CLU common mistakes
CLU · Understand the traps and how to avoid them.
Testing insurable interest at the time of death instead of at policy application or issue.
Fact patterns often describe who benefits at death, so candidates apply the requirement at the wrong point in the timeline.
What to do instead
Write a timeline for every insurable-interest fact pattern: identify the applicant, insured, beneficiary, and the date the interest must exist. State that insurable interest generally must exist when the contract is formed, not when the claim is paid.
Using gross salary instead of after-tax income minus personal consumption when calculating human life value.
The formula is memorized, but the input definitions are not, so candidates plug in the insured's total earnings rather than the economic value dependents actually lose.
What to do instead
Write the formula with labeled inputs before calculating: present value of the insured's net contribution to dependents, using after-tax earnings and excluding income spent on the insured's own maintenance. Compare it explicitly with a needs-analysis approach.
Treating every uncertain loss exposure as insurable without checking fortuitousness, measurability, catastrophic correlation, and the risk of moral hazard.
Candidates memorize risk-handling categories but skip the insurability tests when a fact pattern sounds like a familiar peril.
What to do instead
Apply a short checklist to each exposure: pure vs. speculative risk, accidental vs. certain loss, measurable dollar loss, large enough to justify premium, and no severe concentration or catastrophic correlation. Then select avoidance, reduction, retention, or transfer.
Assuming the policyowner and the insured must be the same person.
Consumer-facing descriptions usually show one person buying insurance on their own life, which hides the ownership, payor, and beneficiary distinctions tested on the exam.
What to do instead
Draw an ownership map for every policy: owner, insured, payor, beneficiary, and who holds incidents of ownership. State that ownership controls policy rights and estate inclusion, while the insured is merely the measuring life.
Calling any cash-value life insurance policy a modified endowment contract because the cash value grows tax-deferred.
Candidates conflate tax-deferred inside buildup with MEC status and do not apply the seven-pay test.
What to do instead
Separate the concepts: tax-deferred buildup is normal life insurance treatment; MEC status depends on the seven-pay test. If a policy is a MEC, apply the distribution ordering rules and the 10% penalty before age 59½ unless an exception applies.
Ignoring policy ownership and beneficiary designations when determining whether life insurance proceeds are included in the insured's gross estate.
Candidates focus on the death benefit amount and the named beneficiary, not on incidents of ownership held by the decedent.
What to do instead
Ask who owned the policy and who held incidents of ownership at death. Include proceeds if the decedent owned the policy or retained incidents of ownership; treat beneficiary designation as separate from estate inclusion. Note that an irrevocable assignment may remove inclusion if completed properly.
Applying the unlimited marital deduction to a transfer to a noncitizen spouse without requiring a qualified domestic trust.
The general rule that transfers to a spouse qualify for the marital deduction is overapplied without the noncitizen-spouse exception.
What to do instead
Check the spouse's citizenship status in every marital-deduction question. If the surviving spouse is not a U.S. citizen, require a QDOT or another qualifying arrangement; otherwise the unlimited marital deduction is not available.
Assuming every inherited asset receives a stepped-up basis at death.
The general step-up rule is remembered, but its limits for income in respect of a decedent and lifetime gifts are not applied.
What to do instead
Classify each asset: assets included in the decedent's gross estate generally receive a new basis; income in respect of a decedent does not; lifetime gifts generally carry over the donor's basis. State the basis rule before calculating gain.
Mismatching the buy-sell agreement type with who owns and is beneficiary of the life insurance policies.
Entity-purchase and cross-purchase arrangements are studied separately, so candidates pair an entity agreement with cross-owned policies or vice versa.
What to do instead
Use an alignment matrix: entity-purchase agreement means the business owns policies on each owner and is beneficiary; cross-purchase means each owner owns policies on the other owners and is beneficiary. Count policies explicitly: n policies for entity purchase versus n(n-1)/2 for cross-purchase among n owners.
Deducting life insurance premiums paid by a business when the business is the policy beneficiary.
Candidates treat premiums like ordinary business expenses and overlook the general nondeductibility rule for life insurance protection.
What to do instead
State the default rule first: premiums are generally not deductible when the business is directly or indirectly a beneficiary. Then note that death proceeds are generally income-tax-free under the general life insurance exclusion, with only limited exceptions, and identify who owns the policy and who receives the proceeds before answering.