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					    Introduction to
  Insurance Planning
  Virtual Class 3 of 3

Long-Term-Care Insurance, Life
Insurance, Viatical Settlements,
   and Taxation of Insurance
   Long-Term-Care Insurance
• The average nursing home stay is about 2-1/2 years.

• It’s not just for the elderly! Many younger persons are
  also unable to care for themselves because of
  handicaps resulting from birth defects, mental illness,
  or accidents.

• Costs can range from $60,000 - $110,000-plus a year.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
• Long-term-care insurance focuses on situations that
  will result in claims far into the future.

• Most underwriting is done on the basis of
  questionnaires rather than on the use of actual
  physical examinations.




                  Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Financing long-term care:

• Using personal resources (self-insuring).

• Relying on welfare (Medicaid).

• Purchasing a long-term-care insurance policy.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Eligible for assistance under the following programs:

Medicare - benefits are restrictive and limited.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Eligible for assistance under the following programs:

Medicare - benefits are restrictive and limited.

• To receive benefits, both a physician and Medicare
  must certify the need for skilled nursing care.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Eligible for assistance under the following programs:

Medicare - benefits are restrictive and limited.

• To receive benefits, both a physician and Medicare
  must certify the need for skilled nursing care.
• Medicare will only cover up to 100 days of skilled care,
  and only the first 20 days are covered at 100%.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Eligible for assistance under the following programs:

Medicare - benefits are restrictive and limited.

• To receive benefits, both a physician and Medicare
  must certify the need for skilled nursing care.
• Medicare will only cover up to 100 days of skilled care,
  and only the first 20 days are covered at 100%.

Medicaid - provides benefits for the indigent and
  impoverished.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
The policy owner of a long-term-care policy must
  meet one of the two definitions for eligibility:

• Chronic illness, or

• Substantial cognitive impairment




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating
            •Bathing




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating
            •Bathing
            •Dressing




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating
            •Bathing
            •Dressing
            •Transferring from bed to chair




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating
            •Bathing
            •Dressing
            •Transferring from bed to chair
            •Toileting




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Chronically ill
Defined as unable to perform, without substantial
assistance, two of six activities of daily living (ADLs) for
at least 90 days:

            •Eating
            •Bathing
            •Dressing
            •Transferring from bed to chair
            •Toileting
            •Continence




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Substantial Cognitive Impairment
When substantial services are required to protect the
individual due to a substantial cognitive impairment.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Benefit period:

• Unlimited and lasting for life,

• For a certain period of time, and/or

• For a specific dollar amount.




                    Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Medicare benefits are limited to nursing and home
  health care requiring skilled nursing care that is
  rehabilitative in nature.




                 Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Medicare benefits are limited to nursing and home
  health care requiring skilled nursing care that is
  rehabilitative in nature.

• To receive benefits, both a physician and Medicare
  must certify the need for skilled nursing care.




                  Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Medicare benefits are limited to nursing and home
  health care requiring skilled nursing care that is
  rehabilitative in nature.

• To receive benefits, both a physician and Medicare
  must certify the need for skilled nursing care.

• Medicare will only cover up to 100 days of skilled care,
  and only the first 20 days are covered at 100%.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Elimination Period
Ranges from 20, 60, 100, 120, or 180 days.

• Most policies do not pay benefits for the inability to
  perform ADLs unless this inability is expected to last at
  least 90 days.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Benefits provided fall into three broad categories:

• Facility-only policy - provides benefits only if the
  insured is in a nursing home.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Benefits provided fall into three broad categories:

• Facility-only policy - provides benefits only if the
  insured is in a nursing home.

• Home health care policy - designed to provide
  benefits for care outside an institutional setting.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Benefits provided fall into three broad categories:

• Facility-only policy - provides benefits only if the
  insured is in a nursing home.

• Home health care policy - designed to provide
  benefits for care outside an institutional setting.

• Comprehensive long-term-care insurance policy -
  combines benefits for facility care and home health
  care into a single contract.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Policies pay benefits in one of two basic ways:

• Reimbursement basis - reimburses the insured for
  actual expenses up to the specified daily policy limits
  (for example, up to $200 a day). Tax-qualified policies
  that provide benefits on a reimbursement basis must
  be coordinated with Medicare, except when Medicare is
  the secondary payer of benefits.

• Per-diem basis - benefits are paid regardless of the
  actual cost of care. In this case, a policy with a daily
  benefit of $200 will pay this amount even if the actual
  amount is less than $200 a day.



                   Risk Management – Virtual Class 3 of 3
    Long-Term-Care Insurance
Contract must provide:

•   A shopper's guide and a 30-day free look.
•   A two-year incontestable clause for misrepresentation.
•   Defined words and clear, unambiguous applications.
•   The contract must be guaranteed to be renewable or non-
    cancelable.
•   Limitations and exclusions within the last six months are
    prohibited except for preexisting conditions such as mental
    disorders, alcohol and drug addiction, felony, attempted
    suicide, war, and aviation.
•   Applications must have an option to name a third party to be
    notified of a pending lapse due to nonpayment of premium.
•   Applicants must be given the right to purchase inflation
    protection.
•   Replacement policies must waive the time period regarding
    preexisting conditions.



                      Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Shared benefit applies when a husband and wife are
insured under the same policy or with the same insurer.
Under the shared benefit, each spouse can access the
other spouse's benefits.

Example: If each spouse has a 4-year benefit period and
one spouse has exhausted his or her benefits, benefit
payments can continue by drawing on any unused
benefits under the other spouse's policy.




                  Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Guaranteed renewable means that an individual's
coverage cannot be cancelled except for nonpayment of
premiums.

While premiums cannot be raised on the basis of a
particular applicant's claim, they can be raised by class.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Expenses for long-term-care services, including insurance
premiums, are treated like other medical expenses.

  • Self-employed persons may deduct the premiums
    paid, and persons who itemize deductions can
    include the cost of long-term-care services, including
    insurance premiums that are in excess of 7.5 percent
    of adjusted gross income.




                   Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
The maximum deductible premium before the 7.5 percent
phase-out for 2011:

                                  Annual Deductable
                Age               Limit Per Individual

        40 or younger                                       $340

              41 – 50                                       $640

              51 – 60                                  $1,270

              61 – 70                                  $3,390

        Older than 70                                  $4,240


                   Risk Management – Virtual Class 3 of 3
Question 1
    What amount of the long-term care premium is
    disallowed as an itemized deduction on his
    income tax return (ignoring any additional AGI
    limitations)?


    A. $0
    B. $2,260
    C. $4,240
    D. $6,500
                                          Peter, please
                                         update the poll
                                           question for
                                         answers (b) and
                                             (c) Hint




Risk Management – Virtual Class 3 of 3
Question 1
    What amount of the long-term care premium is
    disallowed as an itemized deduction on his
    income tax return (ignoring any additional AGI
    limitations)?


    A. $0
    B. $2,260
    C. $4,240
    D. $6,500




Risk Management – Virtual Class 3 of 3
Question 1
    What amount of the long-term care premium is
    disallowed as an itemized deduction on his
    income tax return (ignoring any additional AGI
    limitations)?


    A. $0
    B. $2,260
    C. $4,240
    D. $6,500


    ($6,500 premium - $4,240 allowable)




Risk Management – Virtual Class 3 of 3
Question 2
    What recommendations would you make to Jack
    concerning his long-term care policy when it was
    originally purchased?

