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Life Insurance Basics an Introductory Guide

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Life Insurance Basics an Introductory Guide Life Insurance Basics An Introductory Guide DISCLAIMER The content contained in this document is designed to help you understand the ideas discussed. Any examples are hypothetical and are used only to help you understand the ideas. They may not reflect your client(s)’ particular circumstances. Your clients should carefully read their contract, policy, and prospectus(es), when applicable. What we say about legal or tax matters is our understanding of current law; but we are not offering legal or tax advice. Tax laws and IRS administrative positions may change. This material is not for use in avoiding any IRS penalty and neither you nor your clients may use it for that purpose. Your clients should ask their independent tax and legal advisors for advice based on their particular circumstances. If this material states or implies that it was prepared or distributed to promote, market or recommend an investment plan or arrangement within the meaning of IRS guidance, or such use may be reasonably expected, then, as required by the IRS, the following also applies: The tax information in this material was written to support the promotion or marketing of the transaction(s) or matter(s) addressed in this material. Changes to tax laws may require changes to the contents of this material from time to time. Once distributed, we cannot be responsible for the continued accuracy of the material. Any examples or excerpts from illustrations are for training purposes only and are not intended to represent any specific product. These examples or illustrations are not valid for use in a sales setting with consumers. FOR BROKER/DEALER USE ONLY. NOT TO BE REPRODUCED OR SHOWN TO THE PUBLIC. Table of Contents Module 1 – Introduction to Life Insurance 1 Why People Buy Life Insurance 1 Income Replacement 2 Personal Uses of Life Insurance 2 Business Uses of Life Insurance 2 Estate Planning Uses of Life Insurance 3 Charitable Giving Uses of Life Insurance 3 Living Benefit Uses of Life Insurance – Accessing Cash Value 4 Living Benefit Uses of Life Insurance – “Death Benefits” During Lifetime 4 The New Business and Underwriting Process 4 Retention and Reinsurance 5 Insurable Interest 6 Financial Underwriting 7 Parties to the Application 7 Drafting Beneficiary Designations 8 Overview of Types of Life Insurance 8 Term Life Insurance 8 Whole Life Insurance 9 Fixed Universal Life Insurance 10 Variable Life and Variable Universal Life Insurance 11 Survivorship Universal Life Insurance 11 Module 2 – Fixed Universal Life Insurance 12 Death Benefits 12 Corridor 14 Premiums 14 Minimum and Maximum Premiums 14 Target Premium 15 Policy Fees And Other Policy Charges 15 Cash Value 16 Premiums are the Primary Driver of Cash Value 16 Cash Surrender Value and Surrender Penalties 17 Policy Loans 17 Withrawals 17 Grace Period 18 FOR BROKER/DEALER USE ONLY. NOT TO B E REPRODUCED OR SHOWN TO THE PUBLIC. Module 3 – Basic Illustrations 19 Compliant Illustrations 19 Parts of A Life Insurance Illustration 19 Current Assumptions Versus Guaranteed Features 20 Module 4 - Fixed UL with “Secondary Guarantees” – Lifetime Guarantee UL 23 Catch-Up Provisions 25 Grace Period And Secondary Death Benefit Guarantees 26 Summary 26 Module 5 – Basics of Life Insurance Taxation 27 Federal Income Taxation of Death Benefits 27 Life Insurance Owned by And Payable to Employer 27 Transfers for Valuable Consideration 28 Federal Income Taxation of Cash Value 28 Modified Endowment Contracts (MEC) 29 IRC Section 1035 Exchanges 30 FOR BROKER/DEALER USE ONLY. NOT TO B E REPRODUCED OR SHOWN TO THE PUBLIC. Module 1 – Introduction to Life Insurance People who live in financially developed societies use insurance to help reduce the risk of suffering a financial loss. A common example is the purchase of auto insurance. Auto insurance policies provide liability coverage to protect us from financial loss if we are held liable for an accident as well as collision coverage to pay for repair to a damaged car and medical coverage to reimburse for the treatment of injuries. Life insurance is also a risk management tool, but a unique type. It is unique because its primary purpose is to create a pool of cash that is payable at the death of the insured person. To meet diverse needs and to enhance the value of life insurance, different types of policies and features have been designed. While some life insurance policies focus exclusively on providing a death benefit, others also build cash value amounts within the policy that the owner of the policy may access to meet emergencies, help purchase a home, or pay for a college education. Finally, to encourage people to buy life insurance, these products have certain income tax benefits. The