up contributions. For §401(k) plans, the increase in the dollar limit starts at
$1,000 in 2002 and increases by $1,000 for each subsequent year until it reaches $5,000 for
2006, with future indexing in $500 increments. Catch-up contributions are not subject to any
other contribution limits and are not subject to nondiscrimination testing. However, the plan
must allow all eligible participants to make the same catch-up contribution election; all plans of
related employers are treated as a single plan for this purpose.

    Multiple Use Test: The Act repeals the multiple use test, which applies to highly compen-
sated employees who participate in plans that allow both § 401(k) contributions and after-tax or
matching contributions. Effective for years beginning after December 31, 2001.

TAX SHELTERED ANNUITIES

    Tax Sheltered Annuities (TSAs) are available only to people employed by specifically
named tax-exempt entities such as religious, charitable and educational organizations. Other
names by which these special annuities are known include Tax Deferred Annuities (TDAs) and
403(b) or 501(c) (3) annuities, the latter two referring to applicable sections of the Internal Rev-



                                                   124
enue Code (IRC). Only the tax-exempt and nonprofit organizations listed in these sections of
the IRC are eligible to purchase TSAs for their employees.

     TSA rules require the employer to purchase the annuity on behalf of the individual employ-
ee. While the employer is responsible for paying the annuity premiums, it is the employee’s
money that is used. Up to 20% of compensation times the employee’s years of service may be
accumulated in the annuity. A total dollar maximum also applies and contribution amounts must
be considered in light of other cash or deferred arrangements as mentioned in the previous sec-
tion for 401(k) plans. In order to participate, employees must either take a salary reduction,
with the reduced amount going to the TSA or the employer must pay additional compensation,
earmarked specifically for the TSA. In both cases, this is income the employee never has be-
cause the employer pays it directly into the annuity.

     Like other qualified plans, the benefit to employees is the tax deferral for the amounts con-
tributed and for interest earnings, with the taxes then being paid at retirement when withdrawals
begin.

                       TAXATION OF ANNUITY PRODUCTS

     The taxation of annuities has remained functionally the same in recent years, with taxation
changes being more applicable to “methods” instead of “instruments.” For example, the rather
recent regulations regarding Individual Retirement Accounts (IRA) and the addition of the Roth
IRA affects the taxation of the method of accumulating funds, and not whether the underlying
mechanism to fund the IRA is taxed differently than previously. However, a note of caution:
while annuity products have retained tax advantages through numerous revisions in tax laws
and Internal Revenue Service and tax court rulings, both laws and interpretations are subject to
change. When the precise details of taxation are important to decisions regarding annuities,
professional counsel is imperative. The information in this textbook does not represent legal or
professional advice of any kind.

                               THE ACCUMULATION PHASE

    As indicated earlier in this text, certain tax benefits accrue during the accumulation phase.
Except where specifically noted otherwise, the tax rules presented here apply to both fixed and
Variable Annuities and equity index annuities.

TAX IMPLICATIONS ON PREMIUM PAYMENTS

      The premiums an individual pays for a nonqualified annuity are not tax deductible for fed-
eral income taxation purposes. For a qualified annuity for an Individual Retirement Account
(IRA), the premiums are deductible as discussed earlier. When the IRA owner is also covered
by an employer-sponsored retirement plan. The amount of the tax deduction permitted gradually
decreases until it reaches zero when the stipulated adjusted gross income maximums are
reached.




                                                 125
     Annuities may be used to fund any of the group retirement plans described earlier. When
these are qualified retirement plans, the premiums, or contribution as they are often called, are
tax deductible to the employer who makes them on behalf of employees. A Keogh plan can ap-
pear to provide an individual tax deduction when the plan benefits only a sole-proprietor that
has no employees. In this case, the effect is the same as an individual’s deduction.

CURRENT INCOME TAXATION

     Payments made to qualified annuities are either tax deductible or the amounts used for this
purpose are not declared as current income when paying income taxes. For example, an em-
ployer’s contributions to a group annuity are not reported as income when the contribution is
made. And, while the employer’s contribution to an employer-sponsored IRA must be reported
as income, it is “washed out” by the tax deduction the employee takes.

STATE PREMIUM TAXES

    Some states assess state premium taxes on annuity premiums. When this is the case, the
purchaser does not pay a separate tax. Instead, the insurance company deducts the correct
amount from each premium payment and pays the tax directly to the state. Where state premi-
um taxes apply, they generally equal about 2% or 2½% of the premium. Some insurers pay the
premium taxes themselves and do not deduct the taxes from the annuity premiums.

TAX DEFERRAL OF INTEREST ACCUMULATIONS

     During the accumulation period, annuity values build on a tax-deferred basis, with the in-
terest remaining untaxed until money is withdrawn from the annuity. This is true for both quali-
fied and nonqualified annuities.

TAXES ON WITHDRAWALS, LOANS AND SURRENDERS

     As stated earlier, interest paid on deferred annuities is not taxed until annuity funds are
withdrawn. Because this tax benefit is intended to encourage long-term savings for retirement,
the Internal Revenue Code requires immediate tax consequences for early withdrawals— de-
fined as withdrawals before the individual’s age 59½. These tax consequences include current
income taxation and an additional penalty tax.

DISTRIBUTIONS OF QUALIFIED PLANS

     Generally, speaking a distribution occurs when the employment is terminated, the employ-
ee retires, or the plan is terminated. However, there is a premature distribution tax of 10%,
which is applicable to many distributions from qualified retirement plans. This premature dis-
tribution tax is in addition to any income tax due on the distributions.

     As with most laws or regulations, there are exceptions. They have been divided into three
categories by many accountants and other tax practitioners.




                                                 126
    Generally, the first exception(s) treats the reason as to why the distribution was made. Ob-
vious exceptions are death or disability before age 59 ½. The least obvious exceptions are
        Distributions to cover certain medical expenses to the extent they are deductibles
           under the IRS Code.
        As the result of a court order in a divorce situation.
        An employee who resigns and then retires after attaining age 55.
        Refunds if there are excess contributions &/or elective salary deferrals under the ap-
           propriate 401(k) provisions.

          The second exception(s) allows distributions because of separation of service for any
     reason, as long as they are in the form of a “Qualifying Annuity.” Basically, a qualifying
     annuity is an annuity starting at any age and paid in (substantially) equal payments and not
     less frequently than annually, for the life of the participant and his/her beneficiary. The
     qualified plan may purchase commercial annuities to satisfy the requirements of this excep-
     tion. (Does this bring visions of “golden parachutes” funded by annuities?)

           The third is the “roll over” discussed briefly earlier. The key words for this exception
     is “timely” and “fully.” This exception can be lost if it takes more than 60 days for a partic-
     ipant to make up their mind, and if less than the entire plan distribution is rolled into the
     new IRA or other qualified retirement plan.

    There is no specific tax penalty for those who retire after age 59 ½, but there is a reduced
benefit in Social Security payments for retiring prior to age 65.

    Funds that are paid to a participant at normal retirement age escape taxation only on the
funds that they have contributed to the plan. The funds that the employee contributes have been
taxed earlier, so are not subject to tax again at retirement.

     Distributions can be made either in installments or annuitized.

INSTALLMENT PAYMENTS OF QUALIFIED PLAN DISTRIBUTIONS

     Distributions that are made in installments are taxed as ordinary income in the year they are
received.

     For annuitization, there are separate rules. First, as can be expected, if the person receiving
the distribution (the distributee) has not paid any money into the plan (i.e. has no cost basis),
then all payments are taxed as ordinary income.

     Secondly, if there is a cost basis (i.e. the distributee has paid for part of the retirement plan)
and if any distributions are made before the annuity starts, then part of the distribution will be
taxed as ordinary income, and part as a “return of cost basis.” In order to determine the cost
basis portion of the distribution, the following formula can be applied:

                Total amount of previously taxed employee contributions.
                Total present value of annuitant’s account balance or accrued benefit.



                                                    127
      Lastly, the Exclusion Ratio may be used only until the distributee has recovered the entire
cost basis. If the distributee/annuitant dies and has not recovered the entire cost basis, then the
amount that has not been recovered can be used as a deduction on the annuitant’s last income
tax return.

REQUIREMENTS FOR LUMP SUM DISTRIBUTIONS

     If a person chooses to take the distribution in a lump sum, they can do so and qualify for
the favorable tax treatment, but the employee must be at least age 59 ½, or dies, separated from
service (common-law employees), or become disabled (self-employeds). The distribution must
be 100% of the employee’s account balance/accrued benefit, and further, the entire distribution
must be made in one taxable year!

TAX RELIEF ACT 1986

     Mention should be made of the TRA ’86 related to those who reached age 50 by 1/1/86,
and who elected to receive lump sum distributions on contributions made prior to 1/1/1974.
Without going into all of the technicalities of this rule, this allowed for some of them to be taxed
on the capital gains basis. These rules do not apply to distributions from tax sheltered annuities.
If more detail is needed, one should contact a tax accountant.

     For those who attained age 50 after 1/1/86, the rules are more pertinent. They cannot have
portions of a lump sum distribution on pre 1974 contributions, taxed as capital gains as opposed
to ordinary income. They lose the right to any income averaging on lump sum distributions be-
fore they reach age 59 ½. In addition, under TRA ‘86 there was a 10 year averaging of a lump
sum distribution, that was reduced to 5 years, but effective 1/1/2000 even the 5-year averaging
will not be available.

     The TRA ’86 is discussed here as it is still applicable in certain situations. For example, if
an individual is retiring now and has contributed to his retirement plan, he has several choices in
respect to taxation of distributions. Some of these choices could (and probably are) be applica-
ble:

     On the ordinary income part of the distribution, he can elect either 5 or 10-year income av-
eraging.

      If he should use the 10 year averaging method allowed under TRA ’86, he would be taxed
as if he were single and at the rate effective in 1986 (not present rates). Further, if he uses this
method, this distribution and any other income will be separated for tax purposes.

    If any part of the distribution is attributed to contributions made prior to 1974, he may be
taxed at capital gains rates effective prior to 1974.




                                                   128
     He can make the choice of rolling the entire distribution into an IRA (see below) and post-
pone paying any taxes until he withdraws his funds. However, he would lose his right to do any
5 or 10 year averaging.

     As should be obvious, this is a highly technical area of taxation that has little to do with Fi-
nancial Planning, but if it should arise, it would call for the professional expertise of a qualified
tax accountant.

ROLLOVERS

    This subject has been approached previously, but deserves more detail and some repetition.

     Any income tax on an annuity or insurance contract that has been distributed from a quali-
fied plan can be postponed by converting the annuity or insurance contract to a “nontransfera-
ble” annuity within 60 days. Current taxation on the qualified distribution can be avoided if it
is rolled over into a regular IRA.

      Important: The funds must be rolled over directly into the IRA to avoid tax consequences.
If the funds are not rolled over directly into the IRA or if they receive the money and then roll it
over within 60 days, the taxable portion of this distribution is subject to withholding tax of 20%,
i.e. the IRS requires that 20% of the money be withheld in anticipation of income taxes being
due on that money. Oh yes, the “distributee” can recover that 20% at the end of the year when
the individual income tax is filed. But (and it’s a big “but”) the distributee must pay into the
new rollover account (IRA) the total amount. This means that the distributee would have to dig
deep into their own pockets to pay the 20% that the IRS is holding, and which the distributee
cannot recover until they have filed their next income tax.

     If the distributee just deposits 80% of the amount into the IRA, the 20% that is being held
in account for the distributee or the IRS will be taxed as ordinary income – even though the dis-
tributee only has 80% of the fund. In addition, there is a possibility that the distributee would
be subject to a 10% penalty tax. (Double whammy!)

    Once the funds have been deposited into the IRA, taxes will not have to be paid on the roll-
over until the IRA starts to distribute its assets. Any lump sum distribution will be taxed as or-
dinary income, and any annuity distributions will be taxed as previously discussed.

     A partial distribution to an employee of the funds held in their account may be rolled over
into a regular IRA unless (1) the employee reaches age 70 ½, (2) payments will be made for
10 years periodically or for the life expectancy of the employee, or (3) the amounts are not in-
cluded in the gross income in the absence of the roll over.


                 INCOME TAX AND THE INTEREST-OUT-FIRST RULE

     The income tax that must be paid on an early withdrawal or surrender is based upon wheth-
er or not the cash accumulation value of the annuity is greater than the premiums paid at the



                                                   129
time of withdrawal. When the cash value is greater, the so-called interest-out-first rule applies
and the withdrawal is taxed entirely as interest to the extent of the cash value excess.

     CONSUMER APPLICATION
     Billy has paid $15,000 into his annuity, which has a present cash value of $20,000, when he
decides to withdraw $3,000. The value of the annuity is $5,000 more than he has personally
paid in. Therefore, the $3,000 will be subject to taxation as interest.
     Billy decides that if he has to pay taxes on his withdrawal, he will have to take out more
money in order to purchase what he wants, so he withdraws $6,000. Then the first $5,000 is
treated as interest, and the other $1,000 is treated as both interest and principal, with taxes to be
paid only on the interest portion of the $1,000.

TAXING ANNUITY LOANS

     While only a few insurers offer loan options with annuities, they are treated as the receipt
of current income. As a result, the amount of the loan is taxed as income. Besides having to
pay income taxes, the annuity buyer also pays interest to the insurer, so loans from annuities are
not particularly attractive.

ANNUITY LIQUIDATION PAYMENTS

     The distribution of benefits of a qualified plan has been discussed above. While the taxa-
tion of individual plans closely follow those discussed for the qualified plans, they must be stud-
ied separately.

     When the annuity liquidation phase begins as scheduled, special tax rules apply to annuity
distributions provided the income payments meet the Internal Revenue Code requirements to be
considered amounts received as an annuity. The requirements are:

        The first income payment must be made on or after the annuity start date specified in
         the annuity contract or after age 59½.
        The income payments must be made on a regular basis and over a period of more
         than one year.
        The amount, of the payments must be based upon the annuity contract agreements,
         standard mortality tables, and/or compound interest tables or a combination of two
         or more of these items.

     By meeting these requirements each income payment is divided into taxable and nontaxa-
ble portions. The part that is considered return of premium is not taxed, but the interest por-
tion is taxed. How the taxable portion is calculated is a function of what the IRS calls an Exclu-
sion Ratio.




                                                  130
EXCLUSION RATIO

     The Exclusion Ratio is a percentage determined by dividing all premiums paid for the an-
nuity by the expected benefits:

    Total Premiums Paid               = Exclusion Ratio
    Total Benefits Expected

     While some fairly complex rules govern this calculation, the following example describes
basically how it works. The IRS provides tables to help determine the expected benefits, using a
number called a multiple which is the number of years the annuitant is expected to live (assum-
ing there is only one annuitant). This multiple is applied to the monthly annuity benefit that will
be paid and also factors in the age at which the annuitant’s benefits are to begin.

    CONSUMER APPLICATION

     Tim Foyt has paid $90,000 for an annuity that will pay him $1,000 per month for life be-
ginning at his age 65. The multiple from the IRS table is 20 at age 65 (and would be a different
number at other ages). The multiple times the monthly benefit times 12 months equals the ex-
pected benefits:

                                      20x$1,000x12 = $240,000

    After the expected benefits are calculated, the Exclusion Ratio is then determined:

                         $90,000             = 37.5% (the Exclusion Ratio)
                         $240,000

    For each $1,000 monthly payment Foyt receives, 37.5% or $375 is excluded from taxation.
The balance, $625 per month, is taxed as current income. Or it may be stated: 62.5% of every
monthly payment is taxed.

     The specific numbers that apply to each situation will differ depending upon premiums
paid, monthly benefit promised and the age at which liquidation begins. For Joint annuitants,
IRS tables take into consideration the life expectancies of both people at their ages when annui-
ty payments start. Once the Exclusion Ratio is calculated, that same ratio applies to every pay-
ment as long as payments are made.


                       VARIABLE ANNUITIES EXCLUSION RATIO

     Obviously, the treatment of Variable Annuities will differ from fixed annuities because the
amount of each Variable Annuity payout can fluctuate making it impossible to determine the
total benefits expected. However, if an individual had paid in $90,000 and expected to receive
payments for 20 years; dividing $90,000 by 20 years results in $4,500 per year - representing


                                                 131
return of premiums only. Then, for example, if the earnings on the account resulted in the annu-
itant receiving $6,000 for one year, $1,500 (“interest” paid over and above the $4,500 base)
would be taxable. If this annuitant received only $3,000 for one year, none of it would be taxa-
ble since it all represents return of premium, no interest. With a Variable Annuity, the exclusion
could be recalculated when payments change, following IRS procedures.

APPLYING THE EXCLUSION RATIO TO DEATH BENEFITS

     When an annuity has a death benefit payable to a beneficiary, the Exclusion Ratio still ap-
plies under certain circumstances. If the annuitant dies after payments have begun in the liqui-
dation phase, the beneficiary must receive the death benefit in installments, either on the same
schedule as the deceased or faster, in order for the Exclusion Ratio to be used.

DEATH PRIOR TO LIQUIDATION PHASE

     Different rules apply if the annuity owner dies before the liquidation phase begins. If the
beneficiary is the spouse of the annuity owner, the spouse is permitted to receive payments on
the same schedule that the deceased would have received them, using the same Exclusion Ratio.
     The Exclusion Ratio also applies to distributions to beneficiaries other than the spouse if
the death benefit is handled in one of the following ways:

        The beneficiary either receives the entire annuity value within five years after the
         annuity owner’s death, or

        Within one year, the beneficiary takes the death benefit in a lump sum and uses it to
         buy a life annuity or to begin receiving installment payments that will end when the
         beneficiary dies.

     If, on the other hand, the survivor simply receives the annuity death benefit as a lump sum,
taxes are due on the entire amount that represents interest earned. This results in taxes being
due currently on a larger amount than is the case when the Exclusion Ratio applies.


                       FEDERAL ESTATE TAXES AND ANNUITIES

     Those persons whose estates are of a substantial size, must deal with federal estate taxes.
The value of the annuity at the time of death must be included in the annuitant’s estate in pro-
portion to the amount the deceased person personally contributed to the premiums that bought
the annuity. The value of the annuity is the accumulated cash value to date if the individual dies
before the liquidation phase begins. After liquidation payouts have begun, the insurance com-
pany determines the value of the annuity at the time the annuitant died.

     The determination of how much of the annuity’s value must be included in the estate for
federal estate taxation is quite simple. If the annuitant had paid 100% of the premiums, 100%
of the annuity value would go into the estate. On the other hand, if the annuitant had paid 50%




                                                 132
and someone else had paid 50% of the premiums, only 50% of the annuity value would be in-
cluded in the estate.

                                    MORE ABOUT TAXES

     This text has addressed the simpler aspects of annuity taxation. Tax laws can be quite com-
plex as a particular type of annuity is used in any given case since different people have a varie-
ty of personal, business and financial situations that can affect taxation. Professional counsel is
always recommended for determining the tax consequences of financial transactions.




                         CHAPTER 8 – STUDY QUESTIONS


1.     The main difference between a “qualified” and a “non-qualified” annuity is
       A.      the qualified annuity allows a tax deduction on premiums paid and a non-
               qualified annuity is paid for with after tax dollars.
       B.      a qualified annuity can be sold in every state while a non-qualified annuity can
               only be sold in certain states.
       C.      The qualified annuity allows any amount to be deposited, tax deductible, while
               the non-qualified is limited to $3,000 per year.

2.     “Keogh” plans are designed specifically for
       A.      individual employees that do not have a retirement fund.
       B.      large foreign based companies.
       C.      small unincorporated businesses.

3.     A qualified “defined benefit” plan defines the amount of benefits that can be paid upon
       retirement. What is this maximum amount in the year 2000?
       A.      $100,000 during the rest of the retiree’s lifetime.
       B.      $150,000 every 5 years.
       C.      $160,000 per year with indexing of $5,000 per year.




                                                  133
4.   The increase in value in an annuity
     A.     is taxable each year, the same as any other investment.
     B.     is taxable in accordance with the “exclusion ratio” when the annuity becomes
            annuitized..
     C.     is not taxable.

5.   Early distribution of money in a qualified pension plan is not penalized if
     A.     the monies are used to purchase a second home.
     B.     the money is used to satisfy a court order in a divorce case.
     C.     the money is used to purchase a car.

6.   A 40 year old person has decided to change jobs and has a retirement plan furnished by
     the present employer. They should
     A.     take out the money in the present retirement plan and use to buy a new home.
     B.     “Role over” the funds into an individual IRA.
     C.     leave the money in the retirement plan.

7.   When an early withdrawal is done on a pension plan, the taxation of the withdrawal is
     based upon
     A.     last in, first out (LIFO).
     B.     first in, first out (FIFO).
     C.     last in, last out (LILO).

8.   If an annuitant has a death benefit in an annuity and the annuitant dies after the annuity
     has been annuitized, the beneficiary will receive
     A.     nothing.
     B.     the same payout as the annuitant if the beneficiary is the spouse.
     C.     the balance of money in the annuity are paid out in a lump sum in an amount
            equal to 50% of the money still remaining in the annuity.

9.   A qualified plan that specifies a formula for the amount of money to be paid into a plan
     is called
     A.     a defined benefit plan.
     B.     a contributory benefit plan.
     C.     a defined contribution plan.




                                               134
10.   Whose money is used to fund a TSA?
      A.    The employer’s.
      B.    Employer and employee in equal shares.
      C.    The employee.



ANSWERS TO CHAPTER EIGHT REVIEW QUESTIONS
1A 2C 3C 4B 5B 6B 7B 8B 9C 10C




                                           135
                INDIVIDUAL RETIREMENT ACCOUNTS (IRAS)

    One of the best, if not the best, plans to supplement Social Security and qualified benefit
plans for retirement, is the Individual Retirement Account – IRA. This has been briefly dis-
cussed in Chapter Eight in discussions of EIAs. As of 1998, there are two types of IRAs – the
“regular” IRA, which will be addressed first, and then the “new” form of IRA, named the Roth
IRA (after the Senator who introduced the legislation).


                                         “REGULAR” IRA
     Subject to certain restrictions, for many taxpayers, both married couples and single persons,
who have earned income and have not reached age 70, the IRA gives them an opportunity to put
aside the lesser of $3,000 per individual for 2002 and indexed thereafter (or 100% of earned in-
come, whichever is lesser), or $6,000 per couple on a tax-deductible status. This means that the
amount of the IRA is subtracted from the earned income on their federal income tax (and some
state’s income tax).