         (I)     Consider adding inflation protection.
         (II)    Select no caps limiting total payouts.
         (III)   Add home health care benefits.



    A.    (I) only
    B.    (I) and (II) only
    C.    (II) and (III) only
    D.    All of the above




                                          Hint


Risk Management – Virtual Class 3 of 3
Question 2
    What recommendations would you make to Jack
    concerning his long-term care policy when it was
    originally purchased?
         (I)     Consider adding inflation protection.
         (II)    Select no caps limiting total payouts.
         (III)   Add home health care benefits.



    A.    (I) only
    B.    (I) and (II) only
    C.    (II) and (III) only
    D.    All of the above




Risk Management – Virtual Class 3 of 3
Question 2
    What recommendations would you make to Jack
    concerning his long-term care policy when it was
    originally purchased?

         (I)     Consider adding inflation protection.
         (II)    Select no caps limiting total payouts.
         (III)   Add home health care benefits.



    A.    (I) only
    B.    (I) and (II) only
    C.    (II) and (III) only
    D.    All of the above




Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Under contracts written on a per-diem basis, proceeds
are excludible from income up to $300 per day in 2011.




          Q&A


                  Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Under contracts written on a per-diem basis, proceeds
are excludible from income up to $300 per day in 2011.

 • Amounts in excess of $300 are also excludible to the
   extent that they represent actual costs for long-term
   care services.




          Q&A


                  Risk Management – Virtual Class 3 of 3
   Long-Term-Care Insurance
Under contracts written on a per-diem basis, proceeds
are excludible from income up to $300 per day in 2011.

 • Amounts in excess of $300 are also excludible to the
   extent that they represent actual costs for long-term
   care services.

 • However, if the actual expense is less than the $300
   per-diem amount received, this will be taxed as
   ordinary income.



          Q&A


                  Risk Management – Virtual Class 3 of 3
              Life Insurance
A “needs analysis” is used to determine:

• How much immediate funds are needed to pay off
  debts.




                 Risk Management – Virtual Class 3 of 3
              Life Insurance
A “needs analysis” is used to determine:

• How much immediate funds are needed to pay off
  debts.

• How much of a lump sum is needed to provide a
  stream of income.




                 Risk Management – Virtual Class 3 of 3
              Life Insurance
A “needs analysis” is used to determine:

• How much immediate funds are needed to pay off
  debts.

• How much of a lump sum is needed to provide a
  stream of income.

• How much of a lump sum is used to provide an annuity
  for a period of time.




                 Risk Management – Virtual Class 3 of 3
              Life Insurance
Insurance contracts are contracts of adhesion, which
means that the policy owner and the insurer DO NOT
negotiate the contract's terms.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Even after the policy owner accepts the coverage and the
contract is binding on the insurer, the policy owner may
reject the contract and obtain a full refund, based on the
10-day free-look provision.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Grace Period
A provision that grants the policy owner an additional
period of time to pay any premium after it has become
due.

 • All life insurance policies have a grace period of 31
   days from the premium due date before the contract
   will lapse.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Grace Period
A provision that grants the policy owner an additional
period of time to pay any premium after it has become
due.

 • All life insurance policies have a grace period of 31
   days from the premium due date before the contract
   will lapse.
 • Therefore, the insured has 31 days from the due date
   to pay the premium in order to continue the policy as
   active.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Grace Period
A provision that grants the policy owner an additional
period of time to pay any premium after it has become
due.

 • All life insurance policies have a grace period of 31
   days from the premium due date before the contract
   will lapse.
 • Therefore, the insured has 31 days from the due date
   to pay the premium in order to continue the policy as
   active.
 • Also, if the insured dies during the grace period, the
   amount of the premium due will be withheld from the
   benefits paid.


                  Risk Management – Virtual Class 3 of 3
                Life Insurance
Incontestable Clause
A provision that makes the life insurance policy
incontestable by the insurer after it has been in force for
a certain time period.

No state permits a clause that would make the policy
contestable for more than 2 years.




                    Risk Management – Virtual Class 3 of 3
               Life Insurance
There are three exceptions to the incontestable clause:

   • There was no insurable interest at the inception of
     the policy.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
There are three exceptions to the incontestable clause:

   • There was no insurable interest at the inception of
     the policy.

   • The policy was purchased with the intent to murder
     the insured.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
There are three exceptions to the incontestable clause:

   • There was no insurable interest at the inception of
     the policy.

   • The policy was purchased with the intent to murder
     the insured.

   • There was a fraudulent impersonation of the
     insured by another person (for example, for
     purposes of taking the medical exam).



                   Risk Management – Virtual Class 3 of 3
                Life Insurance
 • Reinstatement provision - allows a policy owner to
   reacquire coverage under a policy that has lapsed.

 • Misstatement of age or sex - inaccurate
   statements of the insured's age or sex are material
   misrepresentations. Rather than voiding the contract
   based on such misrepresentations, the practice is to
   adjust the policy's premium or benefits to reflect the
   truth.

Example
If the insured is still alive when the age and/or sex
misrepresentation is discovered, the parties typically will
agree to adjust the premium to correct the amount,
rather than to adjust the benefits.



                    Risk Management – Virtual Class 3 of 3
               Life Insurance
Suicide Provision
Generally, if the insured commits suicide within the first
two years of the policy, the insurance company only
repays the benefits (without interest) that have been paid
on the policy. After the stipulated period (two years or
fewer), suicide is considered the same as any other
death, and full benefits are payable.




                   Risk Management – Virtual Class 3 of 3
Question 3
     Assume that Jack takes $70,000 from his life
     insurance policy as a loan and then embarks
     on a world tour. While traveling, Jack finds he
     cannot take the pain from his many ailments
     anymore, and commits suicide. How much
     will the insurance policy pay upon Jack’s
     death if interest on the loan is $5,000?


    A. $0
    B. $25,000
    C. $30,000
    D. $150,000




                                         Hint


Risk Management – Virtual Class 3 of 3
Question 3
     Assume that Jack takes $70,000 from his life
     insurance policy as a loan and then embarks
     on a world tour. While traveling, Jack finds he
     cannot take the pain from his many ailments
     anymore, and commits suicide. How much
     will the insurance policy pay upon Jack’s
     death if interest on the loan is $5,000?


                                         A. $0
                                         B. $25,000
                                         C. $30,000
                                         D. $150,000




Risk Management – Virtual Class 3 of 3
Question 3
     Assume that Jack takes $70,000 from his life
     insurance policy as a loan and then embarks
     on a world tour. While traveling, Jack finds he
     cannot take the pain from his many ailments
     anymore, and commits suicide. How much
     will the insurance policy pay upon Jack’s
     death if interest on the loan is $5,000?


                                         A. $0
                                         B. $25,000
                                         C. $30,000
                                         D. $150,000




    ($225,000 death benefit - $70,000 loan
    - $5,000 interest)




Risk Management – Virtual Class 3 of 3
               Life Insurance
Dividend Options
Any available surplus (appears only in participating
policies) that an insurer decides to distribute to the
policyholders and/or stockholders of the insurer. The
various dividend options are:

 • Reduction of premiums
 • Accumulation at interest




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
The death benefits received in a life insurance contract
are usually income-tax-free.

