Basic Principles of Life and Health Insurance and Annuities Part 4

40 Group Life Insurance PRINCIPLES OF GROUP INSURANCE Different from individual life insurance, which is written on a single life, group life insurance is written on more than one life. Group life insurance is usually written for employee-employer groups and is most often written as an annual renewable term policy. An important underwriting principle of group life insurance is that all or a large percentage of persons in the group must be covered by the insurance. Contributory and Noncontributory Plans Contributory – An employee group plan in which employees share the cost. Insurance company requires that at least 75% of all employees participate. Noncontributory – An employee group plan in which employees do NOT share in the cost. Insurance company requires that 100% of all employees be eligible. FEATURES OF GROUP INSURANCE The following are the two features that separate group insurance from individual insurance. • the individual does not have to provide evidence of insurability- group underwriting is involved • are not issued as individual policies- master contracts are issued instead • low cost due to lower administrative, operational, and selling expenses associated with group plans • flow of insureds: entering and exiting under the policy as they join and leave the group typically issued as level term insurance, which provides a fixed amount of coverage throughout the term of the contract Note: Since the individual does not own or control the policy, they are issued a certificate of insurance to prove they have coverage. The actual policy, which is called the master policy, is issued to the employer. • Employees are called – certificate holders • Employers are called- contract holders 41 ELIGIBLE GROUPS Group life insurance can be formed by the following as well as other organizations, just as long as they are formed for a reason other than to purchase insurance. There is no minimum # of members required for group life insurance. • Single –employee groups • Multiple-employee groups • Labor Unions • Trade Associations • Credit/Debit groups • Fraternal Organizations • Trustee Groups (Established by two or more employers or labor unions) Eligibility of Group Members – (employees) • • Employee must be full time and actively working If contributory, employees must approve of automatic payroll deduction • New employee probationary period is usually 1 to 6 months • The employee has 31 days during the enrollment period to sign up, otherwise they may need to provide evidence of insurability Classification of Risk Insurers require that a minimum number of group members/employees participate in a group insurance plan in order to minimize adverse selection. Adverse selection means that the people most likely to need life insurance will purchase life insurance in greater numbers than those in good health. After all necessary information is collected on an applicant, the underwriter will classify the applicant based on the degree of risk assumed. The following rating classification system is used to categorize the favorability of a given risk: ►Preferred – Low Risk – Lower Premiums ►Standard - Average Risk – No Extra Ratings or Restrictions ►Substandard – High Risk – Rated Up – Higher Premiums ►Declined – Not Insurable – Potential of Loss to Insurance Company is 42 Lower risks tend to have lower premiums. If an applicant is too risky, the insurer will decline coverage. Types of Group Life Insurance Plans Group Term Life: Life insurance is normally offered as a guaranteed annual renewable term policy. The policy is issued for one year and may be renewed annually without evidence of insurability at the discretion of the policyowner. Group Whole Life: Though not as common, group whole life offers permanent protection for insured members under the group. Note: The most common types of Group Permanent (whole life) plans are: Group Ordinary, Group Paid-Up, and Group Universal Life Dependent Coverage: Most group life insurance policies cover the member’s dependents, as long as the amount of coverage does not exceed 50% of the insured member’s coverage. Taxation of Group Life Insurance Plans For a group life insurance plan to receive favorable tax treatment, there are certain requirements in place. This makes sure that the average employee is not discriminated against in favor of higher-level employees. Determining eligibility: Must benefit at least 70% of all employees. At least 85% of all participating employees must not be key employees. Premiums for group life insurance: If paid by the employee are not tax-deductible. However, if the employer pays, it can deduct the premiums it pays as a business expense. Proceeds from a group life policy are tax-free if taken in a lump-sum. Proceeds taken in installments will be subject to taxes on the interest portion of the installments. How Benefits are Determined Most employers will establish benefit schedules according to the following: • Earnings • Employment position • Flat benefit Conversion to Individual Policy: If a member’s coverage is terminated, the member and his dependents may convert their group coverage to individual whole life coverage, without having to show proof of insurability. Conversion Period: An individual must apply for individual coverage within 31 days after the date of group coverage termination. An individual is covered under the group policy during the conversion period. Group Policy Termination: If the master policy is terminated, each individual member who has been insured for at least 5 years is permitted to convert to an individual policy, providing coverage up to the face value of the group policy. 