     If each spouse has earned income of more than $3,000 a year, each can make up to $3,000
contributions to the IRA. Even if one of the spouses’ has no earned income, there can still be up
to $3,000 contributed to their IRA for the total of $6,000 (for exact limits, see below). If there
are investment earning in the IRA, it will remain there on a tax-deferred status until withdrawn
from the IRA. The funds must be “earned” (as opposed to investment earnings, including divi-
dends and interest) and the individual must not have reached age 70 ½.

     When the owner of the IRA reaches age 59 ½, they may withdraw funds from the IRA and
such funds will be subject to taxation as regular income at that point. (This is one of the main
differences between a “regular” IRA and the Roth IRA).

     Contributing to an IRA is rather simple and can be set up by banks, savings and loan insti-
tutions, insurance companies (through annuities – life insurance is not permitted), mutual funds
or brokerage houses. Investments must be made in cash or other legal tender; i.e. works of art,
jewelry, or other valuable assets do not qualify.

    There is considerable leeway to changing IRA’s, but the rollover of an IRA may occur only
once a year if the owner takes control of any of the assets. If it is a tax-free rollover, such as
between trustees of IRA accounts, there is no once-a-year limitation.

    Since 1986, only those persons who do not participate in a company retirement plan or
whose adjusted gross income fall below certain limits can deduct their contribution. If neither
spouse participates in a company retirement plan, they can make a contribution to an IRA re-
gardless of how much money they make.




                                                 136
    More Rollover Options: Eligible rollover distributions from qualified plans,         § 403(b)
annuities, and governmental §457(b) plans can be rolled over to any of such plans as well as to
an IRA. IRA distributions can be rolled over into a qualified plan, § 403(b) annuity, govern-
mental § 457(b) plan, or another IRA. A distribution to an individual from a qualified plan will
not be eligible for capital gain or averaging treatment, however, if the same individual previous-
ly made a rollover to the plan that would not have been permitted under prior law. Employers
must revise the rollover notice to reflect the new rules. Effective for distributions after Decem-
ber 31, 2001.
    Rollover of After-Tax Contributions: Employee after-tax contributions may be rolled over
into another qualified plan or a traditional IRA. Effective for distributions after December 31,
2001.

    Waiver of 60-Day Rollover Rule: The Treasury may waive the 60-day rollover period if the
failure to waive the 60-day period would be against equity or good conscience. Effective for dis-
tributions after December 31, 2001.

     IRA Contribution Limits: The IRA contribution limits are increased gradually, to $3,000
for 2002-2004, $4,000 for 2005-2007, and $5,000 for 2008 and later years, subject to future
indexing in $500 increments. Catch-up IRA contributions are permitted for individuals age 50
or older in annual amounts starting at $500 in 2002-2005 and increasing to $1,000 in 2006 and
thereafter.

   Employers may permit employees to make voluntary contributions to deemed traditional IRA
accounts and deemed Roth IRA accounts under qualified plans. Effective in years beginning af-
ter December 31, 2002.



      If IRA funds are withdrawn before the owner reaches age 59 ½, they are designated as
“premature” by the IRA, and are subject to a 10% tax penalty on any of the taxable part of the
withdrawal. The “taxable” part is the part of the withdrawal that represented deductible contri-
butions or earnings. This is in addition to the regular income taxes that will be paid on the
withdrawal; therefore it is a true “penalty.” However, there are some exceptions where the pen-
alty tax will not have to be paid:

     Obviously, if the owner has died, or become disabled.

     If the money is withdrawn in equal payments that is based upon the life expectancy of
      the owner (or the joint life expectancy of the owner and beneficiary). If, after five
      years from the date of the first payment, the owner turns age 59 ½ , the pattern of pay-
      ment can be changed without incurring the penalty tax.




                                                 137
     If the money is used to either (1) pay health insurance premiums while unemployed for
      at least 12 months, or (2) pay medical bills that exceed the 7.5% of the owners adjusted
      gross income.

     Transfer in the interest in the IRA is the result of a divorce or separation action as pro-
      vided by a state court ruling.

     If the money is used to pay for expenses of higher education.

     If the money is used to purchase a “first” home, with a maximum of $10,000.

     An individual may not borrow against an IRA or pledge it as collateral for a loan. This is
specifically prohibited and could result in the IRA losing its entire tax-deferred status. To fur-
ther strengthen this prohibition, not only will the income tax on the full value of any previously
untaxed amounts of the IRA become payable, but there will be a 10% excise tax imposed.

     CONSUMER APPLICATION
     Rhonda and Renee are twins and usually agree on things of common interest. However,
when they both reached age 35, Rhonda’s husband insisted that she starts an IRA and contribute
$2,000 each year towards it.
     Renee and her husband decided that they needed a new van more than they need to worry
about retirement. After 10 years, on Rhonda & Renee’s 45th birthday, Rhonda finally convinced
her sister that she should start an IRA with $2,000 paid in each year.
     If both women earned 8% on their IRA’s, at age 65:
     Renee’s IRA would be valued at $98,846.
     Rhonda’s IRA would be valued at $244,692.


                                       EDUCATION IRA

     A Parent can make a non-deductible contribution of $500 per year per child into an educa-
tional IRA until the time that the child reaches age 18. The deduction amount, $500, is reduced
for those single parents with incomes between $95,000 and $110,000 couples with joint in-
comes between $150,000 and $160,000. There can be more than one educational IRA as long
as the total does not exceed $500. Some states offer tuition plans and in those states, a child
who is enrolled in one of the state qualified tuition plans would not be eligible for the education
IRA.

     The money that is in the education IRA can be withdrawn tax-free for the purposes of tui-
tion, fees, books, supplies and equipment. If a student is enrolled on more than half time, then
board and room can also be withdrawn tax-free. All money must be withdrawn by the time the
student is age 30, or they will be assessed a 10% penalty tax. If there are funds remaining and
there is another family member (of the same generation), the remaining funds can be used for
their education.




                                                  138
                                          ROTH IRA


                                        NEW ACCOUNT

     As of January 1998, as a result of the Taxpayer Relief Act of 1997, an individual may es-
tablish the Roth IRA, regardless of age, which have earned income below $95,000 for single,
$150,000 for joint filing. The contribution of $2,000 will be reduced for amounts above
$96,000 and will not be allowed if single income is over $110,000. For couples filing jointly
the amount is between $150,000 and $160,000.

Roth IRA accumulates income tax-free instead of tax-deferred, but there is no annual de-
                        duction for Roth IRA contributions.

     A Roth IRA can be established by individuals who participate in various company, agency,
or not-for-profit plans, such as SEP IRA’s, SIMPLE IRA’s, 401(k), 403(b) and 457 plans. The
maximum contributed would be $2,000, but the earned income must at least equal the amount
contributed.

     Dividends, interest and capital gain growth within a Roth IRA is not taxable, and money
that is eventually removed is tax free, if the account is owned at least 5 years and the owner is
over 59 ½.

     There are no minimum distributions or withdrawal requirements after age 70 ½. At any age
after the Roth IRA has been created and in operation for at least 5 years and the owner is over
age 59 ½, any withdrawals are tax-free. In addition, at any age after the account has been
opened for at least 5 years, the owner can withdraw a lifetime maximum of $10,000 in contribu-
tions and earnings, without taxes or penalties, for a first time home purchase.

     There is a wide variety of investment vehicles available for this plan. Many planners sug-
gest Variable Annuities or mutual funds.


                                  ROTH IRA CONVERSION

     As of January 1998, many traditional IRA investors have the option to convert their regular
IRAs to a Roth IRA. A regular IRA offers tax deferred growth on all earnings, and the earnings
will be taxed upon withdrawal. However under a Roth IRA while the deductions are not de-
ductible, the growth of the Roth IRA is tax deferred, and is tax free when the distributions are
taken from the Roth IRA under certain guidelines:

     Roth IRA withdrawals are tax-free if the account is opened for a period of at least 5
      years and the owner is over age 59 ½. For a first-time homebuyer, funds can be with-
      drawn as stated above.



                                                  139
     Unlike the “regular” IRA, there is no requirement to withdraw funds from a Roth IRA,
      so they can be held until death and then passed on to spouses, children or other heirs on
      a tax-free basis.

     No conversion from a regular IRA to a Roth IRA is allowed when their annual gross in-
      come reaches $100,000 per year, whether joint or single filers, during the year when
      conversion takes place.

     The full or partial amount of money that is converted from a regular IRA to a Roth IRA
      will be included in the owner’s taxable income in the year that it is converted. Any tax-
      es due on conversion must come from outside sources as a withdrawal from a Roth IRA
      to pay the taxes is prohibited.

     If an individual converts from a regular IRA to a Roth IRA and discovers that they have
      exceeded the income eligibility requirement, they are allowed to reverse the conversion
      without tax penalties.

TAXES ON CONVERSION

     While the conversion of a regular IRA to a Roth IRA sounds good to a great many holders
of IRA accounts, they must be aware that the entire amount that is converted to a Roth IRA is
subject to income taxes. Therefore, this amount is added to any earned income for that year and
taxes are due on the total gross income at the appropriate rate for that particular filing. And as
stated above, the taxes that are due cannot be taken from the IRA. (See discussion example be-
low).

WHY CONVERT?

     Many regular IRA holders will want to know the advantage of converting to a Roth IRA.
The philosophy of always deferring taxes as long as possible especially since the money that
they would pay in taxes would continue to grow on a tax deferred basis inside of the regular
IRA is not necessarily true in the case of a Roth IRA. Actually, the money in a Roth IRA com-
pounds tax free as opposed to compounding at a tax-deferred basis.

      Simply put, a Roth IRA conversion will give the account holder more, net after taxes, than
if they continued with the regular IRA. The reason is that within any retirement plan, the largest
component of the plan is the growth, not the amount of contributions. The tax-deductible plans’
compounded growth is eventually taxable (pay now or pay later), whereas the Roth plan com-
pounded growth is tax-free. It has been stated by Wall Street On-line that it is “sort of like com-
pounding out 8.0% Net After Tax versus 10% Tax Free.”

    According to “Roth to Riches,” written by John Bledsoe, CLU, CFP, to first determine if
consideration should be given to converting an IRA to a Roth IRA, 2 questions must be asked:
(1) Are you over age 59 ½? and (2) Do you have funds outside the IRA with which to pay the
income tax, if you were to convert to a Roth IRA? If either answer is “Yes,” then they should
convert to a Roth IRA, according to this author.



                                                 140
      As an example, Assume the client had $300,000 in a traditional IRA and $99,000 in (let’s
say) a money market account outside of the IRA. For simplicity, assume further that everything
grows by 10% per year, and taxes are at the 33% rate. Therefore, from the IRA, annual income
would be $30,000 with tax of $10,000 if the client took the money that year – leaving a net of
$20,000 to the client.
      The client receives $9,900 from the other funds, after tax the fund would be $6,600. So to-
tal (spendable) income is $26,000.
      For the “Roth” version:
      For the client to pay the entire tax on the $300,000 IRA and make it a tax-free Roth, she
      would have to pay the tax on the IRA today. Therefore, the $99,000 in the other fund is
      used to pay the taxes. (Can you imagine how it would feel to give Uncle Sam $99,000 in
      one fell swoop?) Now the client still has the income from the IRA of $30,000. And guess
      what? A Roth IRA is tax free, so she is better off by $4,000 of spendable income.
      If the client does not spend the income or even part of it, each year, the advantage of the
      Roth IRA becomes even bigger!

    For Roth conversions, the client must not exceed $100,000 “modified” gross income the
year that the IRA is converted. The Modified Gross income is similar to Adjusted Gross In-
come, but does not include the Roth conversion.

    Usually, couples may not filed as “married filing separately” for the year that they want to
convert an IRA to a Roth IRA.

        Income tax must be paid on the entire IRA balance the year that it is converted.




   SALARY CONTINUATION / DEFERRED COMPENSATION PLANS

    A Salary Continuation plan arrangement, which is often funded by life insurance, continues
an employee’s salary in the form of payments to a beneficiary for a certain period after the em-
ployee’s death. The employer may be the beneficiary, collect the death benefit and then make
payments to the employee’s beneficiary.

      A Deferred Compensation plan is a means of supplementing an executive’s retirement ben-
efits by deferring a portion of his or her current earnings. To qualify for a tax advantage, the
IRS requires a written agreement between an executive and the employer stating the specified
period of deferral of income. An election by an executive to defer income must be irrevocable
and must be made prior to performing the service for which income deferral is sought.

     In a salary continuation plan in its generic form, the employee prior to retirement, does not
lose any compensation or pay into the plan as the employer pays all benefits. The nonqualified
deferred compensation plan provides basically the same benefits after retirement, but the funds




                                                 141
either comes from a reduction of salary of the employee, or any salary increases will be used for
the funding.

     Either arrangement is primarily used with key employees as a method to entice them to re-
main with the firm and is frequently combined with a “non-compete” arrangement. These plans
are supplemental to IRA’s, Social Security, and qualified pension plans, and are taxed at time
that the employee receives them. Ironically, the only way to make certain that the maximum tax
benefit can be obtained with either plan, is to make them unsecured and unfunded. This is the
only way to show that there has been no ‘constructive” receipt of an immediate and therefore,
taxable, benefit by the employee.


                               QUALIFIED PENSION PLANS

     Qualified Pension plans are retirement programs designed to provide employees and fre-
quently, their spouses, with a monthly income payment for the rest of their lives. To qualify, an
employee must have met minimum age and service requirements. Benefit formulas can be ei-
ther the Defined Contribution Pension” (Money Purchase Plan) or the “Defined Benefit Plan.”
See earlier discussion.

     NOTE: The term “Instrument” in describing methods of providing funds for a pension
plan, is used in the legal sense, which is defined as a formal legal document, as a contract, deed,
etc. An insurance policy/plan is considered as an “instrument.” An established method of fund-
ing for a qualified plan may be also considered as an “instrument.”

      The Employee Retirement Income Security Act of 1974 (ERISA) requires a pension plan to
provide an income for the rest of a retired employee’s life, and at least 50% of that amount to
the surviving spouse of a retired employee for the rest of her life, unless the spouse waives this
right in writing. Death and disability benefits are also provided by most pension plans. The Tax
Reform Act of 1986 changed the vesting requirements, as did the Economic Growth and Tax Re-
lief Reconciliation Act of 2001 (discussed earlier). Funds for these plans can be generated un-
der numerous Pension Plan Funding Instruments as described below.


                                  DEFINED BENEFIT PLAN

    Under the Defined Benefit Plan, the retirement plan is fixed (defined) in advance by an ap-
proved formula. The contributions of the employer to the plan may vary (and are not “defined”
as defined below). The defined benefit plan can either be a Fixed Dollar plan, or a “Level Per-
centage of Compensation” approach, as follows:




                                                  142
1. FIXED DOLLARS:

    The Fixed Dollar plan can use the “Unit Benefit” approach, the “Level Percentage of Com-
pensation,” or the Flat Amount approach.

           (a) Unit Benefit approach is where a unit of benefit (that is not discriminatory and
               is approved by the commissioner of the Internal Revenue Service) is credited to
               the employee for each year of service recognized by the plan as determined by
               the employer. The “Unit” may either be a flat dollar amount or usually, a per-
               centage of the employee’s compensation - usually 1% - 2% - and the total years
               of service is multiplied by this percentage.

     CONSUMER APPLICATION
     Sam has worked for BH Plumbing for 30 years. The percentage of his income that is cred-
ited to him for each year is 1 ½%, therefore 45% (1.5 times 30) would be applied to either (1)
his career average earnings or (2) his highest income for 3 out of his highest 5 years of earn-
ings.
     Sam’s five consecutive years of earnings were $120,000, $100,000, $80,000, $75,000
$60,000, therefore the average Sam has made would be $100,000 as the average of 3 out of the
5 consecutive years of earnings. His retirement benefit would be $45,000.

           (b) Level Percentage of Compensation approach is where, after an employee has
               served for a minimum number of years (usually 20) and has reached a minimum
               age (usually 5O), then all employees will receive the same percentage of earn-
               ings as a retirement benefit, regardless of how much money they make, how
               long they have been with the organization, and regardless of position.

CONSUMER APPLICATION
     Earnest turns age 50 in July. At that time he will have worked for the Southeastern Ship-
ping Co. for 20 years. He is making $80,000 a year salary, and does not expect an increase be-
fore he retires. At his retirement, under his company’s “level percentage of compensation” ap-
proach to the retirement plan, he would receive 20% of $80,000, or $16,000 per year.

           (c) The Flat Amount approach states that after an employee has been with the or-
              ganization a minimum period of time (such as 20 years), and has reached a speci-
              fied age (usually 50), then all employees meeting this criteria will receive the ex-
              act same dollar amount of retirement benefit (again, regardless of income, posi-
              tion in the company, or years of service). For example, the plan could state that
              each employee who is at least 50 years of age; with at least 20 years of service
              would receive $80,000 a year in retirement benefits.




                                                143
2. VARIABLE AMOUNT PLANS

  (a) Cost-of-Living Plan is quite popular during inflationary times as it is tied to changes in a
      designated price index, usually the Consumer Price Index (CPI). Simply put, if the CPI
      would increase by 3%, then benefits would increase by 3%.

  (b) Equity Annuity Plan pays premiums into a Variable Annuity plan, which is used to pur-
      chase “Accumulation Units.” At retirement, the Accumulation Units are converted to re-
      tirement units whose values fluctuate according to the common stock portfolio in which
      the premiums were invested.

INTEGRATION WITH SOCIAL SECURITY

    Defined Benefit plans can be integrated with Social Security in either of two ways: (1) the
Excess method, or (2) the Offset method.

     It is a rule of the IRS, (“engraved in stone”) that any qualified pension plan must be non-
discriminatory. However, there is an inconsistency when integrating Social Security whereby
the more highly compensated employees may be allowed to receive higher benefits. This is be-
cause Social Security has a maximum benefit so that they do not replace the same percentage of
income for those with higher incomes, than those of lower incomes. Therefore, the laws allow
Social Security benefits to be considered so as to increase disproportionately either the plan
contributions or the plan benefits of those with higher incomes.

    The “Excess” is a plan that provides an additional amount to supplement the employee’s
Social Security Benefits. These plans provide benefits based on an employee’s “annual average
compensation.”

     The “Offset” plans are based upon a predetermined percentage of salary, which is then
“offset” by the portion of the employee’s Social Security benefits that was provided by the em-
ployer. The number of years that the employee has been employed by the organization may also
be taken into consideration in determining the employee’s retirement benefits.

ELIMINATION OF OPTIONAL FORMS OF DISTRIBUTION UNDER DEFINED CONTRIBUTION
PLANS
     If a participant or beneficiary makes a voluntary election to transfer an account from one
defined contribution plan to another, and if certain other requirements are satisfied, the receiv-
ing plan is no longer required to provide all of the forms of distribution previously available
under the transferor plan. In addition, an employer may amend a defined contribution plan to
eliminate a form of distribution, provided that (1) a single sum distribution is available at the
same time or times as the eliminated form of distribution, and (2) the single sum distribution
applies to a portion of the participant's account at least as great as the portion that was eligible
for the eliminated form of distribution. (The new rules permitting the elimination of distribution
options are less restrictive in certain respects than similar rules recently included in Treasury
regulations.) Effective for years beginning after December 31, 2001.



                                                  144
ELIMINATION OF OPTIONAL FORMS OF DISTRIBUTION UNDER DEFINED BENEFIT AND
DEFINED CONTRIBUTION PLANS
     Under the 2001 Act, the Treasury is directed to issue regulations providing that the prohi-
bitions against eliminating or reducing an early retirement benefit, a retirement-type subsidy, or
an optional form of benefit do not apply to amendments that eliminate benefits, subsidies, or
optional forms that create significant burdens and complexities for the plan and its participants,
but only if the amendment does not adversely affect the rights of any participant in more than a
de minimis manner. (An example in the Joint Explanatory Statement indicates that this rule
could be used to eliminate one of two similar benefits after a plan merger.) The Treasury is di-
rected to issue final regulations by December 31, 2003.


      DEFINED CONTRIBUTION PENSION PLAN (MONEY PURCHASE PLAN)

     The Defined Contribution Pension Plan is also known as the Money Purchase Plan. Under
this plan, contributions are fixed in advance by formula, and benefits vary. (As opposed to the
Defined Benefit plan, where the benefits are fixed but contributions may vary). These plans are
used by those organizations that must know what their pension plan will cost in the future. A
good example of this are nonprofit organizations who must project their pension expenses that
are set at a predetermined limit, thereby enabling the organization to be able to present an accu-
rate a budget each year as possible for the benefit of its contributors, members, stockholders,
etc. Obviously, it is needed so that they can solicit funds during the year.

    The most common types of Qualified Defined Contribution pension plans are:

       Money Purchase plans (see below)
       Profit-sharing plans.
       401(k) profit sharing plan
       Simplified Employee Pensions (SEP)
       403(b) Tax Sheltered Annuities (TSA)
       Employee Stock Ownership plans (ESOP)


            TAXATION OF QUALIFIED DEFINED CONTRIBUTION PLAN

     With all of the rules and regulations of creating a Tax Qualified retirement, the inducements
to the employer must be significant. Basically, the employer is allowed to take a business in-
come tax deduction for the amounts that it contributes to the plan. As one would expect, the
amount that can be deducted for tax purposes, and the maximum amount that can be contribut-
ed, is tightly regulated. The IRS considers the amount of new money that is contributed each
year, as an “annual addition,” which must include the sum of employer contributions, any allo-
cated “forfeitures” and all employee contributions.

     A “forfeiture” is the amount of an employee’s plan that remains when a plan participant
leaves a plan and is not fully vested. Generally, if the employee leaves the plan (usually termi-


                                                 145
nates employment) for a specified period of time – such as 5 years – then the amount remaining
in his “account” becomes the property of the plan itself. The administrator can then either use
them to offset future employee contributions or to increase benefits of the remaining partici-
pants.

    The reason that the law specifies “annual additions” is so that they can be limited. In The
Tax Reform Act of 1986, employer contributions may be deducted to the extent that they do not
exceed the lesser of: 25% of the annual compensation of a plan participant, or $30,000 (in-
dexed). This provision of the law limits both contributions and deductions.

     Additionally, a restriction on profit-sharing plans such as the 401(k) allows the employer to
deduct an amount equal to 15% of the total annual compensation of the employees in the plan.
Therefore, an employer may contribute more to a money purchase plan than to a profit sharing
plan.


                                 MONEY PURCHASE PLAN

     A Money Purchase Plan specifies contributions to a pension plan on a fixed basis according
to a formula, but with variable benefits. Contributions can be made under an “allocated funding
instrument” (paid to an insurance company that purchase an individual annuity or a group de-
ferred annuity –see below), or under an “unallocated funding instrument.” Benefits due to an
individual would be determined by the person’s age, sex, normal retirement age and rate (pre-
mium) schedules in effect at the time the insurance company receives the contributions. The
Money Purchase Plan is attractive particularly to an organization or business that must know in
advance, the amount of funding &/or premium it must provide in future years.