During the life of a permanent policy, the policy owner
may:

 • Terminate the policy and receive the cash value.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
The death benefits received in a life insurance contract
are usually income-tax-free.

During the life of a permanent policy, the policy owner
may:

 • Terminate the policy and receive the cash value.
 • Borrow a loan against the cash value of the policy.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
The death benefits received in a life insurance contract
are usually income-tax-free.

During the life of a permanent policy, the policy owner
may:

 • Terminate the policy and receive the cash value.
 • Borrow a loan against the cash value of the policy.
 • Take a distribution from the cash value of the policy.




                   Risk Management – Virtual Class 3 of 3
                 Life Insurance
The death benefits received in a life insurance contract
are usually income-tax-free.

During the life of a permanent policy, the policy owner
may:

 •   Terminate the policy and receive the cash value.
 •   Borrow a loan against the cash value of the policy.
 •   Take a distribution from the cash value of the policy.
 •   Sell the policy to a third party.




                     Risk Management – Virtual Class 3 of 3
              Life Insurance
Permanent insurance or Term insurance?



• There is no correct answer. Show the pros and cons
  and let the client decide.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term provides a large death benefit at low cost.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term provides a large death benefit at low cost.

• Premiums increase exponentially after original term as
  the insured ages.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term provides a large death benefit at low cost.

• Premiums increase exponentially after original term as
  the insured ages.

• Look for a convertible policy that converts to a
  permanent insurance product without evidence of
  insurability.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term life is an excellent choice for temporary
  insurance needs.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term life is an excellent choice for temporary
  insurance needs.

• Term provides no savings component and may not
  meet permanent insurance needs.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term life is an excellent choice for temporary
  insurance needs.

• Term provides no savings component and may not
  meet permanent insurance needs.

• Decreasing term insurance is often used to provide the
  funds necessary to pay off a mortgage. Be cautious of
  a level payment with insurance protection eventually
  becoming zero.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
• Term life is an excellent choice for temporary
  insurance needs.

• Term provides no savings component and may not
  meet permanent insurance needs.

• Decreasing term insurance is often used to provide the
  funds necessary to pay off a mortgage. Be cautious of
  a level payment with insurance protection eventually
  becoming zero.

• It is extremely important that the term insurance is
  convertible into permanent insurance without evidence
  of medical insurability.



                   Risk Management – Virtual Class 3 of 3
                Life Insurance
Permanent Insurance:

• Permanent insurance accumulates cash with tax
  advantages while the insured is still alive.




          Q&A


                 Risk Management – Virtual Class 3 of 3
                 Life Insurance
Permanent Insurance:

• Permanent insurance accumulates cash with tax
  advantages while the insured is still alive.
• Provides for one’s family or business at one’s death.




           Q&A


                   Risk Management – Virtual Class 3 of 3
                 Life Insurance
Permanent Insurance:

• Permanent insurance accumulates cash with tax
  advantages while the insured is still alive.
• Provides for one’s family or business at one’s death.
• Builds cash to supplement retirement income.




           Q&A


                   Risk Management – Virtual Class 3 of 3
                 Life Insurance
Permanent Insurance:

• Permanent insurance accumulates cash with tax
  advantages while the insured is still alive.
• Provides for one’s family or business at one’s death.
• Builds cash to supplement retirement income.
• Is used to pay taxes on one’s estate at death.




           Q&A


                   Risk Management – Virtual Class 3 of 3
                Life Insurance
Permanent Insurance:

• Permanent insurance accumulates cash with tax
  advantages while the insured is still alive.
• Provides for one’s family or business at one’s death.
• Builds cash to supplement retirement income.
• Is used to pay taxes on one’s estate at death.
• Is a ready source of income for a loan if an emergency
  or opportunity arises.



          Q&A


                  Risk Management – Virtual Class 3 of 3
               Life Insurance
The following slides deal with permanent policies.

 • Regardless of the various life insurance choices, all
   are a variation on whole life, term insurance, or
   universal life.

 • The basics of life insurance policies remain the same
   with various options of add-on features called riders.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Endowment Life Insurance - A variation of cash value
life insurance that allows the purchaser to specify the
policy's maturity date. This type of insurance is available
in 10-, 15-, 20-, 25-, 30-, 35-year, or longer endowment
periods.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Endowment Life Insurance - A variation of cash value
life insurance that allows the purchaser to specify the
policy's maturity date. This type of insurance is available
in 10-, 15-, 20-, 25-, 30-, 35-year, or longer endowment
periods.

Purchasing an endowment policy with a face amount
equal to the desired accumulation amount ensures that
the funds will be available, regardless of whether the
insured survives to the target date.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
There are two types of endowment policies:

• Pure endowment policy - pays the face amount of
  the policy only if the insured survives the endowment
  period. This type of policy is NOT sold in the United
  States.

• Regular endowment policy - pays the face amount
  of the policy only if the insured dies within the
  endowment period, or pays the face amount in the
  form of an annuity if the insured survives beyond the
  endowment period.




                  Risk Management – Virtual Class 3 of 3
                Life Insurance
Whole Life Insurance - Offers permanent lifetime protection
and cash values, and can be either participating or
nonparticipating.

 • Nonparticipating or non-dividend-paying policies are
   associated with stock life insurance companies. The
   insurance company retains all gains from favorable
   experience for its shareholders.




                    Risk Management – Virtual Class 3 of 3
                Life Insurance
Whole Life Insurance - Offers permanent lifetime protection
and cash values, and can be either participating or
nonparticipating.

 • Nonparticipating or non-dividend-paying policies are
   associated with stock life insurance companies. The
   insurance company retains all gains from favorable
   experience for its shareholders.

 • Participating policies anticipate charging an extra margin
   in the fixed premium with the intention of returning part of
   the premium in the form of policy owner dividends. These
   dividends are based on favorable experiences, such as
   higher-than-expected investment returns or lower-than-
   expected mortality and/or expenses for operations. A
   mutual insurance company sells these policies.




                    Risk Management – Virtual Class 3 of 3
              Life Insurance
There are various premium payments made on whole life
insurance policies:

 • Ordinary life insurance – Premiums continue until
   the policy endows.
 • Limited-payment life insurance - Premiums are
   limited by contract to a specified number of years.
   Examples are 5-, 10-, 15-, and 25-year policies. This
   may be a good option for a 45-year-old who wants to
   retire at age 65 and also wants the policy paid up at
   the same time.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Graded Premium Whole Life
Premiums usually start with pure term insurance and
convert to whole life over 5-, 10-, or 20-year terms. It
starts as a yearly renewable term and then the premium
is leveled at the advanced age where whole life begins.




                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Modified Life
Similar to graded premium, but the first 5 years of
premiums are slightly more than a convertible term life
premium. After that, an increase occurs to a premium
which is slightly more than what a whole life premium
would have been at the age of inception, but slightly less
than the level premium for ordinary life at the attained
age of conversion.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance
Shifts the investment uncertainty of investment gains or
losses to the policy owner.

 • A variable life insurance policy provides no guarantee
   of either interest rate or minimum cash value.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance
Shifts the investment uncertainty of investment gains or
losses to the policy owner.