43 OTHER FORMS OF GROUP LIFE INSURANCE The following are other types of life insurance issued as group plans: Franchise Life Insurance: This is used where participants are employees of a common employer (i.e., the employer may operate several companies) or are members of a common association or society. The employer/association/society is a sponsor of the plan and may or may not contribute to the premium payments. Unlike the employer’s group plan, each individual will be issued an individual policy which will remain in force as long as premiums are paid, and the employee/member maintains their relationship with the sponsor. These are used by small groups who individually do not meet the state’s minimum numbers required by law. Group Credit Life: These are set-up by banks, finance companies, etc. in case the insured dies before a loan is repaid. Policy benefits are paid to the creditor and used to settle the loan balance. The premiums are usually paid by the borrower. A decreasing term policy is commonly used. Blanket Life Insurance: Covers groups of people exposed to the same hazard, such as passengers on an airplane. No one is named on the policy and there is not a certificate of coverage given out. Individuals are only covered for the common hazard. Group Permanent Life: Some group life plans are permanent (whole life) plans, using some form of permanent or whole life insurance as the underlying policy. The most common types of permanent group plans are group ordinary, group paid-up, and group universal life. 44 Annuities PURPOSE AND FUNCTION While life insurance protects against the risk of premature death, annuities protect against the risk of living too long. Annuity Basics Annuities: are ways of providing a stream of income for a guaranteed period of time. • • Simply stated, an annuity is started with a large sum of money that will be paid out in installments over a period of time or until the money is all gone. The monthly amount of benefit an annuitant receives is based on factors such as: principle amount, rate of interest the annuity earns, and length of payout period. Contract owner: The individual who purchases the annuity pays the premiums and has rights of ownership. • An owner may be the annuitant, the beneficiary, or neither Annuitant: The income benefits distributed at regular intervals during the liquidation phase of an annuity contract are normally payable to the annuitant. Beneficiary: The beneficiary is the person who receives survivor benefits upon the annuitant’s death. Accumulation Period vs. Annuity Period Most annuities have two phases, the accumulation period and the annuity period. • • Accumulation Period: The pay-in period, where the contract owner makes the purchase payments. The accumulation period of an annuity normally may continue after the purchase payments cease. Annuity Period: This is also called the liquidation period, annuitization period, or pay- out period. This is the time when the money that has accrued during the accumulation period is paid- out in the form of payments to the annuitant. STRUCTURE AND DESIGN Funding Method When defining an annuity, (describe how you pay for it) + (describe how they pay you) SINGLE PREMIUM (You pay once) + DEFERRED (They start paying you at least a year later). You CANNOT make installment payments and get paid immediately. • • Single Payment – Lump Sum Periodic Payments - Installments paid over a period of time Date Income Payments Begin Immediate Annuities: Purchased with a single lump sum payment and will start providing income payments within the first year, but usually starting 30 days from the purchase date. Its purpose is to provide for liquidation of a principle sum. 45 • Commonly used to structure the payment of liability insurance settlements, lottery winnings, and other large sums • This type of annuity is usually called a Single Premium Immediate Annuity (SPIA) Deferred Annuities: will start providing income payments after the first year. Deferred annuities are usually purchased with either a single lump sum payment known as a Single Premium Deferred Annuity (SPDA) or from monthly payments known as Flexible Premium Deferred Annuity (FPDA). A Fixed Deferred Annuity, for example, pays out a fixed amount for life starting at a future date. Interest credited to the cash values of annuities are deferred until distribution. Other characteristics of deferred annuities include: • • • • When a deferred annuity is cancelled during the early contract years, the insurer normally will assess a backend load known as a surrender charge The “bailout” feature, sometimes found in single premium deferred annuity contracts, waives surrender charges when the interest rate falls below a stated level Before