Whole Life Assurance

Taxes and Life Assurance

Taxation of life assurance in the United States
Premiums paid by the policy owner are normally not deductible for federal and state income tax purposes.

Proceeds paid by the insurer upon death of the insured are not includible in taxable income for federal and state income tax purposes; however, if the proceeds are included in the "estate" of the deceased, it is likely they will be subject to federal and state estate and inheritance tax.

Cash value increases within the policy are not subject to income taxes unless certain events occur. For this reason, assurance policies can be a legal and legitimate tax shelter wherein savings can increase without taxation until the owner withdraws the money from the policy. On flexible-premium policies, large deposits of premium could cause the contract to be considered a "Modified Endowment Contract" by the Internal Revenue Service (IRS), which negates many of the tax advantages associated with life assurance. The assurance company, in most cases, will inform the policy owner of this danger before applying their premium.

Tax deferred benefit from a life assurance policy may be offset by its low return or high cost in some cases. This depends upon the insuring company, type of policy and other variables (mortality, market return, etc.). Also, other income tax saving vehicles (i.e. Individual Retirement Account (IRA), 401K or Roth IRA) appear to be better alternatives for value accumulation, at least for more sophisticated investors who can keep track of multiple financial vehicles. The combination of low-cost term life assurance and higher return tax-efficient retirement accounts can achieve better performance, assuming that the assurance itself is only needed for a limited amount of time.

The tax ramifications of life assurance are complex. The policy owner would be well advised to carefully consider them. As always, the United States Congress or the state legislatures can change the tax laws at any time.

Taxation of life assurance in the United Kingdom
Premiums are not usually allowable against income tax or corporation tax, however qualifying policies issued prior to 14 March 1984 do still attract LAPR (Life Assurance Premium Relief) at 15% (with the net premium being collected from the policyholder).

Non-investment life policies do not normally attract either income tax or capital gains tax on claim. If the policy has as investment element such as an endowment policy, whole of life policy or an investment bond then the tax treatment is determined by the qualifying status of the policy.

Qualifying status is determined at the outset of the policy if the contract meets certain criteria. Essentially, long term contracts (10 years plus) tend to be qualifying policies and the proceeds are free from income tax and capital gains tax. Single premium contracts and those run for a short term are subject to income tax depending upon your marginal rate in the year you make a gain. All (UK) insurers pay a special rate of corporation tax on the profits from their life book; this is deemed as meeting the lower rate (20% in 2005-06) liability for policyholders. Therefore a policyholder who is a higher rate taxpayer (40% in 2005-06), or becomes one through the transaction, must pay tax on the gain at the difference between the higher and the lower rate. This gain is reduced by applying a calculation called top-slicing based on the number of years the policy has been held. Although this is complicated, the taxation of life assurance based investment contracts may be beneficial compared to alternative equity-based collective investment schemes (unit trusts, investment trusts and OEICs). One feature which especially favors investment bonds is the '5% cumulative allowance' – the ability to draw 5% of the original investment amount each policy year without being subject to any taxation on the amount withdrawn. If not used in one year, the 5% allowance can roll over into future years, subject to a maximum tax deferred withdrawal of 100% of the premiums payable. The withdrawal is deemed by the HMRC (Her Majesty's Revenue and Customs) to be a payment of capital and therefore the tax liability is deferred until maturity or surrender of the policy. This is an especially useful tax planning tool for higher rate taxpayers who expect to become basic rate taxpayers at some predictable point in the future (e.g. retirement), as at this point the deferred tax liability will not result in tax being due.

The proceeds of a life policy will be included in the estate for death duty (in the UK, inheritance tax (IHT)) purposes, except that policies written in trust may fall outside the estate. Trust law and taxation of trusts can be complicated, so any individual intending to use trusts for tax planning would usually seek professional advice from an Independent Financial Adviser (IFA) and/or a solicitor.

Pension Term Assurance
Although available before April 2006, from this date pension term assurance became widely available in the UK. Most UK product providers adopted the name "life assurance with tax relief" for the product. Pension term assurance is effectively normal term life assurance with tax relief on the premiums. All premiums are paid net of basic rate tax at 22%, and higher rate tax payers can gain an extra 18% tax relief via their tax return. Although not suitable for all, PTA briefly became one of the most common forms of life assurance sold in the UK until the Chancellor, Gordon Brown, announced the withdrawal of the scheme in his pre-budget announcement on 6 December 2006. The tax relief ceased to be available to new policies transacted after 6 December 2006, however, existing policies have been allowed to enjoy tax relief so far.