 • A variable life insurance policy provides no guarantee
   of either interest rate or minimum cash value.
 • Theoretically, the cash value can go down to zero,
   and if so, the policy will terminate.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance
Shifts the investment uncertainty of investment gains or
losses to the policy owner.

 • A variable life insurance policy provides no guarantee
   of either interest rate or minimum cash value.
 • Theoretically, the cash value can go down to zero,
   and if so, the policy will terminate.
 • The policy is a fixed premium, variable face value
   policy.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance

• Variable life offers investment options for the cash
  value to keep pace with inflation (purchasing power
  risk).




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance

• Variable life offers investment options for the cash
  value to keep pace with inflation (purchasing power
  risk).
• Poor investment performance directly affects the
  policy's cash value, which could possibly cause the
  policy to lapse.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Variable Life Insurance

• Variable life offers investment options for the cash
  value to keep pace with inflation (purchasing power
  risk).
• Poor investment performance directly affects the
  policy's cash value, which could possibly cause the
  policy to lapse.
• Cash value will fluctuate daily based on the closing
  price of the portfolio on any given day.




                   Risk Management – Virtual Class 3 of 3
              Life Insurance
Variable Life Insurance

• Variable life offers investment options for the cash
  value to keep pace with inflation (purchasing power
  risk).
• Poor investment performance directly affects the
  policy's cash value, which could possibly cause the
  policy to lapse.
• Cash value will fluctuate daily based on the closing
  price of the portfolio on any given day.
• Policies must be sold with an accompanying prospectus
  as mandated by the SEC, and the seller must be
  FINRA-licensed.



                  Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal Life Insurance
A flexible premium life insurance policy under which the
policyholder may change the death benefit from time to
time (with satisfactory evidence of insurability for
increases) and vary the premium payments.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal Life Insurance

• Provides ability to withdraw part of the cash value
  without having the withdrawal treated as a policy loan.

• Offers the choice of either a level death benefit or an
  increasing death benefit.

• Market rates of interest credited with unbundling of
  cost elements.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal policies offer two death benefit options:

Option 1 – The death benefit will be the greater of:
   • The specified amount on the date of death, or




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal policies offer two death benefit options:

Option 1 – The death benefit will be the greater of:
   • The specified amount on the date of death, or
   • The cash value on the date of death times the
     applicable percentage.




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal policies offer two death benefit options:

Option 1 – The death benefit will be the greater of:
   • The specified amount on the date of death, or
   • The cash value on the date of death times the
     applicable percentage.

Option 2 – The death benefit will be the greater of:
   • The specified amount plus the cash value on the
     date of death, or




                   Risk Management – Virtual Class 3 of 3
               Life Insurance
Universal policies offer two death benefit options:

Option 1 – The death benefit will be the greater of:
   • The specified amount on the date of death, or
   • The cash value on the date of death times the
     applicable percentage.

Option 2 – The death benefit will be the greater of:
   • The specified amount plus the cash value on the
     date of death, or
   • The cash value on the date of death times the
     applicable percentage.



                   Risk Management – Virtual Class 3 of 3
                Life Insurance
Variable Universal Life Insurance
The policy has all of the premium flexibility features of
the universal life policy with the client-directed
investment aspects of variable life insurance.




                    Risk Management – Virtual Class 3 of 3
              Life Insurance
Variable Universal Life Insurance:

• An interest-sensitive product with investment options
  chosen by the policyholder, such as mutual funds, with
  NO minimum guaranteed rate of return or interest.




                  Risk Management – Virtual Class 3 of 3
              Life Insurance
Variable Universal Life Insurance:

• An interest-sensitive product with investment options
  chosen by the policyholder, such as mutual funds, with
  NO minimum guaranteed rate of return or interest.

• Death benefits are not guaranteed, and cash values
  can decline to zero, causing the policy to lapse.




                  Risk Management – Virtual Class 3 of 3
              Life Insurance
Variable Universal Life Insurance:

• An interest-sensitive product with investment options
  chosen by the policyholder, such as mutual funds, with
  NO minimum guaranteed rate of return or interest.

• Death benefits are not guaranteed, and cash values
  can decline to zero, causing the policy to lapse.

• Must be sold with an accompanying prospectus as
  mandated by the SEC, and the seller must be FINRA-
  licensed.




                  Risk Management – Virtual Class 3 of 3
                Life Insurance
Nonforfeiture Options – When a life insurance policy is
terminated, the policy owner can:

 • Choose to receive the cash value of the policy.




          Q&A


                  Risk Management – Virtual Class 3 of 3
                Life Insurance
Nonforfeiture Options – When a life insurance policy is
terminated, the policy owner can:

 • Choose to receive the cash value of the policy.

 • Elect to receive a reduced amount of paid-up
   insurance equivalent to what the cash value could
   purchase as a net single premium.




          Q&A


                  Risk Management – Virtual Class 3 of 3
                Life Insurance
Nonforfeiture Options – When a life insurance policy is
terminated, the policy owner can:

 • Choose to receive the cash value of the policy.

 • Elect to receive a reduced amount of paid-up
   insurance equivalent to what the cash value could
   purchase as a net single premium.

 • Choose to surrender a cash value policy for a paid-up
   term insurance.

          Q&A


                  Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
No tax consequences when the policy is changed:

• The carrier administering the old policy is financially
  shaky.




                    Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
No tax consequences when the policy is changed:

• The carrier administering the old policy is financially
  shaky.
• The cash values in the old policy may be building up
  too slowly.




                   Risk Management – Virtual Class 3 of 3
      Section 1035 Exchange
No tax consequences when the policy is changed:

• The carrier administering the old policy is financially
  shaky.
• The cash values in the old policy may be building up
  too slowly.
• The premiums may be too high; the old policy may no
  longer adequately serve an individual’s needs.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
No tax consequences when the policy is changed:

• The carrier administering the old policy is financially
  shaky.
• The cash values in the old policy may be building up
  too slowly.
• The premiums may be too high; the old policy may no
  longer adequately serve an individual’s needs.
• To convert an existing policy to a whole life, universal,
  or other type of policy.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
No tax consequences when the policy is changed:

• The carrier administering the old policy is financially
  shaky.
• The cash values in the old policy may be building up
  too slowly.
• The premiums may be too high; the old policy may no
  longer adequately serve an individual’s needs.
• To convert an existing policy to a whole life, universal,
  or other type of policy.
• Determine any surrender charges in your analysis.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
The following transfers are tax-free:

• Life insurance contract for another life insurance
  contract.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
The following transfers are tax-free:

• Life insurance contract for another life insurance
  contract.

• Life insurance contract for an annuity contract or a
  qualified long-term care insurance contract.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
The following transfers are tax-free:

• Life insurance contract for another life insurance
  contract.

• Life insurance contract for an annuity contract or a
  qualified long-term care insurance contract.

• An annuity contract for an annuity contract or a
  qualified long-term care insurance contract.




                   Risk Management – Virtual Class 3 of 3
       Section 1035 Exchange
The following transfers are tax-free:

• Life insurance contract for another life insurance
  contract.

• Life insurance contract for an annuity contract or a
  qualified long-term care insurance contract.

• An annuity contract for an annuity contract or a
  qualified long-term care insurance contract.

• A qualified long-term care insurance contract for a
  qualified long-term care insurance contract.