a deferred annuity contract can be terminated for its surrender value, the insurer must first obtain authorization from the owner The accumulation value of a deferred annuity is equal to the sum of premium paid plus interest earned minus expenses and withdrawals PAY OUT OPTIONS Straight Life Income Payout Option: pays the annuitant a guaranteed income for the annuitant’s lifetime. When the annuitant dies, no further payments are made to anyone. This offers protection against exhaustion of savings due to longevity. Cash Refund Payout Option: Pays a guaranteed income to the annuitant for life. If the annuitant dies before all the money is gone, a lump-sum cash payment of the remaining funds is paid out to the annuitant’s beneficiary. Installment Refund Payout Option: Pays a guaranteed income to the annuitant for life. If the annuitant dies before the money is gone, the beneficiary will continue to receive the same monthly installment payments. Life with Period Certain Payout Option (life income with term certain): is designed to pay the annuitant guaranteed payments for the life of the annuitant or for a specific period of time for the beneficiary. It provides that benefit payments will continue for a minimum number of years regardless of when the annuitant dies. For example, if an annuitant has a 20-year period certain and dies after 10 years, the beneficiary will receive payments for another 10 years. Joint and Full Survivor Payout Option: Pays out the annuity to two or more people until the last annuitant dies. If one of them dies, the other will continue to receive the same income payments. There are two additional options made available with a joint and survivor payout: • • Joint and two-thirds survivor: Survivor will have payments reduced to two-thirds of the original payment. Joint and one-half survivor: Survivor will have payments reduced to one-half of the original payment. 46 Period Certain Payout Option: Pays guaranteed income payments for a certain period of time, such as 10 or 20 years, whether or not the annuitant is living. INVESTMENT CONFIGURATION Annuities can also be defined by their investment configuration, which will determine the amount of income the benefits pay. The two types of annuity classifications are fixed annuities and variable annuities. Fixed Annuity: Provide a guaranteed rate of return. Fixed annuities credit interest at a rate no lower than the contract guaranteed rate. Variable Annuity: Does not provide a guaranteed rate of return, because of the investment risk. The cash value is based on the results of these investment funds. A statement must be provided to the owner of the annuity at a minimum of once per year. Variable annuities can be classified as either immediate or deferred. Insurers that deal with variable annuities are subject to dual regulation by the SEC and the state's Office of Insurance Regulation. • • Accumulation Units: In a variable annuity, the value of the accumulation units varies depending on the value of the stock investment that is a part of a variable annuity. Annuity Units: At the time the variable annuity is to be paid out to the annuitant, the accumulations are converted into annuity units. These payouts can vary from month to month depending on the investment results. The number of units doesn’t change, but the value does. The amount of each variable annuity benefit paid to an annuitant varies according to the market value of the securities backing it. Equity Indexed Annuities: A type of fixed annuity that offers the potential for a higher return than a standard fixed annuity. They are sometimes tied to the Standard and Poor’s 500 or the Composite Stock Price Index. Single-life annuities: Characterized by having only one annuitant. Tax-sheltered annuities: Limited exclusively for employees of religious, charity, or educational groups. • • • Also called 403(b) plans Accumulation payments often come from voluntary salary reductions The annuitant may have an individual account contract Income Tax Treatment of Annuity Benefits: Annuity benefit payments consist of principal and interest. The portion of annuity benefits that consists of principal (premiums paid into the annuity during the accumulation period) are not taxed and is sometimes called the owner’s “cost basis”. The portion of the annuity benefits that is interest earned on the principal is taxable as ordinary income. Interest income must be reported for federal income tax purposes upon receiving distributions or income benefits from the contract. The exclusion ratio is a simple way to determine what portion of each annuity benefit payment is taxable: Exclusion ratio = Investment in the contract / Expected return Partial Withdrawal: is taken from an annuity before age 59 ½ the withdrawal is considered 100% interest and is therefore taxable as ordinary income. A 10% tax penalty is applied if a distribution is received before the annuitant reaches age 59 ½. After this age, withdrawals do not incur the 10% penalty tax, but are taxable as ordinary income. 