Whole Life Assurance vs Universal Life Assurance

Whole Life Assurance
Whole life assurance provides for a level premium, and a cash value table included in the policy guaranteed by the company. The primary advantages of whole life are guaranteed death benefits, guaranteed cash values, fixed and known annual premiums, and mortality and expense charges will not reduce the cash value shown in the policy. The primary disadvantages of whole life are premium inflexibility, and the internal rate of return in the policy may not be competitive with other savings alternatives. Riders are available that can allow one to increase the death benefit by paying additional premium. The death benefit can also be increased through the use of policy dividends. Dividends cannot be guaranteed and may be higher or lower than historical rates over time. Premiums are much higher than term assurance in the short-term, but cumulative premiums are roughly equal if policies are kept in force until average life expectancy.

Cash value can be accessed at any time through policy "loans". Since these loans decrease the death benefit if not paid back, payback is optional. Cash values are not paid to the beneficiary upon the death of the insured; the beneficiary receives the death benefit only. If the dividend option: Paid up additions is elected, dividend cash values will purchase additional death benefit which will increase the death benefit of the policy to the named beneficiary.

Universal Life Assurance
Universal life assurance (UL) is a relatively new assurance product intended to provide permanent assurance coverage with greater flexibility in premium payment and the potential for a higher internal rate of return. A universal life policy includes a cash account. Premiums increase the cash account. Interest is paid within the policy (credited) on the account at a rate specified by the company. This rate has a guaranteed minimum but usually is higher than that minimum. Mortality charges and administrative costs are charged against (reduce) the cash account. The surrender value of the policy is the amount remaining in the cash account less applicable surrender charges, if any.

With all life assurance, there are basically two functions that make it work. There's a mortality function and a cash function. The mortality function would be the classical notion of pooling risk where the premiums paid by everybody else would cover the death benefit for the one or two who will die for a given period of time. The cash function inherent in all life assurance says that if a person is to reach age 95 to 100 (the age varies depending on state and company), then the policy matures and endows the face value of the policy.

Actuarially, it is reasoned that out of a group of 1000 people, if even 10 of them live to age 95, then the mortality function alone will not be able to cover the cash function. So in order to cover the cash function, a minimum rate of investment return on the premiums will be required in the event that a policy matures.

Universal life policies guarantee, to some extent, the death proceeds, but not the cash function - thus the flexible premiums and interest returns. If interest rates are high, then the investment returns help reduce premiums. If interest rates are low, then the customer would have to pay additional premiums in order to keep the policy in force. When interest rates are above the minimum required, then the customer has the flexibility to pay less as investment returns cover the remainder to keep the policy in force.

The universal life policy addresses the perceived disadvantages of whole life. Premiums are flexible. The internal rate of return is usually higher because it moves with the financial markets. Mortality costs and administrative charges are known. And cash value may be considered more easily attainable because the owner can discontinue premiums if the cash value allows it. And universal life has a more flexible death benefit because the owner can select one of two death benefit options, Option A and Option B.

Option A pays the face amount at death as it's designed to have the cash value equal the death benefit at age 95. Option B pays the face amount plus the cash value, as it's designed to increase the net death benefit as cash values accumulate. Option B does carry with it a caveat. This caveat is that in order for the policy to keep its tax favored life assurance status, it must stay within a corridor specified by state and federal laws that prevent abuses such as attaching a million dollars in cash value to a two dollar assurance policy. The interesting part about this corridor is that for those people who can make it to age 95-100, this corridor requirement goes away and your cash value can equal exactly the face amount of assurance. If this corridor is ever violated, then the universal life policy will be treated as, and in effect turn into, a Modified Endowment Contract (or more commonly referred to as a MEC).

But universal life has its own disadvantages which stem primarily from this flexibility. The policy lacks the fundamental guarantee that the policy will be in force unless sufficient premiums have been paid and cash values are not guaranteed.

Universal life policies are sometimes erroneously referred to as self-sustaining policies. In the 1980s, when interest rates were high, the cash value accumulated at a more accelerated rate, and universal life coverage was often sold by agents as a policy that could be self-paying. Many policies did sustain themselves for a prolonged period, but the combination of lower interest rates and an increasing cost of assurance as the insured ages meant that for many policies, the cash option was diminished or depleted.