                   Risk Management – Virtual Class 3 of 3
Question 4
    Which of the following statements is/are
    correct regarding Jack’s current annuity
    contract and IRS Code Section 1035
    exchanges?

       (I)    Jack can exchange an annuity contract for
       another annuity contract.

       (II)   Jack can exchange an annuity contract for a
       long-term-care policy.



    A. (I) only
    B. (II) only
    C. Neither of the above
    D. Both of the above




Risk Management – Virtual Class 3 of 3
Question 4
    Which of the following statements is/are
    correct regarding Jack’s current annuity
    contract and IRS Code Section 1035
    exchanges?

       (I)    Jack can exchange an annuity contract for
       another annuity contract.

       (II)   Jack can exchange an annuity contract for a
       long-term-care policy.



    A. (I) only
    B. (II) only
    C. Neither of the above
    D. Both of the above




Risk Management – Virtual Class 3 of 3
          Viatical Settlements
Prior to the policy owner's death, cash can be obtained
through loans or viatical settlements.

Viatical settlements allow the policy owner to sell the life
insurance policy to a third party without incurring a
taxable transaction.




                    Risk Management – Virtual Class 3 of 3
           Viatical Settlements
Amounts received under a life insurance policy contract
on the life of a terminally ill or chronically ill individual are
excluded from gross income.

"Terminally ill" refers to an individual who has been
certified by a physician as having an illness or condition
that can reasonably be expected to result in death within
24 months of the date of certification.




                     Risk Management – Virtual Class 3 of 3
          Viatical Settlements
"Chronically ill" refers to a person who is unable to
perform at least two activities of daily living (e.g., eating,
bathing, etc.) for a period of at least 90 days.

However, if the individual is only chronically ill, the
benefits will only be excluded from income to the extent
they are used for L/T care services.




                    Risk Management – Virtual Class 3 of 3
          Viatical Settlements
A viatical settlement provider must grant a 15-day
cooling-off period during which the viator can rescind the
viatical agreement.




                   Risk Management – Virtual Class 3 of 3
      Question 5
          Assume Jack sells his life insurance policy in
          a viatical settlement to his life insurance
          company. The life insurance company pays
          Jack $185,000 for his policy. What are Jack’s
          tax consequences?

          A. There is a $85,000 gain taxed as ordinary
              income.
          B. There is a $85,000 gain taxed as a short-
              term capital gain.
          C. There is a $85,000 gain taxed as a long-
              term capital gain.
          D. There is no income to report.




Q&A                                            Hint


      Risk Management – Virtual Class 3 of 3
      Question 5
          Assume Jack sells his life insurance policy in
          a viatical settlement to his life insurance
          company. The life insurance company pays
          Jack $185,000 for his policy. What are Jack’s
          tax consequences?

          A. There is a $85,000 gain taxed as ordinary
              income.
          B. There is a $85,000 gain taxed as a short-
              term capital gain.




          C. There is a $85,000 gain taxed as a long-
              term capital gain.
          D. There is no income to report.



Q&A

      Risk Management – Virtual Class 3 of 3
      Question 5
          Assume Jack sells his life insurance policy in
          a viatical settlement to his life insurance
          company. The life insurance company pays
          Jack $185,000 for his policy. What are Jack’s
          tax consequences?

          A. There is a $85,000 gain taxed as ordinary
              income.
          B. There is a $85,000 gain taxed as a short-
              term capital gain.




          C. There is a $85,000 gain taxed as a long-
              term capital gain.
          D. There is no income to report.



Q&A

      Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Generally, death benefits are tax-free. However, if a
policy is transferred from one owner to another for
valuable consideration, the income tax exclusion is lost
under the transfer-for-value rule.




           Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

The following transfers will not fall under the transfer-of-
value rule:

 • Transfers to the insured.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

The following transfers will not fall under the transfer-of-
value rule:

 • Transfers to the insured.
 • Transfers to the partner of the insured.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

The following transfers will not fall under the transfer-of-
value rule:

 • Transfers to the insured.
 • Transfers to the partner of the insured.
 • Transfers to a partnership in which the insured is a
   partner.




           Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

The following transfers will not fall under the transfer-of-
value rule:

 • Transfers to the insured.
 • Transfers to the partner of the insured.
 • Transfers to a partnership in which the insured is a
   partner.
 • Transfers to a corporation in which the insured is an
   officer or shareholder.




           Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

The following transfers will not fall under the transfer-of-
value rule:

 • Transfers to the insured.
 • Transfers to the partner of the insured.
 • Transfers to a partnership in which the insured is a
   partner.
 • Transfers to a corporation in which the insured is an
   officer or shareholder.
 • Transfer to a transferee whose basis in the policy is
   determined by gift; for example, transfer to an
   irrevocable life insurance trust (ILIT).

           Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

When a life insurance policy is transferred under the
transfer-for-value rules, the death proceeds received,
minus the amount the transferee-owner paid for the
policy, minus any premiums subsequently paid, will be
taxable as ordinary income.

Example:
Assume John sells his whole life policy to his brother
Mike.




           Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Upon death of the insured, the policy can be paid out as
follows:

 • As a lump sum.




                    Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Upon death of the insured, the policy can be paid out as
follows:

 • As a lump sum.
 • As interest only for a period of time, until either a
   lump sum or annuity option is elected.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Upon death of the insured, the policy can be paid out as
follows:

 • As a lump sum.
 • As interest only for a period of time, until either a
   lump sum or annuity option is elected.
 • In installments in the form of an annuity.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Withdrawals of cash value within the first 15 years of a
life insurance policy that result in a reduction of death
benefits are subject to LIFO basis treatment. Amounts
beyond the first 15 years of the policy are subject to FIFO
basis treatment.

 • Loans are generally tax-free (except for a MEC);
   however, interest is charged and can either be paid
   by the policyholder or added to the outstanding loan
   balance.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

• Any lump-sum payments, interest payments, or the
  tax portion of installment payments, in excess of basis,
  are subject to ordinary income.

• Any amount sold for less than the policyholder’s basis
  is a nondeductible personal expenditure.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Premium payments for individual life insurance policies
are not deductible for federal income tax purposes.

Exceptions that allow premiums to be deductible apply
to:

 • Premiums made on behalf of a charitable
   organization.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Premium payments for individual life insurance policies
are not deductible for federal income tax purposes.

Exceptions that allow premiums to be deductible apply
to:

 • Premiums made on behalf of a charitable
   organization.
 • When a corporation pays a premium on a policy
   covering an employee and the death benefit is
   payable to the employee's beneficiary, the premium
   can be deductible as compensation paid to the
   employee.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Premium payments for individual life insurance policies
are not deductible for federal income tax purposes.

Exceptions that allow premiums to be deductible apply
to:

 • Premiums made on behalf of a charitable
   organization.
 • When a corporation pays a premium on a policy
   covering an employee and the death benefit is
   payable to the employee's beneficiary, the premium
   can be deductible as compensation paid to the
   employee.
 • Premium payments that constitute alimony made on
   behalf of an ex-spouse.


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Dividends – are not taxable, as they are first treated as
a return of basis (FIFO).

 • If the dividend received exceeds the premiums paid,
   the amount is taxable as ordinary income.

 • Dividends are earned on participating life insurance
   policies and can be either distributed to the
   policyholder or remain in the policy.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Dividend Distribution Rules:

   • Dividends distributed to the policyholder in the
     current year that are less than the yearly premium
     are a tax-free return of premiums.