                                PENSION TRUST FUNDING

     During the discussion of the various methods of funding tax-qualified pensions pension
trust funding must be mentioned. Trust funds are the oldest, and still the most common, method
of funding pensions. All contributions made by the employer and employees are deposited into
a trust fund, with a trustee responsible for investing the money, administering the plan, and pay-
ing benefits.

     Full Funding Limit: The current-liability full funding limit is increased to 165% of current
liability for plan years beginning in 2002 and to 170% of current liability for plan years begin-
ning in 2003, and then is repealed for plan years beginning on or after January 1, 2004.
     If a plan terminates, the employer may deduct a contribution equal to the plan's unfunded
termination liability. Effective for plan years beginning after December 31, 2001.

     Excise Tax on Nondeductible Contributions: For purposes of the 10% excise tax on non-
deductible contributions, an employer may elect to take into account only contributions exceed-
ing the accrued-liability full funding limit.


                                                 146
     If an employer makes this election, it loses the benefit of certain exceptions that are availa-
ble under current law.
     Effective for years beginning after December 31, 2001.

     Timing of Plan Valuations: The Act codifies the proposed regulation generally requiring
plan valuations to be made as of a date within the applicable plan year or within the immediate-
ly preceding month. The Act also includes an exception that permits the valuation date to be any
date within the preceding plan year if, as of that date, the value of the plan's assets is not less
than 100% of the plan's current liability. Effective for plan years beginning after December 31,
2001.


                           GROUP DEPOSIT ADMINISTRATION

      The Group Deposit Administration is a pension plan-funding instrument in which contribu-
tions paid by an employer are deposited to accumulate at interest. (These plans are usually non-
contributory.) Upon retirement, an immediate annuity is purchased for the employee. The ben-
efit is determined by a formula, and the investment earnings on funds that are left to accumulate
at interest. This is a flexible plan because the annuity is purchased at the time of retirement, so
the deposit administration plan can be used with any benefit formula.


         GROUP IMMEDIATE PARTICIPATION (IPG) CONTRACT ANNUITY

     The IPG is a modification of the group deposit administration annuity under which an em-
ployer participates in the investment (which entails some risk to the employer, and perhaps to
the employee, as participation in an investment may prove to be adverse as well as favorable),
mortality, and expense experience of the plan on an immediate basis. Under the IPG, contribu-
tions are paid into a fund to which interest is credited. At retirement, an immediate annuity is
purchased for the employee. The size of the benefit will depend on the benefit formula used
and the investment, mortality, and expense experience of the plan.


                             GROUP PERMANENT CONTRACT

     Another method of funding a pension plan involves using a Group Permanent Contract,
which is an insurance policy under which the value equals the benefits to be paid to the plan
participants (employees) at normal retirement age, assuming that (1) their rate of earnings re-
mains the same until normal retirement age, and (2) the contributions to the plan are sufficient
to meet funding requirements for benefits under the plan. Normal retirement age is the earliest
age at which an employee can retire without a penalty reduction in pension benefits after having
reached a specified minimum age and served a minimum number of years with an employer. In
the past this has usually been age 65, however many employers have changed this to a lower
age. Age 65, of course, is when full Social Security retirement benefits are payable. Adjust-
ments to contributions are made as employee earnings increase. Retirement benefits depend on
the benefit formula used, and the investment, mortality, and expense experience of the plan.


                                                  147
                        INDIVIDUAL CONTRACT PENSION PLAN

     As the wording would indicate, an individual contract pension plan is a retirement plan for
an individual based on a single contract with a benefit based on current earnings, as if they will
remain static until normal retirement age. As the earnings of the plan participant increase, addi-
tional contracts are purchased (with an increase in the contributions to the plan). The amount of
retirement benefits depends on the benefit formula used and the investment experience of the
company underwriting the plan.


              PENSION PLAN INTEGRATION WITH SOCIAL SECURITY

     Many, if not most, pension plans are integrated with Social Security benefits which offset
or subtract the Social Security benefits from earned benefits in a qualified pension plan and
which has the effect of reducing the pension benefit. Many business firms offset their pension
payments by the amount of a retiree's Social Security benefit.

     CONSUMER APPLICATION
     Bob Freeman has earned a monthly pension benefit of $1,000. His monthly Social Security
payment is $766. If his employer applies 100% integration, his pension is reduced by the entire
Social Security benefit; he will receive $1,000 minus $766, or $234 monthly. More commonly,
integration is based on a percentage of Social Security. With 50% integration, 50% of the So-
cial Security benefit ($383) would be subtracted from the $1,000 pension for a monthly benefit
of $617. Offsets were limited by the Tax Reform Act of 1986.


                             PENSION PLANS DISTRIBUTIONS

    Prior to 1988, there was a right to withdraw retirement assets before age 59 1/2 without
having to pay a 10% penalty under the following circumstances:
    1. medical expenses are incurred or
    2. the plan participant becomes disabled.

    With the passage of the Technical And Miscellaneous Revenue Act Of 1988 (TAMRA), Em-
ployee Benefits, a third option is available to the plan participant:
    (3.) …” distribution must be a part of a scheduled series of substantially equal periodic
       payments.” This means that any distributions from the pension plan must be made so
       that they will continue for the lifetime of the plan participant, or for the participant and
       his/her beneficiary.

WITHDRAWAL BENEFITS

    There are certain rights of employees who leave an employer with a qualified plan to with-
draw their accumulated benefits. With a Contributory plan, employees have immediate rights to


                                                  148
their own contributions, plus earnings. If they leave the employer, the accumulated money be-
longs to them. However, they are not entitled to the employer contributions, unless the plan is
vested (See VESTING below). Vesting depends on the terms of the plan, but law sets maximum
time limits. A vested employee who withdraws accumulated benefits.

PENSION PLAN TERMINATION INSURANCE

     There is insurance coverage available that is provided by the Pension Benefit Guaranty
Corporation (PBGC) that guarantees plan participants a certain level of pension benefits even if
the plan terminates without assets. The PBGC was authorized under ERISA. The insurance,
paid for by employers, protects vested interest only.


                                           VESTING

    “Vesting” refers to the benefit entitlement of a participant in an employee benefit insurance
plan to receive benefits regardless of his or her employment status.

     The term “vesting” refers to the entitlement of a pension plan participant (employee) to re-
ceive full benefits at normal retirement age, or a reduced benefit upon early retirement, whether
or not the participant still works for the same employer. ERISA had previously (1974) estab-
lished vesting provisions under (1) 45-year rule, (2) 5 to 15 year rule, or (3) 10-year rule.

     On January 1, 1989, (under the Tax Reform Act Of 1986), these vesting requirements were
replaced with the following:

       1. Full vesting (100%) after a participant completes five years of service with an em-
          ployer; or
       2. Vesting of 20% after completion of three years of service with an employer, increas-
          ing by 20% for each year of service thereafter, until 100% vesting is achieved at the
          end of seven years of service.

   There are three types of Vesting:

          1.    Deferred Vesting – To provide for deferred vesting, there must be specific and
                specified requirements of the minimum age and years of service to be met by an
                employee before the employee’s benefits are vested. To illustrate, under the 10
                year vesting rule, an employee must be employed by the employee for a period
                of 10 years before the benefits vest.

          2.    Immediate Vesting – Immediate vesting provides the employee with full enti-
                tlement to the retirement benefits with no waiting period. If the plan is Contrib-
                utory, there is immediate vesting of the employee’s own contributions, plus any
                earnings that may be attributed to the employees contributions. In respect to
                employer contributions in Contributory and Noncontributory plans, vesting de-
                pends solely on the terms of the plans, but maximum time limits for full vesting



                                                 149
                are set by law (see above discussion). Frequently plans will provide for imme-
                diate vesting of employer contributions incase of death or disability. Simplified
                Employee Pension (SEP) plans require immediate vesting of employer contri-
                butions.

          3.    Conditional Vesting is a limitation under a contributory pension plan in respect
                to the employee’s rights to receive vested benefits. The employee can only
                withdraw benefits according to stated conditions.

     Faster Vesting of Matching Contributions: Employer matching contributions must vest at
least as fast as under one of two schedules: (1) 100% vesting after 3 years of service, or (2)
20% after 2 years of service and an additional 20% per year thereafter, with 100% vesting after
6 years of service. Effective for contributions for plan years beginning after December 31, 2001,
with a delayed effective date for collectively bargained plans.


                        PROFIT – SHARING PLANS – 401(K)

    This very important retirement vehicle has been discussed earlier, but it should also be dis-
cussed in this particular section with other tax-related and tax-qualified retirement plans.

     A 401(l) plan is named for the section of the IRA code that permits employees to invest
pre-tax dollars into the plan and the employer usually matches the funds provided by the em-
ployee in some proportion. The Tax Reform Act of 1986 limited their use as a short-term sav-
ings plan by imposing a 10% penalty on any and all money withdrawn before the employee’s
retirement. The maximum contribution (annual) had been $30,000 and it was lowered to $7,000
(adjusted annually for inflation). Employees may still borrow against there 401(k) and pay
themselves interest.

     §401(k) Dollar Limit: The limit on § 401(k) contributions is increased from $10,500 to
$11,000 in 2002. Beginning in 2003, the limit is increased in $1,000 annual increments until the
limit reaches $15,000 in 2006, with future indexing in $500 increments. Similar changes are
made to the limits on contributions to § 403(b) annuities, § 457(b) plans, and other elective
plans.
     Catch-Up Contributions to Qualified Plans: An additional increase in the dollar limit on
§401(k) contributions and other pre-tax elective contributions allows individuals age 50 or old-
er to make catch-up contributions. For §401(k) plans, the increase in the dollar limit starts at
$1,000 in 2002 and increases by $1,000 for each subsequent year until it reaches $5,000 for
2006, with future indexing in $500 increments. Catch-up contributions are not subject to any
other contribution limits and are not subject to nondiscrimination testing. However, the plan
must allow all eligible participants to make the same catch-up contribution election; all plans of
related employers are treated as a single plan for this purpose.

     Individual Tax Credit: The Act provides a temporary nonrefundable tax credit for contribu-
tions to a qualified plan made by certain lower-income taxpayers, including contributions to §
401(k) plans. The maximum annual contribution eligible for the credit is $2,000. The credit rate


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depends on the taxpayer's adjusted gross income ("AGI"). Only joint returns with AGI of
$50,000 or less, and single returns with AGI of $25,000 or less are eligible for the credit. Effec-
tive in taxable years beginning after December 31, 2001, and before January 1, 2007.

     Deduction Limits: The annual deduction limit for profit sharing and stock bonus plans is
increased from 15% to 25% of compensation, and a money purchase pension plan is treated like
a profit sharing or stock bonus plan for deduction purposes. Under the Act, § 401(k) contribu-
tions are not subject to the qualified plan deduction limits, and do not count against the limits in
determining whether other contributions are deductible. In addition, the participant compensa-
tion used to calculate the deduction limits includes salary reduction contributions that are treat-
ed as compensation for § 415 purposes. Effective in years beginning after December 31, 2001.

     Age 70 1/2 Minimum Distribution Rules: The Treasury is directed to revise the life expec-
tancy tables used to calculate required minimum distributions to reflect current life expectancy,
effective on date of enactment.

    Plan Loans: The Act eliminates the special restrictions for plan loans to owner-employees,
and makes such loans subject to the general statutory exemption for plan loans. Effective in
years beginning after December 31, 2001.

 • Top-Heavy Rules: The Act makes a number of changes in the top-heavy rules, such as
    amending the definition of "key employee," establishing an exemption for plans meeting the
    nondiscrimination safe harbors for 401(k), after-tax, and matching contributions, and al-
    lowing matching contributions to count toward the minimum top-heavy contribution re-
    quirement. Changes in the key employee definition will also affect funding limits for port-
    retirement life and medical benefits and other provisions that incorporate the definition by
    reference.

     The 401(k) plan may be a “salary reduction plan,” a “cash or deferred plan,” or a “salary
deferral plan.”

    There are two traditional ways for an employee to defer income into a 401(k) plan.
    1. The employee is given a cash bonus and most or some of it will be deferred into the plan
       on a before-tax basis.

    2. The employee may defer part of his compensation under a “salary reduction” agreement,
       such funds to go directly into the 401(k) on a tax-advantaged basis.

     When the 401(k) was first under discussion prior to 1974, it was expected that it would be a
way for an employer to reward certain select key employees. However, the law states that the
amount deferred (or percentages of salary) or the most highly compensated employees, are lim-
ited by the elective deferrals of the other employees. The IRS is very cognizant of anti-
discrimination and will not allow any discrimination of any sort in a qualified plan.

     Subject to certain rules that apply to some collectively bargained plans, there is a maximum
dollar amount that an individual can elect to defer into any Cash or Deferred Arrangement


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(CODA) plan in which the employee participates. This would not only apply to 401(k) plans,
but to a 403(b) plan (described below) also. Contributions to a 403(b) plan will reduce on the
same basis, the amount that can be contributed to a 401(k) plan.

     Option to Treat Pre-Tax Contributions as After-Tax Contributions: A §401(k) plan (or a §
403(b) annuity plan) is allowed to include a "qualified Roth contributions program" that per-
mits a participant to have all or part of his future elective contributions treated as after-tax Roth
contributions. A qualified distribution of contributions and related investment earnings from a
Roth contribution account is not included in gross income. Effective for taxable years beginning
after December 31, 2005.

    Repeal of the "Same Desk" Rule: The Act repeals the "same desk" rule, which generally
prohibited a § 401(k) plan from distributing an employee's account when the employee contin-
ued in the same job for a successor employer after a business sale. (The Act uses the term "sev-
erance from employment" to describe changes in employment status that may trigger distribu-
tions under the new rule.) The repeal is effective for distributions after December 31, 2001, even
if the severance from employment occurred many years earlier.          A plan may provide, howev-
er, that specified types of severance from employment are not distributable events. If a portion
of the employee's benefit is transferred (other than by rollover or elective transfer) to a plan
sponsored by the employee's new employer, the employee is not deemed to have severed from
employment.


                    SIMPLIFIED EMPLOYEE PENSIONS (SEP)

     The term “simplified” certainly pertains to the SEP pension plan. It is a defined-
contribution plan, wherein, according to a written (and non-discriminatory) plan, the employee
opens an IRA. The employer makes tax-deductible contributions on behalf of the employee.
The SEP has the same tax treatment as a 401(k) or profit-sharing plan, but the administrative
rules are also simple.

    1.     The amount that an employer can contribute to an SEP is limited to the lesser of
           15% of the employee’s compensation, or $24,000.
    2.     Annual contributions are not mandatory.
    3.     Employer’s contributions are considered as discriminatory unless they bear a uni-
           form relationship to every employee’s total compensation.
    4.     Total compensation may not exceed $160,000, indexed for inflation.

    The eligibility requirements are rather severe, particular in comparison to other qualified
plans.

          1.      There must be 100% participation of all eligible employees.




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          2.     An eligible employee is considered as an employee who
                 (a) is at least 21 years old
                 (b) has been paid over $400 (1996 figure, adjusted for inflation) during the
                      year.
                 (c) has worked for the employer who is contributing to the SEP, during the year
                    of contribution and any part of 3 of the immediately preceding 5 calendar
                    years, and
                 (d) qualified during the year, whether still employed or not at the end of the
                    year.

          3.     Exclusions are available for certain nonresident aliens and employees covered
                 under a collective bargaining agreement.

     An SEP may be used as a retirement plan for an employer with less than 25 employees. In
that case the maximum contribution is limited to $7,000.

     A major difference between an SEP and other pension plans is that the employee is imme-
diately vested, and the employee has total control over the investments.

     Federal income taxes, FICA and FUTA withholding taxes are not necessary on SEP contri-
butions.

    SEPs (like IRAs) are not allowed to use contributions to purchase incidental life insurance.

     Whether an individual is completely self employed, or is just bringing in self-employed in-
come from part time work or consultations, they should seriously consider setting up an SEP. If
the individual is self-employed, there are special rules that apply when calculating the maxi-
mum deduction for those contributions. In determining the percentage limit (15%) on contribu-
tions, compensation is considered as net earnings from self-employment, taking into considera-
tion the contributions to the SEP.


                           SIMPLE RETIREMENT PLANS

     The “Simple” Retirement Plan, (Savings Incentive Match Plan for Employees) pertains on-
ly to employers with no more than 100 persons who earned more than $5,000 the preceding
year. The business must not have any other qualified plan, and can either be an employer-
established IRA or 401(k) plan.

     Employees can contribute a percentage of their compensation, not to excess $6,000 a year
adjusted for inflation, and these contributions are not included in the employee’s taxable income
(but they are subject to employment tax). Employers may contribute to the plan by matching
the employee’s contribution up to 3% of the employee’s income, or they may contribute 2% of
the compensation to every employee who has earned at least $5,000 that year. If the employer
elects to set up an IRA type of account, they can reduce the employer’s contribution to 1% but


                                                 153
may not reduce the participation to less than 3% for more than 2 years in any 5-year period.
This does not apply if they use the 401(k) format.

      Employees are immediately vested for 100%, and distributions from the plan are taxed as if
they were regular IRA distributions. A 10% penalty is imposed for early withdrawals, but there
is a 25% penalty if withdrawals are made during the first 2 years.

    The employer may exclude contributions from the employer’s income and are excluded
from the employee’s income. They are not subject to employment tax.

     Small Employer Tax Credit: The Act provides a nonrefundable tax credit for a small busi-
ness that adopts a new qualified defined benefit plan or defined contribution plan, SIMPLE
plan, or simplified employee pension. The credit applies to 50% of the first $1,000 in adminis-
trative and retirement-education expenses for the plan for each of the plan's first 3 years. Effec-
tive for costs paid or incurred in taxable years beginning after December 31, 2001, with respect
to plans established after that date.



           VARIABLE LIFE IN NON-QUALIFIED BENEFIT PLANS

     For years, life insurance products have been frequently used to fund employee benefits, in-
cluding non-qualified plans such as executive bonus plans and non-qualified deferred compen-
sation. When the base life insurance policy is combined with the investment features of the
Variable Life, it is relatively easy to meet the benefits needs of employees.

EXECUTIVE BONUS PLANS

     As a background, the Executive Bonus Plan (EBP) the employer gives a tax-deductible bo-
nus to a key employee or executive who then must pay taxes on the bonus, but uses the money
to purchase a life insurance policy. The employee is the owner of the policy and as such, ap-
points the beneficiaries and has availability to the cash values. Being life insurance, it provides
a death benefits, either during retirement or prior to retirement. The cash value may be used to
supplement retirement if needed.

     The EBP is the least restrictive of any of the benefit plans. Occasionally, the employer
wants to have more control of the policy, so an agreement between the employer and employee
is used, whereby the employee agrees not to access the policy’s cash values until specified re-
quirements (usually regarding length of service, etc.) are met. The employer agrees to continue
the funding as long as the employee is with the firm, These arrangements are known as Restric-
tive Endorsement Bonus Arrangement, or a REBA.

SPLIT-DOLLAR PLANS

    The employer and the employee share (split) the ownership of the premiums, death benefits
and cash values, thereby allowing the employer more control than with and EBP bonus plan.


                                                  154
When the employee retires, the employer is reimbursed for the contributions it has made to the
policy, and the employee then has full ownership of the policy. The employee then can use the
policy for future death benefits and/or supplemental retirement income.

NON-QUALIFIED DEFERRED COMPENSATION PLANS (NQDC)

    Under this arrangement, the employee agrees to defer a certain specified portion of their in-
come and employer credits this money, with interest, such funds to be paid to the employee at
time of retirement.

     The interest rate can be determined by basing it on the performance of the company, a stock
market index, an interest index, or on blended results of certain accounts, or by some other
method agreeable to both parties. Under ERISA rules, the investment vehicle remains as part of
the company’s general assets.

     Some companies prefer to fund their NQDC plans with mutual fund, stock, or even self-
funding, but life insurance can offer benefits not available in other funding methods, particularly
since life insurance cash values grow at a tax-deferred rate and loans/withdrawals can be taken
from the policy tax-free. Of course, the death benefit is income-tax free to the company in most
cases (they could have alternative minimum tax problems). Further, the policy can provide the
most unique of benefits used for funding, the recovery of the cost. Since the company is the
owner and beneficiary of the life policy, this plan provides maximum control while at the same
time, helping employee retention.

SUPPLEMENTAL EXECUTIVE RETIREMENT PLANS (SERPS)

     Under IRS Section 401(a)(17), companies can supplement the retirement income provided
to executives, as the amount of income that can be considered for the purpose of qualified pen-
sion plans, is limited to $200,000 in 2002 (indexed in later years). This limits the amount of
money that highly compensated personnel can receive in retirement income.

     Many companies offer their highly-compensated employees a Supplemental Executive Re-
tirement Plan (SERP) wherein the employer provides an additional bonus to be paid at time of
retirement. This amount is “unfunded” for ERISA purposes, so the funding vehicle remains as
part of the company’s assets. Therefore, the tax-deferred cash value, tax-free loans and with-
drawals, plus the income tax-free death benefit of the life insurance policy, makes life insurance
one of the best (if not the best) funding vehicles available.

     CONSUMER APPLICATION
     William is a Vice President of Ajax Corp. and has an annual income of $250,000. Ajax
pays its retirees 50% of their pay at retirement. William would receive $125,000. However,
according to the IRS regulations, in 2002, 40% is available, William would receive $100,000.
     William feels that he will have a difficult time maintaining his standard of living with such
a dramatic reduction in pay. Ajax agrees to provide a supplemental plan (SERP) which would
alleviate this situation, and the company would still control the policy and its benefits in case
William is tempted to join another company with perhaps a little higher salary.


                                                 155
                 USING VARIABLE LIFE INSURANCE FOR FUNDING

    Variable Life can prove to be a most unique vehicle for the funding of these non-qualified
programs. The tax-deferral growth, loans and withdrawals and the tax-free death benefit have
been discussed. The tax-free death benefits are particularly important in executive’s benefits.

     If the employee dies prior to retirement, the death benefit can be used to automatically
complete the plan, or provide additional funds to the employee'’ beneficiaries, and the company
can use the proceeds to recover the costs of the plan to the corporation since inception. And of
course, as discussed earlier in this text, the death benefits can be used as key employee cover-
age to help the company fund a search for a replacement. Again, no other funding vehicles can
offer these advantages.

WHY VARIABLE LIFE?

     These advantages are available with any permanent life insurance product. However, with
Variable Life , there are so many options and the plan is so flexible, there are unique advantages
to both the employer and the employee.