death benefit paid to the beneficiary is usually income tax free. And any cash value growth inside the policy is not subject to income tax unless it is removed from the life insurance policy. Why People Buy Life Insurance Income Replacement People use life insurance for many reasons. But, the most important reason, by far, is to protect the family from the financial loss that occurs when a wage earner dies. The death benefit paid to the beneficiaries can be used to replace lost income, ensure that the family can stay in their home, purchase food, clothing and other necessities, pay funeral expenses, as well as create a fund to meet future expenses or education costs. Let’s look at an example. Joseph and Marie Alvarez are both hard working individuals who place high value on the family. Joseph is a pharmaceutical salesperson, with the same employer for 8 years. He makes about $85,000 per year. Marie works as an x- ray technician at the hospital, earning about $50,000 per year. She went back to work when their youngest started pre-school. Their son, Michael, is 11 and their daughter, Kelly, is 9. With Marie back to work, they were able to qualify for a bigger mortgage and three years ago they bought their dream house in a new suburb that isn’t far from her parents. They have all settled comfortably into the community. Michael plays both Little League and soccer. Kelly takes ballet and also plays soccer. And, Marie’s job is only a few miles away – her short commute means she’s able to spend more time with her family and get the kids to their soccer games on time – especially important since Joseph’s job often takes him out of town. Everything is perfect. FOR BROKER/DEALER USE ONLY. NOT TO BE REPRODUCED OR SHOWN TO THE PUBLIC. 1 Fast forward a few years… Joseph was coming home from a week of sales calls when he was in a serious traffic accident. Unfortunately, Joseph was pronounced dead at the hospital. This story could have two endings depending on the amount of life insurance that Joseph had on his life. • Joseph had no life insurance: Marie is devastated by the loss of her best friend and husband. After she got through the ordeal of the funeral, she realized she couldn’t afford the mortgage payments on her salary. She was forced to sell the house and rent an apartment that was more within her means. Unfortunately, the apartment isn’t in the same neighborhood as the old house. The kids had to change schools and make new friends. For the kids, the devastating loss of their father was compounded by this upheaval in their lives. Marie has a longer commute and her parents aren’t nearby if she is late getting home. Worse, the dreams that she and Joseph had for their children’s college education and for their own comfortable life through retirement seem far off and unobtainable now. • Joseph had life insurance: Marie is devastated by the loss of her best friend and husband. But she and the kids have managed to move on with their lives. Thanks to Joseph’s deep sense of responsibility, there was enough life insurance to pay off the mortgage and to set aside money for both kids’ college educations and other future needs. The kids are still active in sports and Kelly has started acting in school plays. Marie’s parents are still nearby and drop by to help out when needed. She wonders what she and the kids would have done had Joseph not insisted on buying enough life insurance to offset his income in the event of his death. She can only imagine how difficult it would have been. This story can’t capture the pain of losing a loved one, but it does demonstrate the important role life insurance can play in the lives of real people. Personal Uses of Life Insurance Life insurance death benefits can help in many ways including, but not limited to the following: • Replace the income of a deceased wage earner; • Pay off the mortgage and other debts (including funeral expenses); • Provide funds for the education of the surviving spouse or the children; • Fulfill the obligations of a divorce decree or child support agreement; • Benefit charitable organizations, churches or schools (such as one’s alma mater); • Equalize the inheritance heirs receive. Business Uses of Life Insurance Life insurance is a valuable tool in the business setting as well. For example, it is common for businesses – large and small – to purchase life insurance on the lives of those key people in the business who are responsible for its success. The business owns the policy and also receives any death benefits paid. If the insured key FOR BROKER/DEALER USE ONLY. NOT TO BE REPRODUCED OR SHOWN TO THE PUBLIC. 2 person dies, then the business can use the cash it receives to help offset the associated business losses such as: • Make up for any lost profits • Settle business debt; or • Use the funds to recruit, hire and train a replacement.
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