                  Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Dividend Distribution Rules:

   • Dividends distributed to the policyholder in the
     current year that are less than the yearly premium
     are a tax-free return of premiums.

   • Dividends distributed to the policyholder in the
     current year that are greater than the yearly
     premium are taxed as ordinary income.




                  Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Dividend Distribution Rules:

   • Dividends distributed to the policyholder in the
     current year that are less than the yearly premium
     are a tax-free return of premiums.

   • Dividends distributed to the policyholder in the
     current year that are greater than the yearly
     premium are taxed as ordinary income.

   • Dividends left in the policy earn interest. The
     interest earnings are taxed as ordinary income.




                  Risk Management – Virtual Class 3 of 3
        Dividend Example #1
If John pays his first $10,000 premium on a whole life
policy and receives a $1,300 dividend, his basis is:




                   Risk Management – Virtual Class 3 of 3
         Dividend Example #1
If John pays his first $10,000 premium on a whole life
policy and receives a $1,300 dividend, his basis is:

$8,700

($10,000 - $1,300 refund option) after year one.




                   Risk Management – Virtual Class 3 of 3
        Dividend Example #2
If John pays a $10,000 premium on a whole life policy
and receives $11,500, he will have:




                  Risk Management – Virtual Class 3 of 3
        Dividend Example #2
If John pays a $10,000 premium on a whole life policy
and receives $11,500, he will have:

$1,500 of ordinary income as the yearly dividends
exceed the yearly premiums.




                  Risk Management – Virtual Class 3 of 3
         Dividend Example #3
If John pays his first $10,000 premium on a whole life policy
and chooses to leave the $1,300 dividend received at the end of
the anniversary date in the policy earning 5%, his basis is
$10,000 ($10,000 - $1,300 + $1,300) after year one.

Assume that, after year two, there is another $1,300 dividend
received in year two on the $10,000 premium payment and
that John chooses to leave the dividend in the policy.




                    Risk Management – Virtual Class 3 of 3
         Dividend Example #3
If John pays his first $10,000 premium on a whole life policy
and chooses to leave the $1,300 dividend received at the end of
the anniversary date in the policy earning 5%, his basis is
$10,000 ($10,000 - $1,300 + $1,300) after year one.

Assume that, after year two, there is another $1,300 dividend
received in year two on the $10,000 premium payment and
that John chooses to leave the dividend in the policy.

John’s basis after year two is $20,065 [$10,000 year one
premium + interest income $65 ($1,300 x 5% interest earned
during year two) + $10,000 for year two premium].

John will report ordinary income of $65 on his year two income
tax return, creating the additional $65 basis in the policy.




                    Risk Management – Virtual Class 3 of 3
          Dividend Example #4
If John pays his first $10,000 premium on a whole life policy
and chooses to leave the $1,300 dividend in the policy earning
5%, his basis is $10,000 after year one.
Assume that, after year two, there is another $1,300 dividend
on the second yearly $10,000 premium payment and that John
chooses to receive it as a refund. John’s basis after year two is:




                      Risk Management – Virtual Class 3 of 3
          Dividend Example #4
If John pays his first $10,000 premium on a whole life policy
and chooses to leave the $1,300 dividend in the policy earning
5%, his basis is $10,000 after year one.
Assume that, after year two, there is another $1,300 dividend
on the second yearly $10,000 premium payment and that John
chooses to receive it as a refund. John’s basis after year two is:

$18,765

[$10,000 year one premium + interest income $65 ($1,300 x
5% interest earned during year two) + $10,000 for year two
premium - $1,300 refund option].

John will report ordinary income of $65 on his income tax
return, creating the additional $65 basis in the policy.



                      Risk Management – Virtual Class 3 of 3
           Dividend Examples
Final surrender proceeds minus the above computed
basis will determine the realized gain or loss in these
examples.

The realized loss is a nondeductible personal loss.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Modified endowment contracts (MECs) - any policy is
considered a MEC if it fails the 7-pay test.




                Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Modified endowment contracts (MECs) - any policy is
considered a MEC if it fails the 7-pay test.

This test is applied at the inception of the policy and
applied again if the policy experiences a material change
(an increase in death benefits under the policy resulting
from a flexible premium payment).




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance

Modified Endowment Contracts (MECs):

• LIFO tax treatment regardless of the age of the policy
  (ignore the 15-year rule) for both distributions and
  loans.

• The 7-pay test is designed to impose MEC status on
  policies that take in too much premium during the first
  7 policy years, or in 7 years after a material change.




                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Modified Endowment Contracts (MECs):

• For each policy, a net level premium is calculated. If
  the total premium actually paid into the policy at any
  time during the 7-year testing period exceeds the sum
  of the net level premiums needed to result in a paid-up
  policy after 7 years, then the policy is a MEC.




          Q&A


                  Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Modified Endowment Contracts (MECs):

• For each policy, a net level premium is calculated. If
  the total premium actually paid into the policy at any
  time during the 7-year testing period exceeds the sum
  of the net level premiums needed to result in a paid-up
  policy after 7 years, then the policy is a MEC.

• A 10% penalty will apply for any loan or withdrawal if
  the taxpayer is under age 59-1/2.




          Q&A


                   Risk Management – Virtual Class 3 of 3
Income Taxation of Life Insurance
Modified Endowment Contracts (MECs):

• For each policy, a net level premium is calculated. If
  the total premium actually paid into the policy at any
  time during the 7-year testing period exceeds the sum
  of the net level premiums needed to result in a paid-up
  policy after 7 years, then the policy is a MEC.

• A 10% penalty will apply for any loan or withdrawal if
  the taxpayer is under age 59-1/2.

• The taxpayer will not receive an increase in basis in
  the policy equal to the amount of the loan that is
  taxable.

           Q&A


                   Risk Management – Virtual Class 3 of 3
                    Annuities
The primary function of life insurance is to create an
estate or principal sum. The primary function of an
annuity is to liquidate a principal sum, regardless of how
it was created.




                   Risk Management – Virtual Class 3 of 3
                     Annuities
• An annuity is a periodic payment that will begin at a
  specified or contingent date, and continue throughout
  a fixed period, or for the duration of a designated life,
  or lives.

• The person on whose life the duration of the payments
  is based is called the annuitant.




                    Risk Management – Virtual Class 3 of 3
                    Annuities
• The purpose of an annuity is to protect against loss of
  income arising out of excessive longevity.

• Each annuity payment is composed partly of the
  annuitant's principal and investment income on these
  funds.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
Annuities can be classified as immediate or deferred.

 • Immediate annuity - makes the first benefit
   payment one payment interval after the date of
   purchase.

 • Deferred annuity - a period longer than one
   payment interval must elapse after purchase before
   the first benefit payment is due.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
Payment structures of annuities:

• Pure/straight life annuity - provides income
  payments that continue as long as the annuitant lives
  and terminates at the person's death.

• Refund annuity - any annuity type that promises to
  return a portion of (or all of) the purchase price of the
  annuity.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
There are two types of joint annuities:

• Joint-and-last-survivor annuity - continues benefit
  payments until the last of the named annuitants dies.