     To the employee, a Variable Life plan offers as many different investment options as a
401(k) plan – if not more. The wide choice of sub-accounts (some insurers offer 60 or more) is
quite attractive to an employee. When the Variable Life is used in an EBA, REBA or split-
dollar plan, the employee has direct control of the underlying investment choices that will have
the most impact on the cash values of the policy. If the employer agrees, the employee can have
some choices in the underlying investment options of a NQDC plan.

     Since the employer is both the policy owner and beneficiary, the employee cannot make the
actual fund choices or the employee would be in the position of having “incidents of owner-
ship” in the policy, and therefore, all the deferrals would become immediately taxed. But, the
employer can give the employee the option to allocate the deferral amount different investment
styles – such as between equity index, growth and income, balanced, etc. The employer then
allocates the employee’s deferral to the funds offered by the insurer that matches the generic
type of investment vehicle chosen.

     The advantages of flexibility, choice and control to the employer are important, but there is
one more significant advantage. With a NQDC plan funded by life insurance or Universal Life
insurance, the employer would have to choose a rate to credit the deferrals of the employees. If
the chosen fund did not keep up with the chosen interest rate, the employer would have to put in
sufficient funds to make up the difference.

     However, with Variable Life insurance, the employee’s deferral account would be based on
the performance of the policy’s sub-accounts, and this would be chosen by the employer. The
employee gains flexibility and choice and at the same time, the employer does not have to wor-
ry about having to fund the plan in order to meet the specific interest-crediting rate.



                                                 156
IRS NOTICE 2002-8, PROPOSED TAX REGULATIONS FOR SPLIT-DOLLAR PLANS

    One of the leading authorities on business and estate planning, James G. Blase, CPA, JD,
LLM, writing in industry publications, recently raised the subject of proposed new tax “re-
gimes” for employee-owner and company-owned split dollar plans.

     In Notice 2002-8, the IRS has taken two approaches to the taxation of split-dollar plans.
These proposed regulations, which appear to have no opponents, will not be effective until 2003
at the earliest, but they may be used today. These two approaches (called “regimes” by Mr.
Blase) are based upon how the arrangements are structured.

     Previously, the IRS maintained there was no difference for tax purposes between the collat-
eral assignment split-dollar plans where the employee is the policy’s legal owner and assigns the
policy to the company with the promise to repay the company for the portion of the premiums
that the company paid – and the tax rules which apply to the endorsement split-dollar where the
company is the policy’s legal owner but endorses certain interests in the policy to the employee,
such as naming beneficiaries of the employee’s portion of the benefit. The IRS proposes to tax
these two plans under mutually exclusive set of rules.

     Rather than entering a discussion at this point as to the new proposed tax rules, briefly
summarized, the proposed rules in respect to a company-owned plan, current life insurance pro-
tection would be treated as being provided by the company and taxed on this basis. If the em-
ployee is the owner of the policy, the company-paid premiums will be treated as a series of
loans by the company to the employee (if the employee is obligated to repay the company) and
taxed accordingly.

     The current life insurance will be valued according to proposed (and detailed) rules. The
IRS does propose that for existing split-dollar arrangements, entered into prior to Jan. 28, 2002,
the parties can terminate the arrangement without tax consequences if terminated prior to Jan 1,
2004.

     What will this mean? Experts maintain (correctly) that sound income tax planning requires
that whenever possible, any arrangement should never be structured to generate an item of taxa-
ble income without an offsetting income tax deduction.

     Notice 2002-8, when combined with the 2001 Tax Act, lowers individual income tax rates
relative to corporate income tax rates, over the next four years and will necessitate re-thinking
of tax strategies regarding life insurance in an employee’s benefit package. By 2006, the maxi-
mum federal individual marginal income tax rate will fall to 35% applicable to taxable income
in excess of $75,000. Corporate income tax of 35% applies to taxable income in excess of $10
million, with an effective 38 - 39% tax rate because of phase-out of lower income tax rates.




                                                 157
     Under the proposed tax law, the marginal corporate income tax rate will exceed the em-
ployee’s marginal tax rate. However, bonuses paid to C and S Corporations would be income
tax neutral.

     Experts in taxation, as a general rule, believe that the existing pronouncements of the IRS
on split-dollar plans, including Notice 2002-8, means not only that the company cannot deduct
premium payments on split-dollar plans, but also the company cannot deduct the value of the
current life insurance protection taxable to the employee. Therefore, any split-dollar arrange-
ment generating taxable income to an employee for the value of current life insurance protec-
tion, is not an income tax neutral plan. Where split-dollar plans are treated as loans from the
company will cause the person to be deemed to make annual nondeductible interest payments to
the company.

“PURE” BONUS APPROACH

      When a pure bonus approach is used to pay premiums on policies owned by the employee,
this is usually income tax neutral, and therefore should be used for S corporations, in particular,
and C corporations with taxable income in excess of $75,000.

     CONSUMER APPLICATION
     Ajax Corp. is in the 34% marginal federal corporate income tax bracket. Vice President
Sam is in the 30% marginal federal individual income tax bracket. Ajax has a split-dollar ar-
rangement, funded by life insurance, with Sam with annual premium of $10,000. The company
pays Sam a bonus annually of $15,000 for premium payment purposes.
     Ajax takes a tax deduction for the bonus, thereby costing Ajax $10,000. Sam will pay in-
come taxes of approximately $5,000 on the bonus before netting the $10,000 needed for the
premium.
     This arrangement is income tax-neutral as there is no net amount paid to the IRS after fac-
toring in the $5,000 income tax savings for the company.

    If the company wanted to be later reimbursed for after-tax cost of its premium and bonus
payments, the company could purchase a key-man life insurance policy on the life of the em-
ployee for this purpose. Since this policy would not be part of the arrangement with the em-
ployee, it is doubtful that it would be treated as a loan from the company to the employee.

     Also, the pure bonus approach means that since bonuses or premiums never need to be re-
paid to the company, the employee would not have to later use the cash value of the policy to
repay the company.

     This pure bonus arrangement would also work where the employee is not intended to get
the equity in the policy. Under the Notice 2002-8, those non-equity split-dollar arrangements
would be treated as either as taxable current life insurance protection to the employee; or an in-
terest-free loan arrangement where interest payments are considered as paid to the employee
which are not deductible by the employee, but taxable to the company.




                                                  158
     This would seem to indicate that consideration should be given terminating existing split-
dollar plans under existing rules before Jan. 1, 2004, and the pure bonus approach be used.
However, C Corporations with less than $75,000 in taxable income, because the employee
would incur higher income taxes that the company is receiving a benefit because of its income
tax deduction. If the company wants to provide the employee with the policy’s equity above the
total of the premiums paid, then the two-“regime” method may be preferred.

THE TWO-REGIME APPROACH

     At the start, the employee would be taxed on the value of the current life insurance protec-
tion. Then when the policy’s cash surrender value is equal to the total of the premiums paid, the
parties involved should then be able to switch regimes and tax the ongoing arrangement as an
interest-free loan from the company to the employee. According to the Notice 2002-8, and as
contrasted with previous such Notices, it does not appear to require the arrangement to be treat-
ed as a loan from the beginning of the plan in order to achieve loan treatment prospectively.

     Sometimes, it may be wise to convert the arrangement to the loan “regime” before the
break-even point (when the annual nondeductible deemed interest payment is less than the value
of the current life protection and the amount or this interest payment is not expected to rise sig-
nificantly higher than that level in the future – such as if significant future premiums are not ex-
pected and the applicable federal interest rate is not expected to rise significantly in the future
and especially if the full FICA taxes would be payable on the value of the current life insurance
protection.

SUMMARY

     This Notice 2002-8, if enacted (which it is almost certain to be) eliminates an agent from
using split-dollar plans to eliminate income tax on the equity build-up on behalf of the employ-
ee as part of an equity split-dollar arrangement without adverse income tax ramifications.
However, thanks to the new tax law that lowers the individual income tax rates in relationship to
corporate income taxes, usually funding life insurance benefit plans under the pure bonus ap-
proach will provide an income tax neutral approach as premiums are being paid on the policy.
This will allow the employee income tax-free access to the full cash value of the policy during
the employee’s lifetime, plus income tax-free protection of the death benefits.

    The income tax leverage resulting from the inclusion of life insurance as part of the em-
ployee’s benefit package, will remain after Notice 2002-8 is enacted, provided the arrange-
ment is property structured.

      NOTE: “Employee” as referred to above in this discussion, includes a shareholder that en-
ters into the arrangement.

     It is important that those who use split-dollar plans in planning with their client, obtain a
copy of IRS Notice 2002-8 and fully understand it in setting up such employee benefit arrange-
ments. If a tax accountant is to be used during the planning process, either by the client or by
the agent, it would be wise to make sure that the accountant is knowledgeable about this Notice.



                                                  159
                                  KEOGH PLAN (HR 10)

     The Keogh ace was first passed in 1962. It permits the self-employed person to establish
his/her own retirement plan. The self-employed can make nondeductible voluntary contribu-
tions and tax deductible contributions, subject to a maximum limit of 25% of earned income, up
to a maximum of $30,000 for a defined contribution to the Keogh Plan. This is an equivalent
rate of 20% of earned income prior to the contribution of the Keogh Plan

    There are 4 types of Keogh plans:

1. Defined Benefits: As with all Defined Benefit plans, it defines the benefits that is to be paid
   from the plan. The individual is promised a fixed benefit, and the contributions are based on
   the amount that is actuarially needed to provide such benefit at the retirement age.

2. Profit Sharing: The individual may contribute to the plan, and deduct the lesser of 15% of
   the individual’s self-employment income or $24,000 (inflation indexed) into the profit shar-
   ing plan. Usually, contributions to a profit-sharing plan are based upon profits out of the
   company and can therefore vary from year to year.

3. Money Purchase Plans: As with other money purchase plans, the individual may contrib-
   ute up to the lesser of 20% of their self-employed income or $30,000, each year (indexed).
   They can contribute a higher annual amount than under the profit-sharing plan, but a certain
   amount of flexibility is lost because the contribution is mandatory. The benefits that will be
   received are based only on the contributions to the account and the earnings of those contri-
   butions.

4. Combined Profit Sharing & Money Purchase Plans: By combining the two plans, the
   individual may make discretionary contributions of 12% from the profit-sharing plan por-
   tion, and a mandatory contribution of 8% under the money purchase portion. The maximum
   combined deductible contributions are the same as for the Money Purchase plan.


                         TAX DEFERRED ANNUITY - 403(B)

    The Tax Deferred Annuity is generally referred to as the “TSA,” but it also includes 403(b)
and 501(c)(3) plans. These are all plans that are offered only to employees of certain specific
nonprofit, tax-exempt organizations and public schools as outlined in the Internal Revenue
Code, Sections 501(c)(3), 414(e) and 170(b)(1).

     Under these sections, “annuities” refer to the fact that the distributions are made in a series
of installments. The IRS Code Section 403(b) is the section that gives the tax-favored status to
these plans. Basically, TSA contributions are made on a before-tax basis (federal income tax),
and accumulate tax-free (federal income tax) until distributed. Some states also defer taxing of
TSA’s, but not all states do this.


                                                   160
    Under the Federal Rules, TSA contributions can come from employees by voluntary salary-
reductions. They will receive favorable income tax treatment if they are properly funded by any
combination of fixed or Variable Annuity contracts, or the shares of open-ended or closed-ended
investment companies. In some states, life insurance can be used as an incidental TSA benefit.

     The plans must be non-discriminatory if mutual funds are to be used as an investment op-
tion or if the employer is making matching or discretionary contributions to the TSA (in addi-
tion to the salary deferrals by employees). The amount of each participant's annual contribution
that will be allowed to escape current taxation is determined by a formula, called the “Exclusion
Ratio.”

    The Exclusion Ratio is:
                         . Amount Invested in the Annuity
                            Expected Return under Annuity.

    (where the expected return under the annuity equals the life expectancy of the annuitant –
     times – the annual income payment)

     CONSUMER APPLICATION
     Rush had invested $40,000 into an annuity. At age 60, he has life expectancy of 14 years.
He receives an annual income of $5,000. Therefore, 57.14% of each income payment would
not be subject to taxation.
     Amount Invested in the Annuity: $40,000
     Expected Return under Annuity: 14 years – times - $5,000 = $70,000
                        $40,000 divided by $70,000 equals .5714 (57.14%)

     The “Amount Invested in the Annuity” is defined as the “cost basis” of the amount the in-
dividual has personally paid into the annuity and upon which income taxes have already been
paid. An individual may fund the cost basis by life insurance, whereby the pure Term Insurance
cost is taxed to the individual in the year in which each premium payment is made.

     The “cost basis,” i.e. the “Amount Invested in the Annuity” can be continued after the indi-
vidual ceases to be an employee for 501(C)(3) or 403(b) purposes, continue to make payments
after the employer ceases to be a 403(b) plan sponsor. Also, if money has been borrowed from
the TSA plan, if the amount is repaid the cost basis will continue. If an individual had owned
the annuity and had made contributions (nondeductible) to it before it became part of a TSA
plan, they can obtain a cost basis.

     When distributions are made, the benefits will be taxed as ordinary income, except that a
portion of the proceeds may be excluded from federal income tax as “cost basis”

    Qualified participants are usually only employees of 501(c)(3) organizations and public
school systems. Care must always be taken that an employee is in fact an employee and not an
“independent contractor.” Many persons who perform services for educational institutions, or
doctors, who use hospital facilities, are contractors under the law, and not “employees.”


                                                 161
     NOTE: If an individual with an IRA, Keogh plan, or other type of tax-advantaged plan,
uses municipal bonds as an investment for the retirement plan, there are some situations that
must be taken into consideration. If the municipal bonds are issued by the state or municipality
of residence of the individual, there are no taxes paid on the bonds. However, if the bonds are
put into a tax-deferred retirement account, the income that is earned becomes taxable when the
individual receives the money from the plan. Therefore, the individual has converted a tax-free
investment into a low-earning taxable investment!

     Similarly, it is also recommended that the individual remember that Series EE U.S. Savings
Bonds are taxed at the federal level, but at time of redemption. Also, there is no state income
tax. Therefore there is no real reason to include them in a tax-advantaged retirement plan. If
they are put into the retirement plan, they are subject to tax at the time of disbursement from the
fund.

                          GOVERNMENT RETIREMENT PLANS

     As indicated in the previous sections, the government continues to pile one retirement pro-
gram on top of another with the resulting plethora of acronyms – 401(k), 403(b), 457, traditional
IRA, Roth IRA, SIMPLE, SEP, etc. This has resulted in some interesting statistics from those
who are working, regarding what they are doing for retirement and how they plan on saving for
their “golden years.”

     The vast majority of working Americans, ages 22 to 52, say they are confused about how to
save and invest for retirement. And about a third of Americans, who haven’t even started saving
for retirement, cite confusion as a major reason. As a matter of fact, about a third of those eligi-
ble for a Roth IRA say they haven’t opened one because they are too confused about the rules.

      86% of all workers eligible to contribute to a company-sponsored 401(k) plan, do so, which
is approximately 30 million Americans, and they contribute about $1.4 Trillion! However, sta-
tistics also indicate that only 55% of Baby Boomers (those who are ages 34 to 52) contribute to
a 401(k). There are a wide variety of reasons as to why they do not contribute but not surpris-
ing, 57% of Baby Boomers are concerned that they will not have enough to retire on. Baby
Boomers actually got a late start in saving and investing for retirement, as most of them had
considered that the “government” or their employers would take care of them in retirement
without any effort on their part. Even today, the typical Baby Boomer contributes $284 a month
to a 401(k) plan, while the “Generation X” individual contributes $224. This is probably why
that after the long bull market in the 1990’s but before the recent market slide, the average
Boomer has only about $50,000 – and probably some less now, in view of the market volatility -
saved in their 401(k) account.




                                                  162
     CONSUMER APPLICATION
     Pamela is a medical technician in her mid 30’s who has worked at various jobs throughout
her state for more than 10 years.
     Her first job was at a public hospital where she worked long enough to qualify for a tradi-
tional pension plan (although quite small). She also contributed to a tax-deferred 457 retirement
plan (a 401(k) type of plan used for those working for public institutions or entities)
     She then went to work for a doctor’s office in her hometown, but it did not offer a pension
plan but did offer a 401(k). She contributed 15% of her salary to the plan.
     The doctor was bought out, so she went to another public hospital and back to a 457 plan.
     About a year later, she was offered a good position with a nonprofit hospital, where she
was able to contribute to a 403(b) (similar to a 401(k) but with different investment options and
different rules).
     During this period of time, she opened a traditional IRA, and then later converted it into a
Roth IRA with a Mutual Fund. She also opened another Roth IRA with another mutual fund
group. In addition, she acquired other mutual funds that are not in retirement accounts.
     At this point in time, unless there is portability legislation enacted, she will find herself
writing to all of the companies trying to determine how much she has in each account, how
much she can withdraw, and when she can withdraw it.




                            CHAPTER 9 – STUDY QUESTIONS



1.     An individual who has contributed to an IRA can begin to receive payments when they
       reach age
       A.      71.
       B.      59 ½ .
       C.      55.

2.     The major difference between a regular IRA and a Roth IRA is
       A.      how and when the accumulated funds are taxed.
       B.      different financial investments available.
       C.      in a Roth IRA the owner must start taking the funds at age 65 and in a regular
               IRA the funds must start before age 70 ½.




                                                 163
3.   With an IRA
     A.     the owner may borrow against it.
     B.     married couples who have earned income can contribute to an IRA.
     C.     contributions must be to a bank.

4.   A life insurance plan that keeps on paying the compensation of an employee after they
     have died is called a
     A.     buy-sell agreement.
     B.     salary continuation plan.
     C.     401(k) plan.

5.   In order to receive the maximum tax benefit from a deferred compensation plan, the
     funding must be
     A.     in Treasury bills.
     B.     annuities.
     C.     cash value life insurance.

6.   Under the defined benefit retirement plan, the fixed dollar approach can be distributed in
     the following manner
     A.     cost of living plan.
     B.     equity annuity plan.
     C.     flat amount plan.

7.   In order for an employee to receive benefits from a retirement plan, they must be “vest-
     ed” in the plan. This means
     A.     the employee has contributed as much as the employer prior to retirement.
     B.     the employee has worked a sufficient length of time to own either a part of or all
            of the employer contributed funds.
     C.     the employee has contributed enough to get back all of the contributions in the
            event of death.

8.   If an employer has 20 employees, how much can the employer contribute per employee,
     to a Simplified Employee Pension Plan?
     A.     15% of gross wages or $24,000 whichever is less.
     B.     30% of gross wages or $160,000 whichever is less.
     C.     15% of gross wages or $7,000 whichever is less.




                                               164
9.     The “Split-dollar” plan was developed so that
       A.     an employee could get more life insurance and the employer would pay a portion
              of the cost (usually one half).
       B.     the client could pay equal amounts into a life insurance policy and an annuity.
       C.     the client would make one payment, each month, to an insurance company and
              the insurer would split the benefits between life insurance and health insurance.

     10.      Why is it not a good idea to use Municipal Bonds to fund a retirement plan.
       A.     The interest is so low that it would be better to pay taxes on a higher yielding in-
              vestment.
       B.     The interest earned, although tax free when paid, if allowed to accumulate will
              be taxable at time of receipt of the retirement money.
       C.     Municipal Bonds are not allowed to be used in a retirement plan.



     ANSWERS TO CHAPTER NINE REVIEW QUESTIONS
     1B 2A 3B 4B 5C 6C 7B 8C 9A 10B




                                                 165
     Estate planning is the process of creating a master plan for the disposition of an individual's
assets, which involve the disposition of such assets at death, and may also involve lifetime
transfers of property. When planning to dispose of one's assets many things must be kept in
mind:

              Limit administration costs
              Limit tax liabilities
              Facilitating timely payment of estate obligation and taxes
              Satisfying the desires of the estate owner as to property distribution

     Many individuals initiate estate plans for the purpose of tax planning. However, as the plan
develops, a much more comprehensive view emerges with the emphasis on the safeguarding of
assets for the benefit of heirs, playing the critical role.

      In everyday life, estate planning involves people - spouses, children, grandchildren, favor-
ite family members and close friends. Estate planning is attempting to provide for an individu-
al’s security and prosperity without the "bread winner.” Estate planning has also been labeled
“a bundle of taxes - state, federal, income, death and gift - with an army of Lawyers, Account-
ants, Insurance people, Banks and Financial Planners to help administer the estate.”


                 EIGHT COMMON PROBLEMS IN ESTATE PLANNING

1. Tax liability. Although a major concern, it should not be the primary objective of estate
   planning. Estate disposition must be planned to reduce potential tax liability to the lowest
   level consistent with client’s needs/goals.

2. Outdated plan. The Will must be reviewed periodically to stay consistent with client's most
   recent intentions.

3. Psychological impediments. There are two: (1) Dealing with one's own mortality, making
   an estate plan requires the client to acknowledge the fact that the client is going to die even-
   tually. (2) Procrastination, as the client puts off planning an estate because of the magnitude
   of the task.

4. Failure to plan. If a person dies intestate (without a valid Will) state law of succession will
   govern property disposition. A Will is a legal instrument indicating a person's desire of dis-
   position of property after death. Wills need to be periodically reviewed and updated to en-
   sure the property owner's most recent interests are handled correctly at death.

5. Improper position / Ownership of assets. The estate tax liability is calculated on the asset
   ownership form of when the owner's death occurred. (Tenants in common, joint tenants with
   rights of survivorship, etc.).


                                                  166
6. Effects of inflation. What seems to be an adequate sum in terms of today's dollars may have
   little real purchasing power in the future.

7. Lack of liquidity. There are three main considerations in assessing liquidity needs:

   A. Types of assets making up the estate.
   B. Amount of estate owners debt obligations.
   C. Projected estate tax liability.

8. Disability / Last illness. Cost of a lingering illness or disability may eat up valuable estate
   assets. Medical expense and disability insurance should help with these costs thus saving as-
   sets.


                        OBJECTIVES OF ESTATE PLANNING

     There are four distinct objectives of a proper estate plan. Many times a plan is perceived as
only having one or possible two of those objectives. Since there may be different specialists
involved in the Estate Planning process, such as Attorneys or Accountants, an individual should
be sure to not only realize such shortcomings in a plan, but to safeguard against it. A truly com-
prehensive estate plan will address all four of these objectives:


                                      CREATE LIQUIDITY

        Liquidity means the ability to convert assets to cash without giving up value. Because
of death and its related costs that must be paid within a short time following death, one must be
absolutely certain that the estate has sufficient liquid assets to cover such costs. Realistically it
would seem that the annual increase in the cost of dying has exceeded the annual increase in the
cost of living. Costs of burial plots, cemetery monuments, funeral director's fee and attorney
fees have risen. Thus, if an individual’s estate presently lacks liquidity, it can be assumed that
the liquidity problem would continue to increase in the future.