Variable universal life assurance (VUL) is not the same as universal life, even though they both have cash values attached to them. These differences are in how the cash accounts are managed. The cash account within a VUL is held in the insurer's "separate account" (generally in mutual funds, managed by a fund manager).

Life Assurance vs Life Insurance

Outside the United States, the specific uses of the terms "insurance" and "assurance" are sometimes confused. In general, in these jurisdictions "insurance" refers to providing coverage for an event that might happen, while "assurance" is the provision of cover for an event that is certain to happen.

However, in the United States both forms of coverage are called "insurance".

When a person insures the contents of their home they do so because of events that might happen (fire, theft, flood, etc.) They hope their home will never be burglarized, or burn down, but they want to ensure that they are financially protected if the worst happens. This example of insurance shows how it is a way of spending a little money to protect against the risk of having to spend a lot of money.

When a person insures their life they do so knowing that one day they will die. Therefore a policy that covers death is assured to make a payment. The policy offers assurance on death; even if the policy has a prescribed termination date the policy is still assured to pay on death and therefore is an assurance policy. Examples include Term Assurance and Whole Life Assurance. An accidental death policy is not assured to pay on death as the life insured may not die through an accident, therefore it is an insurance policy.

A policy might also be assured for other reasons. For example an endowment policy is designed to provide a lump sum on maturity. Under certain types of policy the lump sum is guaranteed. Therefore, this may also be called an assurance policy.

The test of whether a policy is assurance or insurance is that with an assurance policy the insured event will definitely occur (at some point) whereas with an insurance policy there is a risk the insured event might occur.

With regard to Whole Life policies, the question is not whether the insured event (in this case death) will occur, but simply when. If the policy has nonforfeiture values (or cash values) then the policy is assured to pay.

During recent years, the distinction between the two terms has become largely blurred. This is principally due to many companies offering both types of policy, and rather than refer to themselves using both insurance and assurance titles, they instead use just one.

Life Assurance 101

I found a very good blog post about the features of life assurance insured.blog.co.uk:

The provision of life assurance is a quite different process from the provision of non-life insurance. The main distinction is that in life assurance the event being assured is certain to happen in the case of those policies paying on death, or is scientifically calculable in the event of policies not paying a benefit on death.  read more...

What is Whole Life Assurance?

Where term life assurance offers financial protection against the policy holder's life only for the duration of the insurance term, whole life assurance guarantees the payment of an assured sum on the death of the policy holder, whenever that might happen.

From that simple definition, therefore, it should be possible to see that whole life premiums are going to cost more than term premiums, since the event is definitely going to happen and the insurer will ultimately need to pay out. The insurer's risk, here, is not "if" but "when". Nevertheless, some policies have a specified age beyond which cover continues but without the need to pay further premiums.

More important than this distinction, however, is that unlike a term life assurance policy, whole life assurance does not guarantee the whole of the assured sum. The benefits payable on the death of the insured are instead determined by the investment performance of the fund into which the premiums have been paid. In practice, the monthly premiums will have been used by the insurer to purchase units in an investment fund. Some of the units are then cashed to provide a minimum level of guaranteed life cover. Just what proportion of the premium is used for investment and what proportion for life cover will to a certain extent depend on the options agreed between the insured and the insurer.

For example, the insured might opt to receive the minimum amount of guaranteed life cover and see more of his monthly premiums going towards the purchase of investment units. At the other end of the scale, the policy holder might elect the maximum proportion of life cover and, so, there would be a much smaller proportion available for investment.

Typically, every five or ten years, the policy will have in-built review dates, when the insurer will compare the actual value of the investment fund, its likely future performance, and the benefits expected upon termination of the policy. Such reviews can result in the insurer advising that premiums will need to be increased if the level of cover is to be maintained, or for the level of benefits payable upon the policy holder's death to be reduced if it is preferable that premiums are to remain at the same rate.

A further variation on the whole life policy is a with-profits scheme that guarantees a certain payable benefit on the policy holder's death but also increases that benefit year on year with the addition of annual or "reversionary" bonuses. These will then permanently enhance the amount of the sum eventually paid out. Upon the policy holder's death, most with-profits policies will also incorporate a so-called terminal bonus, in addition to the accumulated annual bonuses, thus further enhancing the total benefits paid.