• Joint-life annuity - provides income benefits only
  until the death of the first of two or more annuitants.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
• A variable annuity is a security within the meaning of
  the Securities Act of 1933, and any organization
  offering such a contract is considered an investment
  company, subject to the Investment Company Act of
  1940.

• Must be FINRA licensed to sell.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
• The portion of benefit payments taxable during the
  liquidation period depends on the applicable exclusion
  ratio.

• After the annuitant has received excludible amounts
  equal to the investment in the contract, the basis in
  the annuity will be fully recovered.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
• Any remaining benefit payments are fully taxable to
  the annuitant. If the annuitant dies before the basis in
  the annuity is fully recovered, a deduction for the
  unrecovered amount is a miscellaneous itemized
  deduction NOT subject to 2% of AGI on the annuitant's
  final tax return.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
If an annuity is not annuitized, the date the annuity is
purchased will determine the taxability of distributions:

 • FIFO Method- Pre August 14, 1982, for
   distributions.
 • LIFO Method - Post August 13, 1982, for
   distributions.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
Under the LIFO method (post August 13, 1982 purchase),
all withdrawals for the annuity are considered fully
taxable to the extent that they represent growth. Once all
growth has been taxed, any excess will be considered
invested principal and will not be subject to income
taxation.




                   Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #1
John purchased a $75,000 annuity on 10/10/01 that is
now worth $100,000. Today, at age 65, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is taxed as ordinary income.




                  Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #1
John purchased a $75,000 annuity on 10/10/01 that is
now worth $100,000. Today, at age 65, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is taxed as ordinary income.
 • John’s basis is still $75,000.




                  Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #1
John purchased a $75,000 annuity on 10/10/01 that is
now worth $100,000. Today, at age 65, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is taxed as ordinary income.
 • John’s basis is still $75,000.
 • John is not subject to a 10% penalty as he was older
   than 59-1/2 on date of distribution. Note – there is an
   exception to the 10% penalty due to disability or
   death.




                   Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #2
John purchased a $75,000 annuity on 10/10/82 that is
now worth $400,000. Today, at age 57, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is a tax-free return of basis.




          Q&A


                  Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #2
John purchased a $75,000 annuity on 10/10/82 that is
now worth $400,000. Today, at age 57, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is a tax-free return of basis.
 • John’s basis is now $65,000 ($75,000 - $10,000).




          Q&A


                  Risk Management – Virtual Class 3 of 3
Annuity Distribution Rule Example
                #2
John purchased a $75,000 annuity on 10/10/82 that is
now worth $400,000. Today, at age 57, John takes a
$10,000 distribution. The tax consequences are:

 • $10,000 is a tax-free return of basis.
 • John’s basis is now $65,000 ($75,000 - $10,000).
 • John is not subject to a 10% penalty as the
   distribution is a return of basis. Ignore his age
   regarding the 10% penalty.




          Q&A


                  Risk Management – Virtual Class 3 of 3
                   Annuities
When annuitizing a contract, you use the exclusion ratio
to determine:

 • The portion of each payment that is a return of
   capital;

 • The portion of each payment that is taxed as ordinary
   income.




                  Risk Management – Virtual Class 3 of 3
                     Annuities
The exclusion ratio is: Payment Received x (Post Tax
Basis in Contract / Expected Number of Payments to be
Received) = Return of Basis.

Note: If the contract is a deferred annuity with no post-
tax basis, the exclusion ratio is zero, as all distributions
are taxed as ordinary income.




                    Risk Management – Virtual Class 3 of 3
                       Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:




                      Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:
   $2,400 x .5556 = $1,333.33




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:
   $2,400 x .5556 = $1,333.33
 • Taxable income:




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:
   $2,400 x .5556 = $1,333.33
 • Taxable income:
   $2,400 - $1,333.33 or $2,400 x (1 - .5556) = $1,066.67




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:
   $2,400 x .5556 = $1,333.33
 • Taxable income:
   $2,400 - $1,333.33 or $2,400 x (1 - .5556) = $1,066.67
 • Adjusted basis of annuity as of 12/01/11:




                    Risk Management – Virtual Class 3 of 3
                     Annuities
Example – John purchases an annuity on 1/1/99 for
$60,000. When annuitizing this contract, John is to receive a
monthly payment of $600 for the next 15 years. What is his
taxable income if the first payment is received on 9/1/11?

 • Exclusion ratio:
   $60,000 / ($600 x 12 months x 15 years) = .5556
 • Total payments received in 2011:
   $600 x 4 months = $2,400
 • Tax-free return of basis:
   $2,400 x .5556 = $1,333.33
 • Taxable income:
   $2,400 - $1,333.33 or $2,400 x (1 - .5556) = $1,066.67
 • Adjusted basis of annuity as of 12/01/11:
   $60,000 - $1,333.33 = $58,666.67


                    Risk Management – Virtual Class 3 of 3
                    Annuities
• Payments received beyond the projected life
  expectancy are fully taxable, except for annuities
  issued before December 31, 1986, for which the
  exclusion ratio applies for the entire payment period.




                   Risk Management – Virtual Class 3 of 3
                    Annuities
• Payments received beyond the projected life
  expectancy are fully taxable, except for annuities
  issued before December 31, 1986, for which the
  exclusion ratio applies for the entire payment period.

• Taxable distributions are taxed as ordinary income and
  subject to a 10% penalty before age 59-1/2, unless an
  exception applies (e.g., death or disability).




                   Risk Management – Virtual Class 3 of 3
Question 6
    For this question only, if Jack takes a $15,000
    distribution from the annuity, how will this be
    treated for tax purposes?
    A. $15,000 is treated as a tax-free return of basis.
    B. $15,000 is treated as ordinary income, subject to
        a 10% penalty.
    C. $15,000 is treated as ordinary income, not
        subject to a 10% penalty.
    D. $15,000 is treated as a long-term capital gain,
        not subject to a 10% penalty.




                                         Hint


Risk Management – Virtual Class 3 of 3
Question 6
    For this question only, if Jack takes a $15,000
    distribution from the annuity, how will this be
    treated for tax purposes?
    A. $15,000 is treated as a tax-free return of basis.
    B. $15,000 is treated as ordinary income, subject to
        a 10% penalty.
    C. $15,000 is treated as ordinary income, not
        subject to a 10% penalty.
    D. $15,000 is treated as a long-term capital gain,
        not subject to a 10% penalty.




Risk Management – Virtual Class 3 of 3
Question 6
    For this question only, if Jack takes a $15,000
    distribution from the annuity, how will this be
    treated for tax purposes?
    A. $15,000 is treated as a tax-free return of basis.
    B. $15,000 is treated as ordinary income, subject to
        a 10% penalty.
    C. $15,000 is treated as ordinary income, not
        subject to a 10% penalty.
    D. $15,000 is treated as a long-term capital gain,
        not subject to a 10% penalty.




    (Post 8/13/82 annuity, use LIFO method)


Risk Management – Virtual Class 3 of 3
Question 7
    Assume that Jack annuitizes the $150,000
    annuity under the straight life option. The
    insurance company will offer him quarterly
    payments of $5,000 starting October 1, 2011.
    The actuarial number of payments is 40. How
    much will Jack report as income on his income
    tax return for 2011?

    A. $0, as this is a return of basis.
    B. $1,125 is taxed as ordinary income.
    C. $3,750 is taxed as ordinary income.
    D. $3,875 is taxed as ordinary income.




