Life Insurance. How The New Regulations Affect Policies Written In Trust.
If you have a life insurance policy that is in trust, and it was written before October 17, 2006, then the new regulations will not affect your policy in any way.
However, if your life insurance policy was written after Oct 17th of 2006, then the new regulations will affect how your financial institution pays benefits to beneficiaries of life insurance policies that were written anytime since these laws were enacted. Your policy would be considered "Qualified Annuity" rather than just a "Life Insurance Policy," and its benefits specifications would not be as broad as they are now. To determine the impact of these laws on your policy, you should ask your insurance agent or your financial institution to see if they are also a "Qualified Annuity" vendor.
This law affects life insurance policies that have either a cash value or fixed annuity component. Life insurance with a fixed benefit is called "life insurance in trust," while life insurance with a cash value component is called "non-qualified life insurance." If you have either type of life insurance, then this law will affect you. This article applies only to non-qualified life insurance policies and to the designated beneficiary who is listed as the owner in the Declarations section of non-qualified life insurance policies.
If your policy was written before Oct 17th, 2006 and you are still the designated beneficiary of that policy, then your policy is considered to be a "Qualified Annuity," and the new regulations do not affect your policy in any way.
Non-Qualified Life Insurance Policies
The basics of non-qualified life insurance policies are as follows: When you buy a non-qualified life insurance policy, you receive a tax deduction for the entire amount of the premiums that you pay. You can make loan transactions with these policies by borrowing against their cash value component.
The cash value component is a savings type account, similar to a Certificate of Deposit or a Money Market Account. You can borrow money from it, and you can use it as collateral for a loan from your financial institution or other lenders.
When you die, the beneficiary listed in the insurance policy will receive the death benefit in either (or both) of two ways: A "lump-sum" payment consisting of your cash-value savings and any loans that you may have outstanding on the account The death benefit will be paid out over time via annuity payments, depending on the form of payment option that you chose when purchasing this policy.
Most non-qualified life insurance policies are purchased with loan transactions. So the benefit that your beneficiary receives will depend not only on how much money is in the policy, but also on whether or not you have made loans against it.
In the early 1980s, Congress passed laws which made it more difficult to make loans from a non-qualified life insurance policy. These laws do not apply to the death benefit that a beneficiary receives when his/her non-qualified life insurance policy is paid out.
The new regulations changed this law by returning to an earlier date (Sept 8th, 1991) the date on which these earlier acts became effective for qualified life insurance policies and by extending the provisions of these acts to non-qualified life insurance policies as well.
The new regulations apply to any non-qualified life insurance policy, whether the policy was written before or after October 17, 2006. The way that the new law affects your non-qualified life insurance policy depends on how much money is in it. If there is less than $500,000 in a non-qualified life insurance policy, then these changes will not affect it in any way. If there is more than $500,000 then there are two possible scenarios:
If you borrowed money from this policy using a non-recourse loan and paid interest on that loan for at least a full year before you die , then the interest payments that you made on this loan will be fully taxable to your beneficiaries. If you borrowed money from this policy using a non-recourse loan and did not pay any interest during the year before your death, then no part of the interest on this loan will be taxable to your beneficiaries.
In either of these two scenarios, any loans that you made after the end of the year before your death will be fully taxable to your beneficiaries.
If you borrowed money from this policy and paid interest on that loan for only part of a year before you die, then only the part of the interest payments that accrued during those months will be fully taxable to your beneficiaries. The rest of the interest payments that accrued during those months will not be taxable to your beneficiaries.
If you did not borrow any money from this policy, then these new regulations will not affect your beneficiary in any way.
Qualified Life Insurance Policies
The basics of qualified life insurance policies are as follows: When you buy a qualified life insurance policy, the premiums that you pay are fully non-taxable, and there is no deduction for premiums. You can make loan transactions with these policies by borrowing against their cash value components. The cash value component is a savings type account similar to a Certificate of Deposit or a Money Market Account. You can borrow money from it, and you can use it as collateral for a loan from your financial institution or other lenders.
When you die, the beneficiary listed in the insurance policy will receive a death benefit as follows: A "lump-sum" payment consisting of your cash value savings and any loans that you may have outstanding on the account The death benefit will be paid out over time via annuity payments, depending on the form of payment option that you chose when purchasing this policy.
When you buy a qualified life insurance policy, it is guaranteed by an insurance company which is licensed by state or federal government agencies. The policies which are guaranteed by that insurance company legally bind each of them to pay their insureds all proper claims.
This insurance company is "principal-protected." This means that if the insurance company itself goes bankrupt, the trust fund for the policyholders will be sufficient to pay all these claims. This is ensured by a fee that every principal-protected life insurance policyholder pays each year – this fee was implemented many years ago as a mechanism to protect policyholders from such a scenario.
Most qualified life insurance policies are purchased with no loans against them. So if your policy had no loans, then your beneficiary will receive the death benefit as you selected it when you purchased this policy.
If your policy had loans outstanding against it, then the death benefit that your beneficiary receives will depend not only on the amount of money in your policy, but also on whether or not you made loans against it. If there is less than $500,000 in a qualified life insurance policy, then these regulations will not affect it in any way. If there is more than $500,000, then these changes will apply:
If you borrowed money from this policy using a loan transaction and paid interest on that loan for at least a full year before your death , then the interest payments that you made on this loan will be fully taxable to your beneficiaries.
Conclusion
As you can see, the rules that apply to non-qualified life insurance policies are quite different from those that apply to qualified life insurance policies. One thing is clear though: If you have any non-qualified life insurance policies, it is essential that you check these rules as they may affect your beneficiaries.
If you still have questions about this subject, please don’t hesitate to contact me at 727-543-4000 or via the form on my website. I will be happy to help in any way that I can.