    The need for liquidity arises because of four general grouping of expenses materialize upon
death. These expenses generally must be paid within one year of death.

    A.           Administration expenses - these are the expenses of opening, administering and
         closing the decedent's estate. Executor's fees and fees for the Executor's attorney repre-
         sent the majority of expenses. Other expenses will include Court costs; costs of apprais-
         ing estate property; costs of insuring estate property while estate is opened; maintenance
         or repair of estate property; expenses of defending a Will contested by disgruntled heirs;
         auction fees; and the cost of administration. Studies of I.R.S. statistics reveal that these
         expenses will shrink the estate by 4 - 5%.




                                                   167
     B.      Indebtedness of the decedent - mortgages are usually the most significant debt.
      Many families will want to retire the mortgage at the death of the first spouse so that the
      surviving widower and children are not burdened with this debt.

            Other debts would include automobile loan balances, credit card accounts and
       other installment credit, and final expenses of the decedent's last illness. Accrued
       taxes would also be considered debt. This would include accrued but unpaid in-
       come taxes, (federal, and state, local); property taxes and any other taxes, which
       the decedent had incurred but not, paid. It should be noted creditors have a limited
       period of time in which to file claims against the estate. The Executor then has a
       period of time, usually the first six months after death in which to decide the validi-
       ty of such claims and settle or pay them. Debts will vary according to the estate
       but they (generally) average 5 - 6% of the total estate.

     C.       Funeral expenses and related costs are a major cause of shrinkage. Expenses
      paid to funeral homes, burial expenses, tombstone, monument or mausoleum expresses,
      the cost of a burial plot, the cost of transportation of the body, florist's fees and prepaid
      expenses for future care of the burial site are all included.

     D.       Death taxes, federal and state, are another cause of estate shrinkage. Such taxes
      are important in the large, unplanned (or poorly planned) estate. The federal estate tax
      rates are progressive, so a higher percentage of the larger estate is forfeited to taxes un-
      less steps are taken to minimize this. If an estate is subject to the federal estate tax, it
      will be taxed at a marginal rate and must be paid within nine months of death. This tax
      was overhauled in 2001 and the exempt amounts increase each year until it reaches zero
      (there is no estate tax regardless of size of estate) in 2010.

    In summary, an estate that is not liquid may have to borrow in order to provide living allow-
ances for spouse and children and to pay estate obligations. Sometimes the value of estate as-
sets rises or falls dramatically due simply to the owner's death. Thus, the death of an artist, au-
thor or entertainer often increases the values of his/her work. On the other hand, the death of a
business owner has the opposite effect.

SOLUTIONS TO LACK OF LIQUIDITY

       There are two ways to solve the liquidity problem: (1) minimize the need for cash at the
time of death and (2) create additional liquidity at death. By minimizing the need for cash at the
time of death a proper estate plan should avoid Probate and reduce taxes. If, after achieving this
objective the estate will probably still have liquidity problems, then the proper estate plan must
find a way to create additional liquidity. Life insurance is probably the best way because of its
unique characteristic of maturing at death just when it is needed the most.




                                                  168
                                   AVOID PROBATE COSTS

     Since Probate expenses tend to vary directly with the size of the Probate estate (the assets
passing under the decedent’s Will), actions, which reduce the size of the Probate, also reduce
Probate's costs. Probate avoidance has become a routine and long overdue part of estate plan-
ning.

     Probate is the legal process of passing ownership of property from a deceased person to an-
other. Probate Courts have been a part of our legal heritage for centuries. Generally speaking,
every county in every state in the U.S. has its own Probate Court. These courts all have the
same purpose - passing ownership of property to the heirs of people who died with a Will plan
or with no plan at all.

     One must understand that if one dies either with a Will or without (intestate), the Probate
process begins. Getting the decedent's property into the hands of his/her beneficiaries or the
state's beneficiaries is but one part of the Probate process. The Probate Agent (Executor / Ad-
ministrator) is responsible for most of the work to be accomplished in the process. The Agent
will report and answer to the Probate Judge through the Estate's Attorney. There are four prob-
lems with Probate:

          1.   Probate is public. The process can be played out in the media thus creating more
               problems.

          2.   Probate is time-consuming. Anywhere from nine months to 10 years has been
               documented.

          3.   Probate is expensive. It is not uncommon to see shrinkage of 10% of the
               estate.

          4.   Probate puts the real control in the judge’s chamber.


                                        REDUCE TAXES

     To the extent one can reduce the tax bite at death, the estate will not need extra liquidity for
tax payments thus conserving estate assets for the decedents dependents and heirs. As with
Probate avoidance, tax considerations should not drive everything else. The estate owner should
not engage in "off the wall" estate planning techniques which may save taxes but which would
be inconsistent with the individuals fundamental objectives.

     There is a tendency among some financial planners to consider and plan for federal estate
tax consequences. However, the total situation should be evaluated, including the Federal In-
come Gift Tax and estate taxes and any other applicable estate income, gift and death taxes.




                                                   169
                   DOCUMENTS USED TO DISPOSE OF PROPERTY

    Transactions and techniques in the estate planning area are subject to more formality than is
usual in the normal course of personal and business affairs.

    If the proper formalities are not observed a well-planned estate plan may fail in the imple-
mentation phase. There are five areas where these disposition techniques are critical.

          1.    Some states honor Wills written by the individual’s own hand (holographic
               Wills), and even oral Wills (nuncupative Wills), but it is always a good idea to
               have a Will typewritten and executed in accordance with state law requirements.
               "Home Made Wills" may be valid but often times fall into trouble when the wit-
               nessing requirement is not met, which could invalidate them.

          2.   Deeds for real property are also subject to proper formalities and must normally
               be recorded in the office of a designated local official.

          3.   Trust agreements are contracts and must comply with the rules for valid and en-
               forceable contracts. The chief advantages of trusts are professional management
               of assets by the trustee; potential income tax and estate tax savings if the trust is
               irrevocable, control over disposition of trust income and principal through the
               trust terms or discretion vested in the trustee, and the flexibility possible in trusts
               design so that virtually any plan of disposition can be achieved.

          4.   Lifetime gifts should also be looked upon as a disposition device. Gifts are a
               way of disposing of an estate before death but are potentially subject to the fed-
               eral gift tax and to state gift taxes in a few states. Gift tax avoidance or minimi-
               zation is a critical part of lifetime gift planning. Gifts may be made in a variety
               of ways - outright transfer, transfer in trust, transfer into joint names, etc.

          5.   Jointly owned property is an area that needs particular care for disposition.


     CONSUMER APPLICATION
     Fred and Mabel Snow are husband and wife who recently purchased the Gayety Theatre.
When the title was transferred, the new owners were shown as “Fred and Mabel Snow.” They
wanted the property to pass after the death of the first spouse, to the other spouse. However, in
the state in which they resided and where the Theatre was located, the courts would treat this as
a tenancy in common without rights or survivorship. If the title stated “Fred and Mabel Snow,
husband and wife,” the property would be considered as tenancy by entirety with right of survi-
vorship.




                                                   170
                            ESTATE PLANNING PROCESS


                    1. DATA MUST BE GATHERED AND COMPILED

       Financial Planning, and in particular Estate Planning, concerns people as well as property
and must be highly personalized. The planner must have information such as the client's domi-
cile, identification of family members, and an inventory of the prospect's property. Family facts
should include general identifying information as well as personal characteristics, behaviors,
and overall health. The planner must have a feeling for the attitudes, expectations, and wealth
of the different family members.

     Identifying Assets and liabilities is usually the most challenging task. This part of the pro-
cess may be quite detailed and can only be effective with accurate facts and figures.

     Identifying current plans is an important step. Copies of Wills and trusts should be gath-
ered, objectives should be noted, discussed and recorded. Definite and specific objectives are
the goals of fact-finding, which can only be achieved through comprehensive interviews with
family members, other client advisors, and the client. After an exhaustive interview process the
planner and client can proceed to the next logical step: Identifying the Problems. A general
guideline for a financial planner to remember is that plans become inconsistent for three general
reasons:

1. The client provides incorrect information.
2. The planner assumes too much.
3. The planner fails to uncover important facts.

    As the financial planner develops his/her practice, a comprehensive fact finder will help
avoid many of these problems. Many planners double their fact-finding forms as a computer
input form which saves time in transferring the data to input sheets for computer calculations.
As one can imagine there are many fact-finding forms used today, ranking from 3 pages to over
40 pages. Some planners ask clients to complete such forms after the first interview and bring
the completed data form to the next interview. Some planners, on the other hand, will request
the data form be completed prior to the first interview. Regardless of when the form is com-
pleted it is a crucial tool for the financial planner in the initial steps of estate planning prepara-
tion and must be completed before any other steps are taken.


                            2. IDENTIFYING THE PROBLEMS.

    The area of identifying and evaluating problem situations create problem areas:

        Is Probate necessary or should a trust be implemented?



                                                   171
        How much should be set aside for the last illness and burial expenses?

        What are the projected costs and fees to be incurred at death?

        What percentage of shrinkage will the estate suffer?

        What debts will come due at death?

        Are there any charitable requests?

        Is there any business interests? If so, how will the interest be handled at death?

        How much will taxes take and how will they be paid?

     By identifying the various areas of concern in the estate plan, the planner will be able to
call upon the estate planning team (life underwriter, accountant, attorney, banker, advisor) for
assistance in solving such problem areas.


                                3. DEVELOPING THE PLAN

     Once the fact-finding has been completed and the proper questions asked leading to prob-
lem areas the planner must now exercise creativity. The planner must help the client find ways
to meet objectives, through the process of elimination and trial and error. Thus, an action plan
can be created to make necessary corrective solution. The ultimate concept is "what will work
best,” not necessarily "what will work.”

     Once the plan is developed, it must be tested. Does it satisfy the needs of estate liquidity?
Are the retirement objectives being met? Does the plan dispose of assets the way the client
wishes? Are the needs of the survivors met? Will the plan minimize the shrinkage of the es-
tate? If all these questions are affirmative, then the plan could pass the test of time.


                                 4. PRESENTING THE PLAN

    When the plan is completed the planner should meet with the client and spouse. This
should be a face-to-face meeting, either at the planner's office or client's home.

     In today's litigious environment it would be advisable to have a checklist of the various
changes suggested and have the clients initialize that the changes were reviewed. When opening
the presentation, the planner should restate the assumptions and key facts on which the plan is
based.

    Do not assume that the client will remember all-or-any of prior discussions. The planner
must reiterate that the plan was molded around the clients input and objectives and not devel-
oped in a vacuum. Finally, any action steps recommended by the planner should be reviewed


                                                  172
and analyzed as to time frames when instituted. Once this is completed the needed steps of im-
plementation have been satisfied.

     The final stage of presenting the plan is to have the client's acceptance. If the client has ob-
jections, the planner's duty is to uncover the reason for the objection. Did the client understand
what was being asked? Possibly an objection might be a "smokescreen" hiding another objec-
tion. Is the client uncomfortable with any of the recommendations? If so, why? The planner
should not be hesitant to probe further and determine the true reason for any problem.

     In many situations the planner must go "back to the drawing board" and implement chang-
es. With a revised plan a second presentation will be needed. Usually, the revised plan will de-
fuse any further objection and the plan will be accepted. Please note that although the client
might not have accepted the first plan, this is not an adverse reflection on the planner. It is im-
portant to remember that the client's wishes are paramount and it is of primary importance to
develop a plan that satisfies the client's needs and objectives.


                               5. IMPLEMENTING THE PLAN

       Once the Plan has been accepted, the planner's responsibilities are only half-completed.
The professional planner must now prove his/her worth by insisting that the accepted recom-
mendations be implemented in a timely fashion. Several steps are usually needed in Plan Im-
plementation such as:

          a.   Various tax-motivated strategies might need to be implemented. The client's ac-
               countant should be consulted, and become appraised of any such situation.

          b.   Insurance products could be needed for retirement income, estate liquidity, estate
               creation and survivor income.

          c.   An attorney must prepare any necessary legal documents, such as Wills, trusts,
               and sale or purchase agreements.

    The financial planner must perform the needed duties as he/she coordinates the implemen-
tation of the plan. The planner is looked upon as the "quarterback" who will make certain that
the needed actions do, in fact, take place. The planner should help the client shop for financial
products and work with the advisors as the need arises.




                                                   173
                                          SAMPLE ACTION CALENDAR


         WHAT                                                WHO                  WHEN

   1. Draft a codicil to the client’s                      John Birnbaum           Feb. 10
      Will to change specific legatees,                    Esq.
      And to name a revocable trust
      As residuary legatee.

   2. Draft the revocable pourover                         John Birnbaum            Feb. 10
      trust referred to in # 1 above.                           Esq.

   3. Review codicil and trust.                            Ross Perot              Feb. 20
                                                           VP and Trust Officer

   4. Execute the documents                                John J. Client          Feb. 28
      referred into # 1 above.

   5. Select and recommend                                 Bernie Seratan, CLU     Mar. 1
      life insurance for estate
      liquid needs.

   6. Purchase life insurance                              John J. Client          Mar. 15

   7 . Purchase tax-exempt                                 John J. Client          Apr. 10
       Mutual fund shares

   9. Open a self-direct IRA                               John J. Client          Apr. 15
      For retirement income needs.




                           6. REVIEWING AND UPDATING THE PLAN

     The final step of the Planning Process is a periodic review and update of the plan. Laws
change, tax codes are modified, but most importantly, client's situations change. Keep in mind
that the economy is cyclical and what seems appropriate today may be considered a major mis-
take years down the road. People tend to move around constantly and planning problems can be
triggered by such mobility.

    Through periodic reviews such changes and their negative impact on estate plans can be
minimized. Inflation and its impact on estate planning must be monitored. If a higher-than-
actual average rate of inflation was assumed, this would obviously have a positive influence on
expected financial needs, such as retirement income, survivor income and college educational
needs. However, if the trend was reversed the client's needs could be woefully under-funded
and additional funding is needed.




                                                     174
     Tax law changes have always been an enormous hindrance to estate planning. There has
been twenty major federal tax Laws enacted since 1974. In addition, there are many minor tax
laws and regulations. It is apparent that the estate plan cannot remain a static plan as it will only
solve yesterday's problems, not today's. The plan must be reviewed and kept up-to-date through
periodic reviews specifically due to the constraints imposed by current tax laws.

       The client's personal, family and financial circumstances and priorities also change as
time passes. Children become financial independent. Client's parents might necessitate a help-
ing hand from younger family members. People come into inheritances or windfalls and also
experience sudden financial reverses. Domestic relations between client and family may
change. Client objectives could change for no apparent reason other than the client themselves
changed. The only thing that a planner can count on is that situations will change.



             LIFETIME TRANSFERS - GIFTS AND THE GIFT TAX


                                         INTRODUCTION

    Lifetime gifts can be effective estate planing tools that can result in substantial tax savings
and provide a source of personal satisfaction to the donor.

      As an insurance agent, it is important to at least understand the basics of the gift-tax laws,
as life insurance can be considered as a gift in some situations. When one uses life insurance as
a vehicle in financial or estate planning, care must be taken so that gift taxes are not involved as
a result of the insurance.

     A gift by transfer will avoid long delays and/or will not be subject to attack by estate credi-
tors or disgruntled heirs. Also, the original owner is relieved of any property management by
transferring the property during life. This can be very important to elderly clients. Since Wills
become a matter of public record after death, lifetime gifts provide an alternative means of
property disposition in which privacy is important to the individual.

     One major factor to be considered involves the removal of highly appreciating assets from
estates. The key is picking assets, which will actually appreciate in value. If a highly apprecia-
tive asset is given to a spouse, and the giftor dies first, the asset with all its appreciation will not
be subject to estate tax on the giftor’s death. The asset and its appreciated value will be subject
to estate tax on the surviving spouse’s death. If a person gives highly appreciating property to
someone other than his/her spouse, effectively both the assets and all its future appreciation will
be removed from the estate of either spouse.

     If one gives highly appreciating property to someone other than the spouse, they may pay
federal gift tax on its value as of the date of the gift, but neither husband nor wife nor their re-
spective estates will ever pay federal estate tax on the appreciation of the property.



                                                    175
     An additional consideration in making lifetime gifts involves reducing federal income tax.
If one owns property, which generates taxable income, they may wish to give the property to
one or more family members who are, or will be, in lower federal income tax brackets.


                                     GIFT GIVING BASICS

     A gift is defined as any transfer of property for which the giver receives less than the full
value in return. To the extent the transfer is for less than full value, a gift has been made. Intent
or desire to make a gift is generally irrelevant for federal gift tax purposes. The mere act of de-
livering the property to its recipient is enough to create a gift subject to federal gift tax laws. A
person who makes a gift is called a "Donor,” and the person who receives the gift is "Donee.”
Three criteria must be met for a transfer to qualify as a gift.

   1.   There must be a transfer for less-than-adequate consideration.

   2.   Donor must deliver the subject matter of the gift.

   3.   Donee must accept the gift.

       The valuation of a gift is the equal value of property transferred minus consideration re-
ceived when property is transferred for less than “adequate and full consideration in money and
money's worth.” The definition of “adequate and full consideration" in money or money's
worth is that the consideration given must equal the value of the property transferred.

POTENTIAL PROBLEMS WITH COMPLETED TRANSFERS

     Incomplete delivery occurs when technical details are left out or when a stage in the trans-
fer process is not completed. With incomplete delivery requirements there are usually four situ-
ations that may occur to create an incomplete delivery:

          1.   A gift made by a dying person who later recovers is an incomplete transfer; the
               gift is not complete until the donor's death.

          2.   A Gift of money made by check is not complete until the check is cashed.

          3.   When one party transfers money to a joint bank account with another individual,
               the gift is not complete until the other joint tenant withdraws the funds.

          4.   Transfer of U.S. Government Bonds is governed by Federal rather than State
               Law. Therefore no completed gift has been made until the registration is
               changed in accordance with Federal Regulations.

   Another potential problem with a completed transfer would be the cancellation of notes. A
donor transfers property then takes back notes from the donee. If the donee pays off the notes,




                                                   176
 the transaction is a sale. However, if the donor forgives (cancels) the notes, the transaction is a
 gift.


       Special note: If a debtor/creditor are unrelated and the debtor performs a service for the
creditor as a repayment for the note, a gift has not been made when the creditor cancels the note.
The cancellation is a form of income to the debtor for services rendered.

       The third problem area for completed transfer would be incomplete gifts in trust. Property
transferred to a revocable trust (that is -the donor retains the right to revoke the transfer) is not a
completed gift. Only when the trust becomes an irrevocable (donor gives up all retained con-
trol) is the gift completed. For example, a Totten Trust (Bank savings account where donor
makes deposit for donee and keeps the savings book) is revocable.


                                        TYPES OF GIFTS

    There are two types of gifts, direct and indirect gifts.

DIRECT GIFTS

    Direct gifts come in four basic forms:

           1.   When cash/tangible personal property is transferred from one individual to an-
                other.
           2.   An author gives a right to future royalties to another (this type of transfer is taxed
                as a single gift, valued on the date the right to future income is given).
           3.   Forgiving a debt in non-business situations.
           4.   Payments in excess of support obligations.

INDIRECT GIFTS

    While there are many situations, six of the more popular indirect gifts are illustrated.

    1.   Paying someone else's expenses such as making car payments for an adult child, life in-
         surance premiums, etc.

    2.   Shifting property rights

    3.   Third party transfers.

    4.   Creating a family partnership in which some family-member partners provide no ser-
         vices/assets.

    5.   Transfers by/to corporation (e.g., a transfer to a corporation for inadequate considera-
         tion is deemed a gift by the transferor to the other corporate shareholder).



                                                    177
    6. Life insurance is an indirect gift if the insured buys a policy on his/her own life and:
       A.        Retains no reversionary interest.
       B.        Makes the beneficiary designation irrevocable.
       C.        Names a beneficiary other than own estate.

    If an insured makes an absolute assignment of a policy or in some way relinquishes all
rights and powers in a previous policy, a gift is made which is measurable by the policy's
replacement cost. This can lead to a tax trap.


                                  GRATUITOUS TRANSFERS

   There are three categories of gratuitous transfers that are not considered gifts:

       1.        Property/Interest in property that has not been transferred.

       2.        Transfers in the ordinary course of business.

       3.        Sham gifts.

PROPERTY/INTEREST IN PROPERTY MUST BE TRANSFERRED

     Property that has not been fully transferred obviously cannot be considered as the property
of the intended recipient.

SERVICES NOT CONSIDERED AS A GIFT

   Property does not include services rendered gratuitously. Even though services are of eco-
nomic benefit, no gift tax will occur.

DISCLAIMERS

   An intended donee refuses to take the gift. A qualified disclaimer is not subject to a gift tax.
There are four requirements for a qualified disclaimer:

            1.   Intended donee must refuse in writing.

            2.   Written refusal must be received by transferor/representative within nine months
                 after date of transfer or date the disclaiming donee is age 21, whichever is later.

            3.   Disclaiming donee must not have accepted any benefits of the gift (including in-
                 terest).

            4.   Because of the refusal, someone else must receive the property interest.




                                                   178
PROMISE TO MAKE A GIFT

    A promise of a future gift is not taxable. (Only when the promise is enforced does the prom-
ise become capable of valuation and subject to gift tax).


               TRANSFERS IN THE ORDINARY COURSE OF BUSINESS

     An ordinary business transaction is a bona fide transfer of property, made at arm's length
and free from donating intent.

COMPENSATION FOR PERSONAL SERVICES

      There is a gift tax on transfers from corporate employers to individuals as compensation for
personal service if payment is made as a legal/moral duty or in anticipation of an economic ben-
efit. Donating intent on payments to employees is determined by:

   1.   Length and value of employee's services.

   2.   How the employer determined the value of the payment.

   3.   Whether the payment was deducted as a business expense.

BAD BARGAINS

    A transfer for less than adequate consideration made in the ordinary course of business is
not taxable as a gift (for example, the selling of stock to key employees at less than fair value,
as an impetus to heightened performance is not a gift).

SHAM GIFTS

     Refers to a transfer whose only purpose is to shift the income tax burden from a high brack-
et tax payer to a lower bracket family member is not considered a gift by the I.R.S. Courts and
will not shift the incidence of taxation.

EXEMPT GIFTS

    The Gift Tax Law exempts certain gratuitous transfers of property. There are five main
types

          A. Qualified disclaimer.

          B. Certain property transfers between spouses upon divorce and a choice of settle-
             ment options and beneficiary designations for receipt of qualified plan death
             benefits.