                                         Hint


Risk Management – Virtual Class 3 of 3
Question 7
    Assume that Jack annuitizes the $150,000
    annuity under the straight life option. The
    insurance company will offer him quarterly
    payments of $5,000 starting October 1, 2011.
    The actuarial number of payments is 40. How
    much will Jack report as income on his income
    tax return for 2011?

    A. $0, as this is a return of basis.
    B. $1,125 is taxed as ordinary income.
    C. $3,750 is taxed as ordinary income.
    D. $3,875 is taxed as ordinary income.




Risk Management – Virtual Class 3 of 3
Question 7
    Assume that Jack annuitizes the $150,000
    annuity under the straight life option. The
    insurance company will offer him quarterly
    payments of $5,000 starting October 1, 2011.
    The actuarial number of payments is 40. How
    much will Jack report as income on his income
    tax return for 2011?

    A. $0, as this is a return of basis.
    B. $1,125 is taxed as ordinary income.
    C. $3,750 is taxed as ordinary income.
    D. $3,875 is taxed as ordinary income.




    ($45,000 / (40 payments x $5,000) x $5,000
    Oct. 1st payment = $1,125 exclusion)


Risk Management – Virtual Class 3 of 3
Question 8
    Assume that Jack dies after receiving his 3rd
    quarterly annuity payment of $5,000. Which of
    the following statements are correct?
    (I)     Jack’s adjusted basis after the 3rd payment is
            $41,625.

    (II)    Jack can itemize any remaining adjusted basis on his
            Form 1040 Schedule A, subject to 2% of adjusted
            gross income (AGI).

    (III) If Jack lives more than 10 years, the annuity will
          continue to pay him $5,000 and he will have to report
          each payment received as $5,000 of ordinary income.


    A.     I and II only
    B.     I and III only
    C.     II and III only
    D.     All statements are correct



                                         Hint


Risk Management – Virtual Class 3 of 3
Question 8
    Assume that Jack dies after receiving his 3rd
    quarterly annuity payment of $5,000. Which of
    the following statements are correct?
    (I)    Jack’s adjusted basis after the 3rd payment is
           $41,625.

    (II)   Jack can itemize any remaining adjusted basis on his
           Form 1040 Schedule A, subject to 2% of adjusted
           gross income (AGI).

    (III) If Jack lives more than 10 years, the annuity will
          continue to pay him $5,000 and he will have to report
          each payment received as $5,000 of ordinary income.


                                         A.   I and II only
                                         B.   I and III only
                                         C.   II and III only
                                         D.   All statements are correct




Risk Management – Virtual Class 3 of 3
Question 8
    Assume that Jack dies after receiving his 3rd
    quarterly annuity payment of $5,000. Which of
    the following statements are correct?
    (I)    Jack’s adjusted basis after the 3rd payment is
           $41,625.

    (II)   Jack can itemize any remaining adjusted basis on his
           Form 1040 Schedule A, subject to 2% of adjusted
           gross income (AGI).

    (III) If Jack lives more than 10 years, the annuity will
          continue to pay him $5,000 and he will have to report
          each payment received as $5,000 of ordinary income.


                                         A.   I and II only
                                         B.   I and III only
                                         C.   II and III only
                                         D.   All statements are correct


    ($45,000 - 3 payments x $1,125 exclusion
    = $41,625)

Risk Management – Virtual Class 3 of 3
Question 9
    Assume that Jack chooses not to annuitize the
    annuity contract and instead cashes it in for
    $150,000. How will this transaction be taxed?



    A. $0 taxed as ordinary income
    B. $100,000 taxed as ordinary income
    C. $105,000 taxed as ordinary income
    D. $150,000 taxed as ordinary income




                                         Hint


Risk Management – Virtual Class 3 of 3
Question 9
    Assume that Jack chooses not to annuitize the
    annuity contract and instead cashes it in for
    $150,000. How will this transaction be taxed?



    A. $0 taxed as ordinary income
    B. $100,000 taxed as ordinary income
    C. $105,000 taxed as ordinary income
    D. $150,000 taxed as ordinary income




Risk Management – Virtual Class 3 of 3
Question 9
    Assume that Jack chooses not to annuitize the
    annuity contract and instead cashes it in for
    $150,000. How will this transaction be taxed?



    A. $0 taxed as ordinary income
    B. $100,000 taxed as ordinary income
    C. $105,000 taxed as ordinary income
    D. $150,000 taxed as ordinary income

    ($150,000 FMV - $45,000)




Risk Management – Virtual Class 3 of 3
                   Annuities
Do Variable Annuities Belong in Qualified Plans?

 • Annuities can provide a guaranteed death benefit to
   the owner, regardless of what happens to the value of
   the underlying investments.
 • Many annuity companies pay a premium bonus of as
   much as 5% when their annuities are purchased.




                  Risk Management – Virtual Class 3 of 3
                   Annuities
Do Variable Annuities Belong in Qualified Plans?

 • Annuities can provide a guaranteed death benefit to
   the owner, regardless of what happens to the value of
   the underlying investments.
 • Many annuity companies pay a premium bonus of as
   much as 5% when their annuities are purchased.

Example:
If an individual has $100,000 to invest from a 401(k)
rollover, a 5% bonus would have $105,000 working for
him or her in a rollover IRA annuity.




                  Risk Management – Virtual Class 3 of 3
                    Annuities
Do Variable Annuities Belong in Qualified Plans?

 • The ability to annuitize the contract.




          Q&A


                   Risk Management – Virtual Class 3 of 3
                    Annuities
Do Variable Annuities Belong in Qualified Plans?

 • The ability to annuitize the contract.

 • Surrender over a 7-to-10-year period.




          Q&A


                   Risk Management – Virtual Class 3 of 3
                    Annuities
Do Variable Annuities Belong in Qualified Plans?

 • The ability to annuitize the contract.

 • Surrender over a 7-to-10-year period.

 • No step-up at death, as annuities are income in the
   respect of a decedent (IRD).




          Q&A


                   Risk Management – Virtual Class 3 of 3
                    Annuities
Do Variable Annuities Belong in Qualified Plans?

 • The ability to annuitize the contract.

 • Surrender over a 7-to-10-year period.

 • No step-up at death, as annuities are income in the
   respect of a decedent (IRD).


 • Taxable distributions are all ordinary income.

          Q&A


                   Risk Management – Virtual Class 3 of 3
           Investment Management
            Session 1 of 3 Preview
These modules introduce students to the vast array of possible
investment choices and risk environment for which all investments are
subject to.

This session will begin with a general overview of the CFP Board’s
Formula sheet and calculator keystroke support; focus on basic
characteristics of the available asset class choices, and then discuss the
investment risks that are associated with these asset classes.

     •   Introduction to Fixed Income Securities
     •   Introduction to Stocks
     •   Introduction to Pooled Investments
     •   Derivatives, Insurance Securities and Other Investments
     •   Buying and Selling Securities
     •   Investment Risks




                         Risk Management – Virtual Class 3 of 3
                  Thank You!

Investment Management
Session 1 of 3
Instructor: William Reeve

Check your virtual materials page in the next few days to
confirm registration for the next session.




                   Risk Management – Virtual Class 3 of 3

				
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