Life Insurance Premiums, Proceeds, and Beneficiaries
Premium mechanics
Premiums reflect mortality, interest, and expense assumptions. Gross premium = net premium (mortality and interest) plus expense loading. Candidates should understand mode (annual, semiannual, quarterly, monthly) and why more frequent payment increases the total annual cost. Participating policies may pay dividends; nonparticipating do not.
Proceeds
The death benefit is generally paid income-tax free to the beneficiary under the general rule, but interest earned on proceeds left with the insurer is taxable. Transfer-for-value rules can make proceeds taxable if the policy is sold to a non-exempt party. Accelerated death benefits may be tax-free if the insured is terminally or chronically ill under the applicable rules.
Beneficiaries
Know primary, contingent, revocable, and irrevocable designations; per capita vs. per stirpes distribution; class designations; and the simultaneous death and common disaster provisions. An irrevocable beneficiary cannot be changed without consent. If no beneficiary survives, proceeds go to the estate and may be subject to probate and creditors.
Traps
- Confusing per stirpes (by branch) with per capita (by head).
- Assuming all proceeds are tax-free - interest is not.
- Forgetting that a minor beneficiary requires a guardian or trust.
Rule of thumb
Name a primary and a contingent beneficiary and consider a trust for minors. Proceeds are generally income-tax free but not necessarily estate-tax free.