                                                  179
          C. Tuition paid to an educational institution.

          D. Payment for medical care.

          E.   Transfer of money/property to a political organization if the transfer is for use of
               the organization, not an individual.


          VALUATION OF PROPERTY FOR GIFT TAX PURPOSES

     The basic premise of gift tax valuation is that property and property interest transferred
during lifetime is valued on the date the gift is made (fair market value is used).

    If donee must pay tax on property, gift value is reduced by the tax imposed.


                   INDEBTEDNESS AND TRANSFERRED PROPERTY

    If the donor is personally liable for indebtedness secured by a mortgage on the gifted prop-
erty, the amount of the gift is the entire value of the property unreduced by the debt.

    However, if the donee has no right to recover the debt from the donor; the amount of the gift
is merely the amount of the donor's equity in the property.

RESTRICTIONS ON USE

    Restrictions limiting the donee's use/disposition of the property do not fix the value of the
property, but may have a persuasive effect on price.

VALUATION OF MUTUAL FUND SHARES

    Mutual fund shares gifts are valued at the shares' net asset value (bid price).


            GIFTS OF LIFE INSURANCE/ANNUITY CONTRACTS

    If the policy is transferred within the first year of purchase, the gift is valued at the gross
     premium paid to the insurer.

    A single premium or paid-up policy is valued at the replacement value (premium amount
     the insurer would change for the same type of policy of equal face amount on the insured's
     life), based on the insured's age at time of transfer.

    A policy in the premium-paying stage is valued at the sum of the interpolated termi-
     nal reserve (roughly equal to the policy's cash value) and the unearned premiums on
     the date of transfer.


                                                   180
     Once it is established that (1) a gift has been made (2) its value is known and (3) it did not
fit one of the exempt categories, it is now possible to determine if a gift tax will be assessed.

    Gift taxes were instituted to discourage persons from transferring property during lifetime to
avoid estate tax. Reductions to the federal gift tax are allowed, including gift splitting, the an-
nual exclusion, the marital deduction and the charitable deductions. Three gifts to minors which
qualify for the annual exclusion are the 2503 (B) trust, the 2503 (C) trust and the uniform gifts
to minor act (UGMA) arrangement. (Discussed in more detail later)


                              CONCEPTS TO REMEMBER

          1.    The purpose of the federal gift tax was to discourage gifts that would avoid es-
                tate and income taxes. For federal gift tax, gifts are all transfers of proper-
                ty/capital for less than adequate consideration.

          2.    The federal gift tax is an excise tax levied on the right to transfer property to
                another person. The federal gift tax is imposed regardless of property's exemp-
                tion from any income tax.

          3.    A good rule of thumb: If a transfer during life shifts either the income or estate
                tax liability from one person to another, there will be a gift tax consequence.

          4.    The donor is primarily liable for the federal gift tax. If donor fails to pay the tax
                then the donee becomes liable to the extent of the value of the gift.

                       Federal gift tax must be paid when federal gift tax return is filed.

                       Extension of time for payment can be granted by the I.R.S. The true
                        test for an extension would be undue hardship.

                       Federal gift tax return is filed annually. Under economic recovery tax
                        act the due date for filing a gift tax return is April 15. If a gift is made
                        in the year the donor of the gift died, the gift tax return must be filed
                        no later than the date for filing the state tax return.

          5.   The federal gift tax is imposed only on the transfer of property and is not im-
               posed on services that are rendered gratuitously.

          6.   The relationship of the federal gift tax to the Federal estate tax involving the fol-
               lowing three concepts:

               (1st) Identical tax rates are used for both Testamentary transfers and gifts made
                     during life.



                                                  181
               (2nd) The unified credit (discussed later) can be applied to both lifetime gifts
                     and transfers made at death. Any remaining credit is available for use
                     against estate tax payable at death.

               (3rd) The federal estate tax is computed by adding lifetime gifts to the tax-
                     able estate.


                               GIFT TAX COMPUTATION

   There are five additional considerations prior to computing the Gift Tax:

   1. Gift splitting.
   2. Annual exclusion.
   3. Gifts to minors.
   4. Gift tax marital deduction.
   5. Charitable deductions.


                                       GIFT SPLITTING

     When elected on the federal gift tax return, a married donor, with written consent of the
non-donor spouse, can elect to treat a gift to a third person as though each spouse had made half
the gift. Splitting lowers total tax!

          A. A married couple can give away $20,000 per donee, each year - no gift tax! If
             the spouses elect to split gift to third parties, all gifts during the reporting period
             (annually) must be split.

          B. The couple must be married in order to split gifts. If legally divorced or if one
             spouse dies, no gifts are split. A gift tax return is required for any split gift even
             if the annual exclusion of $ 20,000 per donee is not exceeded.

          C. Gift splitting, in community property states apply only to separate property (non
             community property).




                                                  182
                                   ANNUAL EXCLUSION
    Up to $ 10,000 of gifts to any number of persons each year can be made free of gift tax.
The purpose is to avoid administrative problems of keeping track of numerous small gifts.

          A. Applies only to present-interest gifts (possession and enjoyment begin immedi-
             ately upon receipt of the gift). Present-interest gifts of $ 10,000 or less do not
             require a gift tax return and would not be included in the decedent's gross estate.


   Note: Premiums paid on life insurance owned by a trust and insurance given outright
constitutes a present-interest gift. Life insurance transferred to a trust does not come under the
exclusion, nor does a gift of closely held non-dividend-paying stock.

          B. Education expenses (direct tuition costs, not room, board, books) and payments
             for direct medical care is allowed in an unlimited amount in addition to the
             $10,000 exclusion.

          C. If there is a gift (transfer) within three years of death "with respect to a policy"
             (meaning life insurance), the full amount of the proceeds will be included. (The-
             ory being this is the fair market value at date of death.)

          D. The contribution to a spouse's IRA is considered a gift of a present interest. This
             contribution will qualify for the $10,000 annual gift tax exclusion!

          E.   Non-dividend-paying stock may not qualify for gift tax exclusion for two rea-
               sons:

                1.    Right to income is a future interest.

                2.    Value of income interest in property that is not income-producing at the
                      time of the gift cannot be determined.

    CONSUMER APPLICATION
    Barry wants to help his son Gene buy a business. He has a life insurance policy with cash
values that would provide the necessary funds. Barry transfers policy ownership to Gene, and
Gene can then cash the policy, or borrow against the policy if he wants to keep it in force.
    This would be considered as a present-interest gift, even though the death benefit is not pay-
able until the death of Barry.
    If Barry would give the policy to Gene and then die within 3 years of giving it to Gene, the
proceeds would be taxed as a gift.
    Conversely, Barry can co-sign with a bank, which would not be a taxable gift. Barry could
also make Gene the primary beneficiary of the policy (his wife being beneficiary originally) so
when he dies, Barry would have the funds to pay off the business. This would not be a gift of
future interest.



                                                  183
                                      GIFTS TO MINORS

     Unqualified and unrestricted gift to a minor, with or without the appointment of a guardian,
is a gift of present interest. This means that the gift does qualify for the $ 10,000 annual exclu-
sion.

     If the gift is made to a trust (to provide management and control), does the transfer still
qualify as a present-interest gift?

     Section 2503 of the Internal Revenue Code provides three ways of qualifying gifts to mi-
nors for the exclusion: Section 2503(B) Trust; Section 2503(C) Trusts; Uniform Gift to Minors
Act Arrangement.

          A. Section 2503(B) Trust: Gifts are made to a trust; the trust is required to distribute
             income annually to or for the use of the minor beneficiary.

              1.      Distribution of the trust assets (corpus) does not have to be made at age
                      21. The corpus may be held in trust for as long as the beneficiary lives of
                      the corpus may pass the beneficiary and go to someone else. The trust
                      agreement controls corpus disposition should a minor die before receiving
                      the trust assets.

              2.      The gift placed in trust is divided into two parts for federal gift tax purpos-
                      es:

                      a. Principal: Does not qualify for the $10,000 annual exclusion; this is
                         not a present interest.

                      b. Income: The present value of the income to be paid will qualify for the
                         annual exclusion.

              3.      Key points about a 2503(B) Trust:

                      a.   Advantage: Distribution of principal is not required when the minor
                           reaches age 21.

                      b.   Disadvantage: Annual distribution of income is required.

                      c.   Section 2503C Trust: Income and principal must be distributed when
                           the minor reaches age 21. Income does not have to be distributed an-
                           nually.




                                                  184
BONA-FIDE GIFT

     The tax court has stipulated that the following six items are essential elements of a bona
fide gift: (There must be - )

          (a) A donor competent to make a gift.

          (b) A donee capable of taking the gift.

          (c) An actual irrevocable transfer of the present legal title and of the dominion and
              control of the entire gift to the donee, so that the donor can exercise no further ac-
              tive dominion or control over gift.

          (d) A clear and unmistakable intention on the part of the donor too absolutely and ir-
              revocable divest self of the title, dominion and control of the subject matter of the
              present-interest gift.

          (e) A delivery of the donee of the subject of the gift or of the most effective means of
              commanding the control of the gift, e.g., a gift of a car may be evidenced by de-
              livery of the car keys).
                                                   -and-
          (f) Acceptance (exercise of the control over the gift) of the gift by the donee.


                             UNIFORM GIFTS TO MINOR ACT

     Uniform Gifts to Minor Act (UGMA) states that during life an adult can make a gift of
stock, a life insurance policy, endowment policy or an annuity contract, cash or other prop-
erty to a minor. The adult becomes the custodian for the minor's property; smaller gifts are
normally involved. The custodian has limited powers as defined by state statute. Custodial as-
sets must be paid to the beneficiary upon reaching majority.

    1. If a donee is not age 21 on the date of the transfer, no part of the gift is a gift of future
       interest where all three of these conditions are met.

        A.      Both the income and the property may be spent by the donee – or for the benefit
                of the donee - before donee attains age 21.

        B.      When the donee reaches age 21 any part of the property and property's income
                that has not been spent by/for the use of the donee will pass to the donee at that
                time.

        C.      If the donee dies before age 21, any part of the property and income not spent
                by or for the use of the donee will be payable to the estate of the donee or as the
                donee appoints under a general power of appointment.



                                                   185
     2. Typically, the donor irrevocably transfers annuities, cash, securities or life insurance to
        a minor by registering the property in the name of a custodian designated by the donor.

        A.      The donor would not be the custodian!


                                       OUTRIGHT GIFTS

    Outright gifts of property are probably the most commonly used form of giving. People
 making an outright gift can make their gifts in money, personal property or real property.

     To receive all the tax benefits that can result from a charitable gift, the gift must be made to
 an Internal Revenue Code qualified charity. To qualify, the charity must be public, semipublic,
 or a private foundation that has received special approval from the I.R.S. I.R.S. approval is
 generally given if the charity is a governmental agency; a religious, charitable, scientific, liter-
 ary, or educational organization; or a war veterans or domestic fraternal organization.

    A lifetime charitable gift has two distinct tax advantages. The first is that an income tax
 deduction is generated. The second is that assets, along with their future appreciation are re-
 moved from the value of an estate.

     Normally, the income tax deduction that can be taken by the giver is limited to 50% of ad-
 justed gross income. Adjusted gross income is not taxable income; it is all income less certain
 deductions. The income tax deduction is limited, however, to 30% of the adjusted gross in-
 come when the gift is made to semipublic or private charities. If one wishes to use the 50%
 limitation, then the total amount of the deduction is not allowed. The deduction is limited to
 the basis or cost of the property. This amount is then subject to the 50% limitation. Any ex-
 cess cannot be carried forward.




                         CHAPTER 10 – STUDY QUESTIONS


1.     When a person dies without leaving a valid Will, it is know as
       A.      dying intestate.
       B.      a writ of habeas corpus.
       C.      common disaster.




                                                   186
2.   The most common document used to dispose of property is
     A.     the probate court.
     B.     to name the primary beneficiary in a life insurance policy.
     C.     a legal Will.

3.   Generally, it is advisable to have professional help in Estate Planning. Along with an
     experienced and educated insurance agent, the client should engage the services of
     A.     a doctor.
     B.     a tax attorney.
     C.     an MBA (Master of Business Administration).

4.   One of the main objectives of Estate Planning is
     A.      to maintain a standard of living.
     B.      tax evasion.
     C.      to satisfy the estate owner as to property distribution.

5.   An estate owner can transfer property at death through
     A.     lifetime gifts.
     B.     a Will.
     C.     a living trust.

6.   What are the two ways to solve a liquidity problem is estate planning
     A.     investing heavily in the stock market and purchasing futures.
     B.     minimizing the need for liquidity and the purchase of the proper amount and type
            of life insurance.
     C.     placing cash assets into Certificates of Deposit and purchasing as much real es-
            tate as possible.

7.   If an insured makes an absolute assignment of a life insurance policy, a gift is made
     which is measurable by the
     A.     cash value of the policy less all premiums paid.
     B.     death benefit.
     C.     policy’s replacement cost.




                                                 187
8.    One of the purposes of estate planning is to avoid the time and costs of probate court.
      The best way to do this is
      A.     have a Will.
      B.     have a trust.
      C.     have sufficient life insurance.

9.    The Uniform Gifts to Minors Act (UGMA) states
      A.     an adult can make a gift of stock, life insurance, an annuity, cash or other proper-
             ty to a minor.
      B.     the value of the gift is limited to $10,000.
      C.     the property given to the minor cannot be used for the beneficiary until they
             reach the maturity.

10.   What is the maximum amount that can be gifted, free from gift tax, by a married couple,
      each year, to an individual?
      A.     $10,000.
      B.     No limit.
      C.     $20,000.



ANSWERS TO CHAPTER TEN REVIEW QUESTIONS
1A 2C 3B 4C 5B 6B 7C 8C 9A 10C




                                                188
                       HOW PROPERTY PASSES AT DEATH

   When individual dies there are three ways property may pass:

   1.    Contract designation.
   2.    By law.
   3.    By Will.


                                 CONTRACT DESIGNATION

     Probably the best examples of property passing by contract are life insurance, annuity
contracts and trust agreements. The benefits of owning a life insurance policy are numerous
but for estate planning purposes the critical benefit is the right the individual has in naming
his/her own beneficiary. By naming a beneficiary the owner obligates the insurance company to
pay the proceeds to the designated beneficiary. If the policy owner named a beneficiary for the
policy in his/her Will, this would have no effect if the beneficiary designation in the policy were
different. One consideration that is usually not conducive to proper estate planning is to name
the estate of the insured as the beneficiary as the proceeds will now be tied up in the probating
of the estate and thus subject to possible long delays.

    Trust agreements are another example of transfer by contract.

  The following IRS Code Sections apply as indicated:
 Section 2037 - covers transfers taking effect at death and provides that the gross estate
  includes the value of property transferred by the decedent for less than full and adequate
  consideration if the possession or enjoyment of the property can be obtained by surviving
  the decedent and if the decedent retained a reversionary interest worth more than 5% of the
  transferred property value before death.

 Section 2038 - provides that if any of the powers to alter, amend, revoke or terminate or to
  affect beneficial enjoyment exists at death, the value of the property subject to the power is
  includible in the decedent's gross estate.

 Section 2039 - Annuities. An annuity is included in the gross estate when payable to dece-
  dent for life, for a period that did not end before death or for a period ascertainable only with
  reference to date of death. The key to whether or not an annuity is included in the gross es-
  tate is whether or not the decedent had an enforceable right to receive payments.



        Five annuities are includible in a gross estate:



                                                 189
           1.   Contract under which decedent received or was entitled to receive annuity or
                other payment immediately before death and for duration of life with stipulation
                that payments continue to beneficiary under decedents’ death.

           2.   Contract under which decedent received payments prior to death together with
                another person for joint lives with the stipulation that payments continue to sur-
                vivor after death of any other individual (joint and survivor annuity).

           3.   Contract between decedent and employer under which decedent received or was
                entitled to receive annuity or other payment after retirement for life with pay-
                ments to beneficiary upon death.

           4.   Contract between decedent and employer that provided for annuity or other
                payments to surviving beneficiary if decedent died prior to retirement or before
                expiration of a certain time.

           5.   Contract under which decedent was receiving or was entitled to receive an an-
                nuity or other payment for a specified time period immediately before death
                with payments to continue to named beneficiary if decedent died before time
                expiration.


          Key Factor: Basically, if the beneficiary receives any benefits under an annuity
        or annuity-like arrangement, these payments are included in the gross estate.

       ESTATE TAXATION OF ANNUITIES

       A. A life annuity with no certain period does not enter the gross estate.

       B. Life annuity with certain period - if death is before the end of the period, the present
          value of remaining payments enter gross estate.

       C. Joint and survivorship life annuity enters the estate of the first to die in proportion to
          the total premium paid.

            Creation of a joint interest in property between spouses is no longer considered a
       gift. Present-interest gifts between spouses qualify for the unlimited gift tax marital de-
       duction.

 Section 2040 - Joint property, jointly held property between spouses is no longer consid-
  ered a gift. Present-interest gifts between spouses qualify for the unlimited gift tax marital
  deduction. Jointly held property with right of survivorship between spouses the estate of the
  first spouse to die will include one-half of the value of the property. When the surviving
  spouse dies, 100% of the property will be included in the estate.




                                                  190
   Note:      If property was acquired by gift/bequest/inheritance by a non-spouse joint owner,
only the value of the fractional interest of the first tenant to die enters the gross estate.

 Section 2041 - Power of Appointment. General Powers of Appointment are powers over
  property that is so broad that the power approaches actual ownership or control of the prop-
  erty.

 Section 2042 - Life Insurance. Life Insurance Proceeds are included in the estate if the
  decedent had any incident of ownership in the policy and if the proceeds are paid to
  the estate or if the proceeds are received by another for benefit of the estate. Life In-
  surance proceeds do not qualify for the marital deduction if life insurance is paid to the
  surviving spouse but is not in decedents’ gross estate (i.e., any incidents of ownership).
  Proceeds will qualify for the marital deduction if proceeds are left at the interest option
  for life of the surviving spouse and if payable to spouse’s estate or persons appointed
  by spouse.


                MARITAL DEDUCTION AND LIFE INSURANCE

    Life insurance proceeds do not qualify for the marital deduction if the life insurance is pay-
    able to a surviving spouse but is not in decedents’ gross estate (any incidents of ownership).

    CONSUMER APPLICATION
    Ralph is employed by Sandler Co. and participates in a pension plan that is entirely paid for
by Sandler Co. The pension plan has a death benefit that would pay $50,000 at his death, to his
beneficiary, his wife. If Ralph dies and his wife elects to receive the $50,000 in a lump sum, she
would have to pay income tax on the proceeds.

         Transfers of Life Insurance within three years of death are included in gross estate as
    gratuitous transfer inclusions of gross income are quite extensive.


                       COMPUTATION OF THE ESTATE TAX

     One of the potential expenses of settling an estate is the federal estate tax. It is a continu-
ous lien on property, but its foreclosure date has yet to be determined. Proper planning involves
anticipating and reducing the estate tax liability wherever possible as well as providing for the
payment of the estate tax. Unlike other expenses of settling an estate, it can be quite burden-
some in that it is generally due and payable in cash nine months after death.




                                                  191
     The estate tax computation is not difficult, and in many ways resembles the calculations in-
volved in determining the income tax. Terms such as gross income, taxable income, deduction
and credits are seen and are familiar because of federal income tax filing. The estate tax com-
putation involves the same terms.

       SEVEN CRITICAL POINTS

       Primarily, there are seven points to remember involving the calculation of the federal estate
tax:

1. Federal estate tax only applies to estates valued in excess of the unified credit ($650,000 in
   1999, growing to zero (no tax) in 2010.

2. The federal estate tax rates have a maximum .

3. Spouses are able to leave property to their U.S. citizen spouses free of federal estate tax.

4. The federal estate tax taxes the right to transfer almost all property interests.

5. The federal estate tax applies to the fair market value of property.

6. The federal estate tax is paid before the beneficiaries receive their shares.

7. The federal estate tax is payable in cash nine months from date of death.


                         DEDUCTIONS FROM THE GROSS ESTATE

   The Adjusted gross estate is equal to the gross estate less:

A. FUNERAL EXPENSES

        Amounts that actually were spent for such expenses. These expenses would include
   such costs for tombstone, monument, mortician service, burial plot, transporting the body,
   etc. The key factor is if the costs are "reasonable" and are allowed as a charge against the
   estate under state law.

B. ADMINISTRATIVE EXPENSES

        Administrative expenses are those concerning the estate which could include court
   costs, Executor's commission, attorney's fees, accounting fees, miscellaneous costs to
   properly settle the estate and medical expenses of decedent's last illness (this could be in-
   cluded as income tax deduction instead). The major requirement for deductibility is that the
   expense must be necessary, essential, actually incurred, and reasonable with respect to set-
   tling the estate.



                                                   192
C. CLAIMS AGAINST THE ESTATE

        Are any bona fide debts incurred by the decedent before death and are certain taxes de-
   ductible from gross estate? Deductible taxes would include the federal income taxes and al-
   so the state local, foreign income taxes and property taxes (these could also be deducted on
   the federal income tax return but not on both), also real estate taxes and local, foreign in-
   come taxes on estate income.

D. MORTGAGE DEBTS

        Mortgage debts will be allowable as deductible estate tax expenses if the full value of
   the property not reduced by the mortgage is included in the gross estate and if the estate is
   liable for the mortgage debt.

E. LOSSES

        Casualty and theft losses may not be claimed if compensated by insurance and may not
   be claimed on both state tax and estate income tax forms.

F. OTHER ADMINISTRATIVE EXPENSES

        Included in this category are funds used to settle non-Probate assets (life insurance and
   jointly held property).

   Note: There are two basic decisions the Executor must make when claiming the various ex-
         penses for estate tax purposes.

   1. Whether to take a deduction on the Federal Estate Tax or Income Tax Return (e.g., med-
      ical and casualty deductions can be taken on either). One solution could be to split the
      deduction-medical expenses from the income taxes and the casualty losses from the es-
      tate tax form.

   2. Whether the Executor wishes to waive the Executor's fee if Executor will also receive a
      bequest, which is income tax free. The fee is considered ordinary income.

   Once these expenses have been calculated, one has arrived at the adjusted gross estate.


                    BACKGROUND OF THE MARITAL DEDUCTION

     In the past the community property states only called for one-half of the community held
property to be included in the estate of the spouse who died first. Residents of the common law
states were envious of this preferential tax treatment so Congress gave a federal estate tax mari-
tal deduction to married residents in the common law states. The Economic Recovery Tax Act
achieved tax parity by allowing an unlimited deduction for assets passing from one spouse to



                                                 193
another, either during lifetime or at death. The Unlimited Marital Deduction applies in both
Community and common law states. Please remember that the marital deduction is not a device
to avoid taxation but defers taxation until the death of the second spouse. Congress's goal was
to treat spouses as one unit for transfer tax purpose and only tax one estate. Presumably, with-
out proper planning, the second estate will be much larger than the first estate thus render-
ing more estate taxes.