As with other forms of life insurance, whole life assurance also generally offers a number of additional options which are available on payment of a further premium. These might include payment of a lump sum benefit to the policy holder in the event of his or her becoming disabled or being diagnosed with a serious or critical illness.

About the Author - Gemma Stanbury
Confused.com is one of the UK's biggest and most popular price comparison services. Confused.com helps consumers save money on everything from life insurance to Mortgages.

Life Insurance - Why Does Less Than Half The UK Population Have Cover?

Less than 50% of the UK population has any form of life insurance cover, says Swiss Re, one of the largest insurance companies in the world. In their latest annual report they estimate that £4.2 trillion worth of insurance cover is needed whereas only £1.8 trillion has been taken up. That leaves an insurance gap of £2.3 trillion.

But in all probability, the gap is not that large. Firstly, there's the people who are ruled out from having life insurance due to their age - just over 1 in 5 are under 18 years of age, the minimum for life insurance cover, and 1 in 6 are over 65 and they're effectively uninsurable. Then there's a raft of single folks aged between 18 and 65 without dependents, and for whom life insurance is just not necessary. Having said that, without doubt, there are still many families who desperately need life insurance but who don't have cover.

Why do they hold back?

There are still plenty of people who have no idea what life insurance does and because it's never top of their minds and they don't care, nothing ever gets done. After all life insurance isn't exactly a thrill to buy, there's no pleasurable window-shopping or sense of enjoyment about it. The likelihood is that unless a financial advisor sits down in front of these people and talks about life insurance, they'll remain totally uninsured and uninterested.

The media coverage given to the insurance industry also tends not to help. The press is regularly full of stories about one company or another that has turned down a claim. These stories make headlines as behind them, there's always a sad story of personal tragedy and distress. It all gives the industry a tarnished image and creates a feeling that they can't be trusted.

Then there are those who realise life insurance is needed but just can't be bothered or say they can't afford it. More realistically, for many “can't afford” actually means, “I choose not to afford”. They might be happy to spend £2,000 a year on a 20 a day smoking routine but are unwilling to cut back to afford the monthly premium that protects their family's future.

Of course, there is no disputing the fact that some people will have applied for life cover and found the final premium truly unaffordable. Whilst for the majority, life insurance at normal rates is okay, over the last seven years we've seen a huge rise in the number of people who have seen the price substantially increased once the insurer has seen their application form. It's a result of the life insurance companies making it increasingly hard for people to meet the insurers definition of “healthy”. Seven years ago half as many people were seeing their premiums increased as a result of the insurance companies rating them as an above average health risk.

Even three to four years ago it was pretty obvious who'd have trouble getting insured at normal rates – someone with a history of heart or circulatory problems, former cancer suffers and diabetics for example. How the situation has changed. Insurers' application forms are now much more detailed and health problems that were previously considered acceptable are now only accepted with increased premiums. Take your weight – insurers are clamping down when they judge a person's weight to be a risk to their longer-term health. And it's not just the obviously over weight that attracts the insurer's notice. Insurers are now using a measurement called the Body Mass Index to identify weight problems. This is a persons weight divided by the square of their height. Insurers now want a BMI of no more than 29, whereas previously up to 40 was fine. This means that a woman weighing 83 kilos and 1.66 meter tall would now face higher premiums.

People can also be put off by the application process. Whilst about 30% of applicants will receive a decision almost straight away, for others the process can become one delay after another. As if a 16 page application form were not enough, some people are being faced with more forms to complete plus medical examinations. The whole process can take up to 8 weeks, even more, before the applicant knows precisely how much their premium will be. If that works out more that they can simply afford, they're often too fed up of the whole application process to start again with a new insurance company. That leaves yet another family without insurance.

Despite these problems, the life insurance companies claim that thanks to more sophisticated underwriting procedures, premiums are lower today that they were a few years ago. Furthermore, around 10% of life insurance is bought on the Internet where discounting has become the norm. This too has helped push average premiums down.

Nevertheless, in the author's view it will take many years to get people covered by life insurance above the 50% mark.

About The Author Michael Challiner writes for Brokers Online ( http://www.life-assurance-bureau.co.uk ) who offer life insurance cover and most UK financial services including mortgage payment protection ( http://www.life-assurance-bureau.co.uk/mortgage-payment-protection/ ). Visit our finance blog for useful tips on uk finance ( http://www.life-assurance-bureau.co.uk/family-finance/ )