Tools and Techniques of Life Insurance Planning
Matching product to need
Temporary needs (mortgage, income replacement to a date) call for term insurance: level, decreasing, annually renewable, convertible. Permanent needs (estate liquidity, final expenses, business funding) call for cash-value products: whole life (level premium, guaranteed cash value, participating dividends), universal life (flexible premium, cost-of-insurance charges against cash value, interest crediting), variable life (separate account, securities registration, client bears investment risk), and indexed UL (index credits subject to a cap, participation rate, and floor).
The tax chassis: §7702 and MEC
A contract must satisfy §7702 - guideline premium/corridor test or cash value accumulation test - to be life insurance. Fail the seven-pay test and it becomes a modified endowment contract: withdrawals and loans are taxed income-first under §72(e) and a 10% penalty applies before age 59½. §1035 exchanges carry basis and gain between contracts.
Traps
- Policy loans are not taxable events unless the policy lapses or is surrendered.
- Dividends are a return of premium, tax-free until basis is recovered.
- Death benefit is income-tax-free, but interest paid under a settlement option is taxable.
- Employer-paid group term above $50,000 creates Table I imputed income.
- Variable products require a prospectus and a registered representative; fixed UL does not.
Worked example
A 45-year-old overfunds a UL policy well beyond the seven-pay limit to build cash value. Every dollar withdrawn is taxable to the extent of gain, plus a 10% penalty before 59½. For accumulation goals, either stay under the seven-pay premium or accept MEC treatment deliberately.