                          MARITAL DEDUCTION BASIC RULES

        As may be expected there are numerous roles that govern the use of the marital deduc-
          tion, with some exceptions. The seven basic rules are:

GENERAL RULE:
          The state tax marital deduction is given on the full net value of a qualifying interest
          passing to a decedent's surviving spouse but will be reduced by any taxes that are
          payable out of the marital share of the estate.

NET VALUE OF GROSS ESTATE:
          Is the gross estate tax value of property interest at date of death (or at alternate - valu-
          ation date) less any charges against the property interest.

    Three charges against property interest could be:

          a.    Mortgage/Liens against the interest.

          b.    Administrative expenses payable out of the interest.

          c.    Taxes payable out of the interest (Federal Estate Tax, state death tax).


Special Note: These charges can be avoided if the decedent's Will requires taxes/expenses
debts to be paid out of the portion of the estate passing to beneficiaries other than the spouse.

PROPERTY PASSAGE:

    Property must pass or have passed to the surviving spouse. A property interest
owned by the decedent must pass from decedent to the surviving spouse and the surviving
spouse must receive that interest as the beneficial owner (not as a trustee or as someone's
agent). Property may "pass" from the decedent to the surviving spouse in many different
ways, and still qualify for the marital deduction. Some of these ways are:
          1. Life insurance proceeds.
          2.   Under the intestacy laws.
          3.   Under the decedent's Will.
          4.   Joint tenancy property, by right of survivorship.


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          5.   Tenancy by the entirety property, by right of survivorship.
          6.   Under a General Power of Appointment.
          7.   Under the spouse's right to elect against the Will.
          8.   Under a dower or courtesy interest.
          9.   As lifetime gift to the spouse that is brought back into the decedent's gross
               estate.
          10. As "Qualified Terminable Interest Property” (Q-TIP).



Note: To qualify for the Marital Deduction the property that passes to the spouse cannot be
a "Terminable Interest.” This is a property interest that will fail to terminate because of the pas-
sage of a time period and the occurrence of some event or contingency or because of failure of
an event or contingency to occur. (See next page)

RESIDENCE OR CITIZENSHIP REQUIREMENT:

     The deceased spouse must have been a citizen or resident of the United States to qualify for
the Marital Deduction and transfer must be made by a decedent who was at the date of death a
U. S. citizen/resident. In general, a marital deduction is not available if the surviving spouse is
not a U.S. citizen unless property passes to the surviving spouse in a qualified domestic trust.

    INCLUSION OF PROPERTY REQUIREMENT:

     To be eligible for the marital deduction, the property must meet all requirements for being
included in the gross estate.

     CONSUMER APPLICATION
    Shelby purchased a $500,000 life insurance single premium policy on her husband, Cecil,
when she received an inheritance from her aunt. If Cecil should die and Shelby would receive
the face value of the policy ($500,000), the proceeds of life insurance policy bought by a wife
on her husband's life with her own funds in which she is owner and beneficiary will not qualify.

MARITAL STATUS REQUIREMENT:

    Spouses must be married, not divorced. A legal separation or decree of divorce does not
change the surviving spouse's status (the marriage was not legally terminated by the date of
death).

    In case of a common disaster there are two methods of determining who died first (who
was the surviving spouse):




                                                  195
          1.   A presumption-of-survivorship clause may be used in the Will/life insurance set-
               tlement option (e.g., husband declares that if there is no evidence to determine
               who died first, "my wife shall be deemed to have survived me").

          2.   Uniform Simultaneous Death Act which states if there is no presumption-of-
               survivorship clause, each decedent's estate will be distributed as if decedent were
               the survivor (husband's Will is Probated as if he survives his wife and wife's Will
               is Probated as if she survives her husband). This results in the loss of marital
               deduction.


                                TERMINABLE INTEREST RULE
    A marital deduction is allowed only when the interest passed to the surviving spouse is one
that, if kept until that spouse's death, will be taxed to the surviving spouse's estate. (See previ-
ous page)

DISQUALIFICATION RULES

   A terminable interest may be disqualified if all three of the following conditions exist:

   1.   The other person (or heirs) could posses/enjoy any part of the property at termination of
        the surviving spouse's interest.

   2.   The interest passed to the other person for less than adequate and full consideration in
        money or money's worth.

   3.   Another interest in the same property passed to some one other than the surviving
        spouse.


Note:     If the decedent in the Will directs the Executor to use assets supposedly available to
the surviving spouse for the purpose of terminable interest, then the marital deduction would not
apply.

     CONSUMER APPLICATION
     If Bill specifically bequeaths $150,000 to his wife but since Bill had little faith in his wife’s
ability to manage money, he directed his Executor to use that money to buy a life annuity for
her. By doing so, however, the bequest will not qualify for the marital deduction.

EXAMPLES OF TERMINABLE INTERESTS:

   1.   Patents and Copyrights.

   2.   Life Estate and Annuities.

   3.   "To wife during widowhood.”


                                                   196
    4.   "To my wife for life. Remainder to our children.”

    5.   "To my wife for Life"


Special note: To avoid any problems under the terminable interest classification, the proper-
ty must be vested in the surviving spouse and no other person may have any interest which may
follow that of the spouse's.

    Exceptions to the Terminable Interest Rule

    1.   A qualified terminable interest property election qualifies as an exception.

    2.   A life insurance policy payable to the surviving spouse in whom that spouse has a Gen-
         eral Power of Appointment over the proceeds qualifies as an exception.

    3.   A bequest for a life estate paired with a General Power of Appointment ("Power of Ap-
         pointment Trust") qualifies as an exception.


                            POWER OF APPOINTMENT TRUST

    This is the most common method of qualifying property in trust for the marital deduction.
 The Power of Appointment Trust is designed to hold assets for the surviving spouse and to
 provide that spouse with a General Power of Appointment over the principal. Five require-
 ments are needed to qualify.

    1.   Surviving spouse has claim to entire income from trust.
    2.   Income is paid at least once a year.
    3.   Spouse can exercise the power to appoint corpus to self.
    4.   Power must be exercisable only by the surviving spouse.
    5.   Only the surviving spouse has power to appoint any part of corpus to anyone other than
         the surviving spouse.

     Final exception to the terminable interest rule: an interest will still qualify for the marital
deduction if the bequest to the surviving spouse was conditioned upon the spouse surviving for
up to six months after the decedent's death and spouse does survive.




                                                   197
ADVANTAGES OF LIFE INSURANCE FOR LIQUIDITY

   There are seven reasons( at least) why life insurance should be included in estate planning:

1. While death is obviously uncertain, life insurance is certain. The estate owner can be as-
   sured that his/her survivors will not be faced with liquidity problems despite death's uncer-
   tainty.

2. The age-old argument still is indisputable - life insurance is discounted dollars. The estate
   owner buys liquidity at a "bargain.” While the estate owner pays a fraction of the policy's
   face amount when premiums are paid, 100% of the face value is available at death.

3. Allows early payment of state death taxes. Several states allow a discount for the early
   payment of death taxes. The tax discounts are usually quite significant. Life insurance will
   provide the instant cash to be able to pay these taxes. Unfortunately there is no discount for
   the early payment of federal estate taxes but there is a penalty for paying late!

4. Life insurance makes settling an estate much more prompt. By generating instant cash for
   the estate, the possibility of long delays for estate settlement is minimized thus preventing
   unnecessary estate administration expenses. Also, estate beneficiaries receive their shares in
   a timely manner.

5. With the proceeds from a Life Insurance Policy, the need for borrowing is avoided. This
   saves the Executor from spending time trying to arrange borrowing sources. Since the de-
   cedent would no longer have credit the Executor would probably have to put up assets in the
   estate as collateral. Loans must be repaid with interest so all a loan performs is "buying
   time.”

6. Forced liquidations are prevented. Forced liquidations result when estate assets need to be
   sold under "forced conditions" in order to pay estate obligations. Buyers are aware of the
   estate problems and can make purchases at drastically reduced prices. Obviously this will
   affect the total new distribution of the estate.

7. There would be no need for a “sinking fund.” Sinking funds are created over a period of
   time and are deposit accounts for estate owners anticipating a need for more estate liquidity.
   The problem exists that death may arrive at any time thus spoiling efforts of funding for the-
   se very needs. Another problem with the sinking fund is the discipline needed to fund it in a
   periodic fashion. Life insurance is much more adaptable than a sinking fund with its self-
   competing characteristics at the time it is needed most - at death.




                                                 198
    CONSUMER APPLICATION
    The following is an example from the files of a Financial planner, who recognized it as the
poorest example of “Estate Planning” he had ever seen!
    Maribell is an heir to a large fortune and has an assessed net worth of over $25 million. She
informed her financial planner that the I.R.S. would probably say that the estate was worth dou-
ble that amount. However, she had purchased sufficient life insurance so that her children
would have enough money and the government would not get all of her money.
    Unfortunately, she informed the Planner that she had instructed the children to keep the in-
surance money and let the government have the property.
    Upon her death her property was worth $40 million. Her life insurance policies paid $20
million to her heirs outside of the taxable estate. Her children did as she asked and took the $20
million, and gave the rest to the I.R.S. to satisfy the taxes.
    The I.R.S., as is its practice, auctioned off the property to the highest bidder, and received
only $10 million from the property. Her heirs are responsible for the other $10 million.
    (Note: Under the 2001 tax act, eventually this estate tax will disappear. Good riddance.)



             OWNERSHIP AND BENEFICIARIES OF ESTATE LIQUIDITY

     Properly designated life insurance will do wonders for an estate plan. It will enable the Ex-
ecutor to sell any property or business interests in a timely fashion and prevent forced sales. It
will save the burden of a long settlement period and reduce the overall shrinkage of an estate.
Life insurance will provide two clear advantages.

   1.   It will provide cash for the decedent's estate when needed the most.

   2.   It will provide a way to retain the full value of assets in an estate.

     The important aspect of life insurance is: Who is the owner and who will receive the pro-
ceeds (beneficiary)? There are five rules to follow when the planner is advising the client as to
the owner-beneficiary designations:

   1.   If a third party is to own the policy any assignment should be absolute in order that the
        insured holds no incidents of ownership.
   2.   Proceeds from a life insurance policy should be paid in a lump sum.
   3.   The planner should emphasize the importance of communication between the insured
        and beneficiary while the insured is alive.
   4.   Steps should be taken to be sure the annual gift tax exclusion is taken for the policy as-
        signment and subsequent premium gifts.
   5.   The policy should not return to the insured if the named beneficiary predecease the in-
        sured.




                                                   199
OWNERSHIP

     The planner should present different situations when discussing the ownership question
with clients. There is no defined rule. Every client is different and each client's objectives will
vary also. The planner’s responsibility is to listen to the client's concerns and then make rec-
ommendations. All decisions should be based on the facts surrounding each particular situation.
In every situation, it is important that the planner understand the ramifications of each in order
to advise a client as to the advantages/disadvantages of the client's specific objections.

BENEFICIARY CONCERNS

     The primary question will be "who should handle the proceeds at the client's death?” Put-
ting such proceeds into the hands of someone who is trustworthy and competent will go a long
way to having liquidity achieved in the estate.

BENEFICIARY DESIGNATIONS

     Basically there are three designations seen during the course of estate planning. The im-
pact of gifting life insurance and the assignment of a group life policy will also be discussed.

1. ESTATE BENEFICIARY:

        Small Estates. In a small estate, naming the estate as beneficiary should not have any
   potential tax problems at death, particularly in view of the increasing amount of an estate
   exempt from estate taxes. If a married couple is involved, the unlimited marital deduction
   will further help reduce or negate entirely the estate tax consequences.

        Larger Estates. By naming the estate as beneficiary could have severe repercussions -
   just the opposite of the intended objective. By including the proceeds in the deceased's es-
   tate, more taxes would be paid and thus subject to Probate and to the claims of creditors.
   Thus, instead of reducing costs, life insurance, in this instance, could result in increased
   costs and liabilities.

2. INDIVIDUAL - BENEFICIARY:

        Usually in this situation a spouse is named as the beneficiary. This arrangement does
    have some advantages and, of course, some disadvantages.

       Proceeds would avoid Probate and usually are not subject to the claims of creditors.
    Many states exempt death proceeds payable to a surviving spouse from the state death tax.
    Consideration must be made before using this designation would be:

        Insured must not put the proceeds under a particular settlement option.




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        A contingent beneficiary should always be named. This could be a trust or adult
         child. Remember that the purpose of this life insurance is to provide liquidity for the
         estate.

        By owning the policy the insured can change the beneficiary designations at life
         event changes (divorce, death of a spouse, etc.).

        The beneficiary should be informed of the Policy's existence, location and objective.

   Disadvantages:

        When the spouse is named, it is assumed that the proceeds will be used for their intend-
   ed purpose, estate liquidity. However, the spouse is not legally obligated to use the proceeds
   in this way. The spouse could have other ideas on how to use the proceeds thus eliminating
   the primary purpose of the proceeds. The one way to prevent this situation is to have the
   policy require the spouse to use the proceeds for the estate's liquidity needs, and the pro-
   ceeds will be considered "payable for the benefit of the estate.”

3. TRUST AS BENEFICIARY:

          Usually seen in larger estates a trustee arrangement offers distinct advantages. The
    trustee will carry out the purpose of the policy - providing liquidity for the estate.

         The trust agreement will authorize the trustee to make loans to the estate and to pur-
    chase assets from the estate if the need arises. The Will of the insured should stipulate the
    relationship of the trustee and Executor.

        The trust probably would be established during a lifetime. If the trust is irrevocable
    and owns the policy then the proceeds will escape inclusion in the insured's estate. The
    disadvantage to the insured is that there are fees involved.


                              THE LIFE INSURANCE TRUST

     Each life insurance policy has three “offices”: The insured, the owner and the beneficiary.
Generally, but not always, the owner and the insured are the same. If life insurance is owned by
the decedent, the life insurance proceeds are in the taxable estate, therefore a tax may be due.


    When people who have a large taxable estate, purchase life insurance to pay the tax,
they often make the mistake of adding to their taxable estate by the purchase of life insurance.




                                                 201
     CONSUMER APPLICATION
     Victor is widowed and has an estate valued at $10,000,000. Because he knows that the
federal estate taxes could equal at least half of his estate, he purchases a $5,000,000 life insur-
ance policy.
     If Victor takes ownership of the policy (i.e. he is both insured and owner), his taxable estate
has grown to $15,000,000 – with a resultant tax of $8,000,000 (1999 figures).
     But, if he creates a life insurance trust, gives the trust money, and lets the trust buy the life
insurance policy, the trust is the owner, with the result now that substantial amounts of federal
estate tax are saved.
     Why? Because the Trust is the owner, and the owner, therefore, does not die.

ASSIGNMENT OF GROUP INSURANCE

      Most clients will want to use their group life proceeds to create estate liquidity. The courts
have allowed clients to absolutely assign all ownership rights to the group ownership out of
their estates. This helps the estate as the proceeds are excluded from the insured's gross estate
thus preventing more estate taxes!


    Note: An employee will be taxed on the cost of coverage in excess of $50,000 as provided
in IRS regulation under Section 79. Absolute assignment does not help in this situation.



                    ESTATE TAXATION OF LIFE INSURANCE

     A life insurance policy is included in the insured's estate for federal estate taxation purposes
if the insured had an incident of ownership in the policy at the time of the insured's death. Inci-
dents of ownership include the following:

   1.   The right to change the beneficiary.
   2.   The right to borrow on the policy.
   3.   The right to assign the policy.
   4.   The right to surrender the policy.
   5.   The right to exercise any basic contractual right.

    If the deceased possessed any of the above rights, the proceeds will be includible in the de-
ceased gross estate. It does not matter whether the incidents were ever exercised or not!

    In respect to life insurance transferred to a third party within three years of an insured's
death, the general rule is that the transfer is automatically includible in the insured's estate.




                                                   202
                                POLICIES ON OTHER LIVES

     If an individual owns a policy on the life of someone else and if the owner dies before the
insured, the value of the policy must be included in the owner's gross estate. The value of such
a policy is the replacement cost.


                           PROCEEDS PAYABLE TO AN ESTATE

     Proceeds would be included in the gross estate if the policy proceeds on the life of the de-
ceased are paid to or used by the Executor or the Administrator of the estate. If the estate or the
estate's Executor is the designated beneficiary of the proceeds, the proceeds are included in the
deceased's gross estate, regardless of when the policy was taken out, or who paid the premiums,
or who owned it.


                               PROCEEDS PAID TO A TRUST

     If the proceeds are paid to an individual or a trust that is legally obligated to pay taxes,
debts or other estate obligations, the proceeds will also be included. At times the trustee of a
living trust is only empowered to use trust assets to pay estate obligations not required to do so.
In this situation, death proceeds of life insurance paid into the trust would only be included in
the gross estate to the extent the trustee exercised the power to pay estate obligations. (See dis-
cussions of ILIT later in this text)


                                    STATE DEATH TAXES

     In most states, any proceeds payable to - or - for the benefit of the insured’s estate is in-
cluded in the decedent's estate. Proceeds payable to the surviving spouse are never part of the
taxable estate due to the unlimited marital deduction. Four qualifications for the marital deduc-
tion are:

   1.    Lump sum proceeds are paid to the surviving spouse.
   2.    Non-refundable life income payments made to the spouse;
   3.    Settlement option used to hold proceeds for surviving spouse;
   4.    Surviving spouse has a general power of appointment.


        STRATEGIES FOR USING LIFE INSURANCE IN THE ESTATE


                  PROTECTING AN ESTATE WITH LIFE INSURANCE

     Any person, whose motivation in purchasing life insurance is to protect the estate, should
first plan that estate to reduce or avoid every cost possible. After the projected costs have been


                                                  203
reduced to the lowest dollar possible, life insurance should then be purchased to cover the re-
maining costs. The estate planning process creates the car, gas tank, and gasoline gauge.
While the life insurance is the gasoline, in the right amount and in the right octane, the amount
and type of life insurance must meet the designer's specifications.

    Prudent estate owners should always plan to pay their estates debts with cash. If Estate
property is to be sold then it should be sold at the highest possible price and should not be time
constrained. Life insurance should be used to create instant estate cash. The more non-liquid
the estate, the greater the potential need for life insurance.

    In summary there are twelve key points to consider when discussing life insurance in the
estate plan:

1. Life insurance is a third party beneficiary contract. Leaving proceeds to third parties,
   whether directly or in trust, removes the proceeds from the Probate process.

2. Life insurance owned by the insured is subject to federal estate taxation on the owner-
   insured's death.

3. The owner of a policy does not have to be the insured, and as a matter-of-fact, the owner
   should not be the insured if insurance proceeds are designed to avoid death taxes.

4. Most state death taxes do tax life insurance after certain dollar deductibles have been met.
   Some states may not tax life insurance proceeds.

5. Precisely written beneficiary designations are of critical importance.

6. Contingent beneficiary designations should always be made.

7. The estate of the insured should never be named as beneficiary: to do so is to subject the life
   insurance proceeds to the Probate process.

8. Minors should never be named as primary or contingent beneficiaries because they cannot
   receive the proceeds without court supervision until they are adults.

9. Insurance proceeds intended to benefit minors should be left to a trust created for their bene-
   fit.

10. Life insurance proceeds left to beneficiaries other than the estate of the insured owner are
    generally not subject to the claims of creditors. This is true with regard to creditors of the
    deceased, of the estate itself, and of the beneficiaries.

11. A life insurance program should always be coordinated with and became an integral part of
    the total estate plan.




                                                  204
12. Life insurance recommendations should be discussed with and reviewed by other members
    of the estate-planning team.


                    JOINT AND LAST SURVIVOR LIFE INSURANCE

     Under the Economic Recovery Tax Act, people can leave their entire estate tax free to their
spouses and can leave all or part of their exemption to non-spouses. Most planning for U. S.
citizens surviving spouses and other family members results in no tax liability on the death of
the first spouse. This is true regardless of the size of the estate. The tax bite may be deferred to
the second spouses’ death. A problem does exist. Most existing life insurance policies pur-
chased prior to the Economic Recovery Tax Act (1986) with federal estate taxes in mind insure
the life of the bread-earner spouse - usually the husband. If the husband does die first - the pur-
pose for which the insurance was purchased may not materialize. There should be no federal
estate tax on his death. A better idea would be to insure the younger of the two spouses. Premi-
ums can be saved and regardless of whose life is insured, the proceeds can be available to pay
the taxes resulting from the death of the surviving spouse. This is of massive importance where
significant insurance programs are in place.

     Many insurance companies provide a unique product called a Joint and Last Survivor
Policy. This type of policy insures two lives and pays out death proceeds only on the death of
the last of the two insured to die. As a method for only insuring the payment of death taxes,
Joint and Last Survivor policies have merit. However, if life insurance proceeds are needed for
any purpose, insuring the younger spouse may be the alternative. The decision whether to in-
sure the younger of the two spouses to purchase a Joint and Last Survivor Policy can generally
be reduced to an economic decision based on the premium costs of each product. The planner
must "price compare" for his/her clients as different companies have different premium struc-
tures for each of their insurance products.

     The decision between these two products may not entirely hinge on economics. There may
be spouses who will elect to insure their young spouses rather than elect the joint and survivor
policy. If the younger spouses do die first, then the other spouse will have the insurance pro-
ceeds to use and invest.

     As is apparent, the Economic Recovery Tax Act has definitely changed the rules and creat-
ed a huge opportunity for planners. It is now imperative that anyone who has purchased life
insurance pre-1985 should have it reviewed and what better way to review its effectiveness than
during an estate planning session?

     Please remember that the discussion of the merits of Joint and Last Survivor insurance ap-
plies only to life insurance purchased solely to protect an estate already created.

     Since the planner could be charged with improper policy comparisons, he/she should be
particularly diligent while doing such comparisons. A complete analysis should be made of the
relative costs between existing policies and new policies. Also if the new policy is less expen-
sive - truly less expensive on an apples-to-apple basis - old policies should still not be canceled



                                                  205
until the new policies are in force. The planner must be very careful to suggest to clients that
they should drop an old policy, as the client could be uninsurable or very highly rated due to
health problems.


                     THE IRREVOCABLE LIFE INSURANCE TRUST

     As life insurance proceeds provide the fuel that powers many an estate planning "car,” most
of the time the fuel mixture is taxed at the "pump" before it finds its way into the estate planning
"vehicle.” A disadvantage associated with the purchase of life insurance is that the life insur-
ance proceeds may increase the taxable estate of the policy owner. Upon the death of the in-
sured owner, the life insurance proceeds will be included in the insured owner's estate for feder-
al estate tax purposes. If the insured owns a life insurance policy on his/her life, all the life in-
surance proceeds will be included in his/her estate for a federal estate-tax purpose. In order to
avoid federal estate tax, many clients have the life insurance on their lives owned by their
spouses or others; then upon the death of the insured, the policy proceeds will be paid to the
owner's beneficiary federal estate tax-free.

    There are problems with this cross-ownership technique:

        The insured loses control of the life insurance policies.

        Proceeds are usually taxed on the death of the policy owner if he/she is the benefi-
         ciary and dies before the insured.

        Few people can plan for the contingency that the owner/beneficiary may die first.

        If the proceeds are payable to other than the insured or the owner, there is a gift of
         the entire insurance proceeds to the beneficiary from the policy owner.

   The goal sought by insurance policy cross-ownership - to avoid federal estate tax on Life In-
surance Proceeds - is a good one. But there may be a better way to accomplish this goal. The
planner can recommend the use of an irrevocable life insurance trust (ILIT) to own Life Insur-
ance policies that insure an individual life. By using the ILIT, the insurance proceeds will be
federal-estate-tax-free upon death. Also, if the client plans for the spouse, the ILIT will keep the
proceeds out of the spouse's estate as well.

    The ILIT is used to own an insurance policy whether it is purchased by the ILIT or given to
it. The ILIT must be irrevocable. Once the trust is drafted and signed, it can never be changed.
If the ILIT is not totally irrevocable or if the maker retains direct control over it, the insurance
proceeds will not be federal estate tax free. By using an ILIT, three estate planning objectives
are achieved:

       1.       Insurance Proceeds can be kept federal estate-tax-free upon the death of both
                spouses.




                                                  206
       2.       Because of the terms provided in the trust document, the trust maker can control
                the insurance proceeds received by the ILIT to care for the maker's beneficiar-
                ies.

       3.       The Life Insurance Proceeds received by an ILIT can be used to pay the death
                expenses, including taxes on both the maker and the maker's spouse.

      In summary please note that ILIT drafting is not for rookies and should be implemented by
an Estate Planning Professional. One small mistake in an ILIT, and all the tax benefits can be
lost; remember, irrevocable means irrevocable!!


                             PRIVATE SPLIT DOLLAR PLANS

     In some situations, using an ILIT to remove the death proceeds from estates, allows almost
no access to the policy values that the insured may need for income purposes. Some financial
planners recommend a private split dollar plan as a consideration, as it is designed specifically
for a client who want to exclude the net death benefits from the estates of the insured and
his/her spouse. At the same time, they want to have the policy values available to fund their
personal needs at retirement. The split-dollar plan should be used only when a person wants to
accomplish both of these objectives.

    It must be pointed out that while the IRS has not ruled specifically on this program, every
“component” of the plan individually has been supported to tax laws applicable. The areas in-
volved are the split dollar part, plus estate, gift and income taxes.

     The Private Split Dollar Plan (PSDP) is based upon a cash value life insurance policy that
is split into its two parts: the insurance and the cash value components. (Sound familiar?) Then
the part that will benefit most from the tax situations of each part then owns that particular
component. For instance, the death benefit (pure insurance) is owned by an ILIT which is de-
signed to not be included in either spouse’s estate. The insured’s spouse owned the cash value
of the policy, which allows them to obtain policy values through the use of policy loans &/or
withdrawals. Incidentally, one financial planner reporting on this method in an industry publi-
cation, points out that this is “particularly useful when one spouse has accumulated a significant
amount of the overall assets, since significant asset re-balancing can be achieved.”

     This program can be designed in several ways, but the most typical is where the insured es-
tablished an ILIT before the application is taken. The trust then becomes one of the owners of
the contract. Then a split dollar contract between the trust and whoever controls the cash values
(the spouse or a revocable trust established by the spouse) is arranged.

     Now, an application on the insured, which must be signed by the trustee and the spouse,
can be submitted. It is highly recommended that a Variable Universal Life policy be used as the
instrument, due to its flexibility and its features that fit the situation.




                                                 207
    It must also be determined at this point as to which death benefit option to use (see previ-
ous discussion in Options). Option A is a level death benefit; Option B is an increasing death
benefit. If Option A were chosen, then a decreasing death benefit would be paid to the trust be-
cause of the split dollar factor. This factor creates a payment of the interest of the spouse (the
cash value) will be paid to the spouse in case of death of the insured. However, if the insured
wants to maintain a level death benefit in order for the trust to meet certain estate liquidity
needs, then Option B would be used.

      Because there is a split ownership of the policy, there must also be split premiums. The in-
sured would contribute the term cost (as determined by the insurance company) by giving it
(gift) annually to the trust. Legally, letters are sent to the beneficiaries notifying them of their
right to withdraw this gift. The beneficiaries would not, in most cases, withdraw this money;
therefore the trustee of the ILIT will pay the insurance company for the ILIT’s share of the pre-
mium.

     Secondly, the spouse will pay the balance of the premium due on the policy directly to the
insurance company. If the spouse doesn’t have sufficient independent income to do so, the in-
sured may make a marital gift of these funds to the spouse, who, for safety’s sake, should use a
personal account to then make the premium payment to the company.

     This process continues until the client either retires or needs the funds. The spouse may
access the cash value by a series of policy withdrawals and loans and these funds can be used
for any purpose including retirement funds.

     The death benefit option can be changed after retirement because of the need for a contin-
ued amount of insurance to the trust. If Option B has been elected, a level amount of death ben-
efit will be paid to the trust. However, if Option A has been elected, then policy loans and with-
drawals will have to be made, which will reduce the cash value and death benefit. The results
would be a continually changing (and decreasing) amount payable to the parties involved.

   Regardless of which Option is used, since the trust is entitled to a death benefit, the actual
amount that will be paid to the trust must be decided so that the trust can pay its share.

     What is the end result of such a program? If it is put together correctly, a rather significant
estate can be established for the surviving spouse (and other beneficiaries), which is tax-free
because of the ownership by the ILIT. PLUS, it provides the spouse access to the cash values,
which allows the spouses to accumulated funds on a tax-favored basis for retirement.

     This plan can be extremely beneficial to any married couple who has enough income
and/or wealth to benefit from the tax advantages. Planners who have used this program are ad-
amant that both parties should have complete and total confidence in each other and in their
willingness to act according to their wishes.




                                                  208
                               SURVIVORSHIP ACCESS TRUSTS
    The survivorship access trust is a very flexible estate-planning tool. This allows clients to
accomplish financial objectives that might not be available through more conventional irrevo-
cable life insurance trust (ILIT) which is used particularly for affluent clients who want to pre-
serve their assets for their family. When the ILIT is funded with a last-survivor life insurance
policy, it is most effective in generating liquidity for a large estate.

    There are limitations to an ILIT and unless care is taken in drafting the instrument, the cash
value of a last survivor insurance policy within an ILIT is not allowed to be touched by the in-
sured. A poorly drafted ILIT could also allow access to the cash value of the policy, which re-
sults in the inclusion of the death benefit in the insured’s estate. They have even been drafted to
where the grantor could never recover contributions to an ILIT.

    With proper drafting an ILIT can be designed that creates estate liquidity and at the same
time, provides a source of tax-efficient assets when can be accessed through income tax-free
loans for supplemental retirement income, or any other need. This is possible because of the
Survivorship Access Trust, which (almost magically) changes the ILIT into a versatile financial
planning tool. If it is drafted properly the trustee may make lifetime distributions to one or two
insureds, usually a spouse. The insured with access to the cash values can use the money for
any reason.

    Some of these trusts include ascertainable standards, which obligates the trustee to make
disbursements needed for the health, education, maintenance and support of the spouse benefi-
ciary. The death benefits are then free of both income and estate taxes, thereby generating li-
quidity and preserving the estate. Some do not contain this provision, especially if there is a
friendly relationship between the trustee and the insureds.

   When setting up such a trust, there are certain things that must be accomplished.

       Only one spouse should be the trust grantor, and the spouse not receiving a lifetime in-
        come interest in the trust should create the trust.
       The non-grantor spouse should not make direct or indirect gifts to the trust – otherwise
        the death benefit may be included in the estate of the non-grantor spouse (a term life
        insurance policy or term rider insuring the grantor’s life could be a source of premium
        dollars in this case).
       Neither insured should act as trustee as the trustee will determine the timing and
        amount of trust distributed (adult children are frequently used as trustee).
       Trust beneficiaries should be the non-grantor spouse or the insured’s children (there is a
        potential problem here if the non-grantor spouse is a Crummey withdrawal beneficiary,
        in which case the withdrawal right should be limited to the greater of $5,000 or 5% of
        the trust corpus – otherwise the non-grantor spouse could be considered as a trust gran-
        tor which could lead to the inclusion of the death benefit in the estate).
       The trustee must have absolute discretion in making distributions of trust income and
        principal to the non-grantor spouse.
       Care must be taken in community property states, and, for instance, the grantor spouse
        should create a separate property agreement and fund the trust with separate property.


                                                  209
SHARED OWNERSHIP WITHIN AN ILIT

    The shared ownership plan revolves around single-life policies, and avoids the problem of
the survivorship access trust wherein the insured is not able to access the cash value of the life
insurance policy in an ILIT. Basically, there is one life insurance policy with two owners who
share the rights, costs and the values of the policy, co-owned by one of two spouses in conjunc-
tion with an ILIT. The ILIT receives the death benefit free of estate and income taxes, and the
co-owner gains tax-advantages access to policy cash values through withdrawals and loans (as-
suming the policy is not a modified endowment contract – MEW) and the policy remains in
force.

    An agreement is made between a “residual” owner and an “equity” owner when the life in-
surance policy is sold. The residual owner is usually the ILIT, and it receives most of the death
benefit protection and pays the cost of that insurance coverage – and it can also own part of the
policy’s cash value is so desired. The equity owner, who is usually the insured’s spouse, retains
a death benefit equal to the cash value.

   This method gives the clients greater flexibility to make the most of their financial re-
sources.

    Using life insurance to supplement retirement income usually requires the policy’s
death benefit to be included in the insured’s gross estate and triggers an estate tax liability.
Sharing the ownership of a life insurance policy overcomes that obstacle. The cash values
of the policy continue to accumulate tax-deferred. The equity owner retains access to the-
se funds through policy loans and withdrawals, and a substantial portion of the policy’s
death benefits is removed from the client’s estate because the ILIT is the residual owner.


                         ESTATE TAXATION OF ANNUITIES

     Depending on the type of annuity, there could be a taxable event when an annuity is used in
estate planning.

     If the annuity is a straight life annuity with no survivor benefits, then nothing is included
in the deceased's annuitants gross estate. Since the monthly payment from the insurance com-
pany ceases at death. There is no value of the annuity to be included in the estate.

      For Refund or Period Certain annuities that do provide some type of survivor benefits af-
ter the first annuitants death, the amount included is the amount refundable or the cost of a
comparable contract that would provide the remaining annuity payment. Keep in mind if the
decedent only paid a portion of the premiums, then only that portion of the annuities value that
is attributable to the deceased's contribution is included in the gross estate.




                                                  210
     CONSUMER APPLICATION
     Bruce purchased a refund annuity with his estate as beneficiary in case of his death. Bruce
dies and leaves his estate annuity proceeds that actuarially could be purchased for $70,000 (Pre-
sent Value). Bruce had paid premiums of $42,000 (60%) for this annuity. Therefore, only
$42,000 is included in Bruce’s gross estate.




                         CHAPTER 11 – STUDY QUESTIONS


1.     An annuity is included in the gross estate when it is payable
       A.      to the annuitant for life.
       B.      to a joint survivor who is still alive.
       C.      for a period certain and that time has expired.

2.     Life insurance proceeds are included in a decedent’s estate if
       A.      the decedent had any incidence of ownership.
       B.      if the beneficiary was the decedent’s spouse.
       C.      a non-relative is named beneficiary.

3.     A Trust is most often used when there is a large estate. The main purpose of a Trust is to
       A.      hold the monies and property for tax payments.
       B.      allow the trustee, established by the trust, to provide liquidity for the estate and
               have an orderly transfer of assets to the parties named in a Will.
       C.      distribute the money and property to a charity.

4.     Property owned by the decedent can be transferred at death in the following manner
       A.      verbal agreement.
       B.      by a Will.
       C.      by federal law, dictating how the estate will be settled.




                                                   211
5.   The Unlimited Marital Deduction
     A.     is not used in community property states.
     B.     avoids estate taxes ordinarily payable by the first to die in a marriage by passing
            on all assets to the remaining spouse.
     C.     allows the highest wage earner, in a marriage, to pass on earned income to the
            spouse.

6.   Only one of the following types of annuities can be included in the gross estate.
     A.     An individual annuity, where the annuitant receives a payment until death.
     B.     An annuity between an employer and an employee, through a pension plan,
            where the payment ceases upon the death of the employee.
     C.     An annuity that is designated as a Joint & Survivor annuity.

7.   To qualify for the Marital Deduction
     A.     the spouse must reside in the same state.
     B.     the deceased spouse must be a citizen or resident of the United States.
     C.     the spouse cannot be legally separated.

8.   When a spouse leaves an estate that is sufficient to be taxed, under the estate tax laws,
     how and when must the tax be paid?
     A.     The tax must be paid in cash and within 9 months.
     B.     The tax must be paid in negotiable securities within one year.
     C.     If the estate were in tax free Municipal Bonds the estate would not have to pay
            taxes.

9.   There are certain allowable deductions from an estate in order to arrive at the adjusted
     gross estate, which is the amount taxed. Which one of the following is an allowable de-
     duction?
     A.     Finance charges to pay off car.
     B.     Funeral expenses including tombstone, burial plot and transportation of the body.
     C.     Expenses of relatives and friends that come to the funeral.




                                               212
10.   Probably the most important reason that life insurance should be included in estate plan-
      ning is
      A.     while death is uncertain, life insurance is certain.
      B.     the taxation of life insurance proceeds is only 10% and this can be easily ab-
             sorbed by increasing the amount of insurance by 10%.
      C.     it will pay the mortgage first and the survivors do not have to contend with mort-
             gage payments.



ANSWERS TO CHAPTER ELEVEN REVIEW QUESTIONS
1B 2A 3B 4B 5B 6C 7B 8A 9B 10A




                                                213
BOOKS, REFERENCE AND TEXT

  The Handbook of Estate Planning
    Robert Esperti & Renno Peterson
    McGraw Hill Book Co., NY

  Principles of Insurance Production
     Peter Kasicky, et al
     Insurance Institute of America, 1986

  Black’s Law Dictionary
     West Publishing Company

  Life Insurance
     Continuing Education Insurance School
     Private Printing 1998

  Estate Planning Concepts
     Pictorial Publishing Co., 1998

  Unified Federal Gift and Estate Tax
    Private Printing, University of Missouri

  Settlement Options
     Noble Continuing Education
     Private Printing 1995

  Life, Health and Contracts
     Noble Continuing Education
     Private Printing 1996

  Estate Planning
     Noble Continuing Education
     Private Printing 1998

  Long Term Care, A Growing Market
    Various chapter authors
    AMC Publishing, 1998




                                               214
Life Insurance
   Mutual of Omaha Training Material
   Mutual of Omaha Printing 1995

Dictionary of Insurance Terms
  Harvey W. Rubin, Ph.D., CLU, CPCU
  Barron’s Educational Series, 1995

Financial and Estate Planning with Life Insurance Products
   James C. Munch, Jr.
   Little Brown & Co. 1990

Law and the Life Insurance Contract
  Muriel L. Crawford
  Richard D. Irwin 1990

Legal Aspects of Life Insurance
  Edward Graves and Dan McGill
  American College 1997

Life Insurance
   Kenneth Black & Harold Skipper
   Prentice Hall 1993

Ernst & Young’s Personal Financial Planning Guide
   Robert Garner, Robert Coplan, Martin Nissenbaum, Barbara Raasch, Charles
   Ratner
   John Wiley & Sons, Inc. 1999

Financial Planning Process Course
   Pictorial Publications
   Pictorial 1997

Long Term Care: A Growing Market
  AMC Publishing 1996

Equity Index Annuities
  Thomas F Streiff, CFP, CLU, ChFC, CFS, Chythia DiBiase, CFS
  Dearborn Financial Publishing 1999




                                           215
PERIODICALS, NEWSPAPERS AND MAGAZINES

  Life Insurance Selling
     Oct., Nov., 1998; Jan., Feb., April., Sept., Oct., 1999, Jan, Feb, 2000

  Health Insurance Underwriters
    Publications of 1997, 1998, 1999 and 2000.

  National Underwriter
    April, May 1998, Feb, April, June, Oct., 1999, Feb. 2000

  Newsweek
    Sept. 1998, March 1999

  Forbes
    Several articles in 1998 and 1999, and January 2000.

  Sarasota Herald Tribune, New York Times, Wall; Street Journal, Tampa Tribune.
          Several articles from newspapers, particularly from the Wall Street Journal over the
     past 2 years. Several excellent articles on Federal Estate Taxes from Wall St. Journal.

  Specializing in Section 401(k) Plans Can Pay Off
    Jeff Van Strien, ChFC, CMFC, CRPS
    Life Insurance Selling Jan. 2000

  Risk Management Something Old is New Again
     Stuart Slonin, LUTC, RHU, CLU, IFA
     Life Insurance Selling July 1999

  Sell Case Management Benefits
     Brian D. Hayes, CEBS
     Life Insurance Selling Nov. 1999

  Enhanced Immediate Annuities
    Shawn McConnell
    Life Insurance Selling Nov. 1999

  An Agent’s Guide to Variable Annuities
    Life Insurance Selling Nov. 2001




                                               216
EIA’s: How to Get The Best Deal
  Ronald K. Wright, CLU
  Life Insurance Selling Feb 2000

How To Perform Due Care
  Richard M. Weber, CLU
  Life Insurance Selling Feb 2000

Reaching Deeper into the EIA Market
  David O’Neill
  Life Insurance Selling April 2000

Young Seniors Need a SIMPLE Retirement Guide
  Wayne Gardner RHU, CLU, ChFC
  Life Insurance Selling May 2000

Universal Life Fits Five Stages of Economic Life
  Roger Loewenheim, CLU
  Life Insurance Selling May 2002

Explaining Annuities to Prospects
  Susan M Miller
  Life Insurance Selling, May 2000

An Agent’s Guide to Single Premium Deferred Annuities 2002
  Life Insurance Selling March 2000

Flexibiltiy is the Key to Estate Planning
   Michael Toth
   Life Insurance Selling, April 2002

A Producers Guide to Single Premium Deferred Annuities
   Life Insurance Selling March 2002

The IRS Creates a Split-Regime for Taxing Split-Dollar Plans
  James G. Blase, CPA, JD, LLM
  Life Insurance Selling, May 2002

A Producers Guide to Equity Index Annuities, 2001
   Life Insurance Selling, Aug. 2001

Variable Life in Non-Qualified Benefit Plans
  Cynthia Crino, CLU
  Life Insurance Selling, Sept. 2001




                                            217
Roth to Riches
  John Bledsoe, CLU, CFP
  Life Insurance Selling, Sept. 2001

EISs for the Changing Economic Landscape
  Gail S. Waisanen, CLU, Editor
  Life Insurance Selling, Aug. 2002

A Producers Guide to Variable Life and Variable Universal Life 2002
   Life Insurance Selling, Sept. 2002

Variable Annuities, Who Wants Them, Who Needs Them?
  Debbie Andrews
  Life Insurance Selling, 2001

A Producer’s Guide to Universal Life 2002
   Life Insurance Selling, 2002

Enhanced Annuities
  Ronald R. Hagelman, Jr.
  Life Insurance Selling, May 2002

The Flexibility of the Variable Annuity
  Lucy Damiani
  Life Insurance Selling, 2002

VUL in a Down Market
  Michael R. Cumminskey, CLU, ChFC
  Life Insurance Selling, Sept 2002

VUL Offers Long Term Benefits in Tough Times
  Richard M. Herrick
  Life Insurance Selling, Sept 2002

Choosing a VUL Carrier
  Bill Riha, CLU
  Life Insurance Selling Sept 2001

The Ghost in the Machine
  Mark Kosierowski & Gabriel R. Schyiminovich
  Life Insurance Selling, May 2001

Let Prospects Lead You to VUL Sales Success
   Bill Riha, CLU
   Life Insurance Selling, Feb. 2002




                                            218
Universal Life: A Top Seller in Tough Times
  Ben Wolzenski, FSU, CLU
  Life Insurance Selling, May 2002

Learning the rules of the Roth, and non-Roth, IRA’s
  Helen Huntley
  Tampa Tribune Feb 20, 2000

Annuities and Life Insurance: The Pillars of Security
  Richard Dobson Jr.
  Life Insurance Selling March 2000




                                            219
INTERNET INFORMATION

  Estate Planning, MFS Fund Distributors. mfs.com 8/14/99

  Changes in Federal Gift & Estate Tax. wmop@mindspring.com

  Financial Planning Forum. bcm.tmc.edi/planning guide (various contributors)
     Your Retirement Plan
     Family Limited Partnership
     Bank Accounts and Stock Accounts
     Payor Death Bank Account
     The Crummy Trust
     The Widows Elections
     The Secret Words of Estate Planning
     How to Disinherit Your Son-in-law.

  Several excellent articles from Recer Estate Services. Recer.com

  Roth IRA. rothirainc.com

  Can You Afford Care In Your Ailing Years
    latimes.cpm/business/retire101

  How the Stock market Affect Annuities
    insure.com/life/annuity/stock market.html

  A Living Trust May Be Unnecessary
    aolpf.marketwatch.com/source/blq/aolpf/archive/20000201/news/current.pf.asp

  Variable Life
    variableannuityonline.com/vlife/vlwhat.cfm

  Financial Planning – GE Center for Financial Learning
  financiallearning.com/financial_life_events/building_basics.html

  Insure.com’s Retirement Roundtable
     insure.com/life/roundtable99/index.html

  Morningstar Fund Selector
    screen.morningstar.com/FundResults.html

  Equity-indexed Annuities, The best thing since sliced bread?
    insure.com/life/annuity/eiamain.html




                                               220
How Much Money Will You Need When You Retire
  e-analytics.com

Roth Conversion IRA Retirement Plan
  roth-ira-conversion.com/

401(k) and 403(b) Retirement Plans
  financialplan.about.com/finance/financialplan/msub401k.htm

Employee Benefit Provisions of the New Tax Law
  Covington and Burling, Washington, D. C.
  www.cov.com




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