47 1035 Exchange: applies to annuities. If an annuity is exchanged for another annuity, a gain (for tax purposes) is not realized. This is also true for a life insurance policy or an endowment contract exchanged for an annuity. However, an annuity cannot be exchanged for a life insurance policy. SUITABILITY OF ANNUITY SALES FOR SENIOR CUSTOMERS Senior Residents Age 65 or Older When making recommendations to a senior consumer regarding the purchase or exchange of an annuity, an agent must have reasonable grounds for believing that this recommendation is suitable for the senior consumer. This recommendation should be based on the facts disclosed by the senior consumer. It should include an evaluation of his investments and other insurance products along with his financial situation and needs. Two-Tiered Annuities: This type of annuity is one that has different values available for distribution at maturity depending upon whether the value is taken in a lump sum before annuitization or is left with the insurer in order to receive monthly payments. If an owner/ insured keeps the contract for a specific number of years (or until it annuitizes), they will have received a higher rate of interest. If the contract is surrendered at an earlier date, the interest credited will be recalculated from the contract’s inception using a lower (i.e., tier) interest rate. A guarantee prior to the annuity starting date is provided since the insurer is obligated to return all or a portion of the annuity cash value if the purchaser dies or voluntarily terminates the contract. 48 Social Security PURPOSE The Social Security system provides a basic floor of protection to all working Americans against the financial problems brought on by death, disability, and aging. Social Security augments but does not replace a sound personal insurance plan. Unfortunately, too many Americans have come to expect Social Security will fulfill all their financial needs. The consequence of this misunderstanding has been disillusionment by many who found, often too late, they were inadequately covered when they needed life insurance, disability income, or retirement income. Social Security, also known as Old Age, Survivors, and Disability Insurance (OASDI), was signed into law in 1935 by President Roosevelt as part of the Social Security Act. Social Security was established during the Great Depression to assist the masses of people who could not afford to sustain their way of life because of unemployment, disability, illness, old age, or death. WHO IS COVERED? Social Security extends coverage to virtually every American who is employed or self-employed, with few exceptions. Those not covered include: • • • Most federal employees hired before 1984 who are covered by Civil Service Retirement or another similar plan Approximately 25% of state and local government employees who are covered by a state pension program and elect not to participate in the Social Security Program Railroad workers covered under a separate federal program called the Railroad Retirement System HOW BENEFITS ARE DETERMINED A person must be insured under the Social Security program for survivors, disability, or retirement benefits to pay. Social Security benefits are based on how long a covered worker has worked throughout his life. Insured Status Social Security establishes benefit eligibility based on an “insured” status. There are two types of insured statuses that qualify individuals for Social Security benefits: • • To obtain Fully Insured Status, a covered worker must accrue a total of 40 quarters of credit, which is about 10 years of work. To be considered Currently Insured, and thus eligible for limited survivor benefits, a worker must have earned 6 credits during the last 13-quarter period. Social Security Payroll Taxes • • • Funding for Social Security is collected from FICA payroll taxes. Social Security payroll taxes are collected from employers, employees, and self-employed individuals. FICA tax is applied to an employee’s income up to a certain income amount. This amount is called the taxable wage base. 49 • There is a maximum amount of earnings that can be subject to Social Security tax each year. This amount is indexed each year to the national average wage index. This maximum applies to employers, employees, and self-employed individuals. Medicare Part A taxes are not subject to a maximum taxable wage cap. Taxation of Social Security Benefits • Social Security benefits are subject to federal income tax if the beneficiary files an individual tax return and his annual income is greater than $25,000. Joint filers will pay federal income tax on their Social Security benefits if their income is greater than $32,000. • Calculating Benefits • • Based on the individual’s average monthly wage during his working years. The primary insurance amount (PIA) is used to establish the benefit. It is equal to the worker’s full retirement benefit at age 65. If a worker retires early, for example at age 62, his retirement benefits will be 80% of his PIA and will remain lower for the covered worker’s life. The PIA is based on the average earnings over your lifetime. • • TYPES OF OASDI BENEFITS Survivors Benefits Social Security Survivors benefits or death benefits: pay a lump-sum death benefit or monthly income to survivors of deceased covered workers. Survivor’s benefits: include a $255 lump-sum death benefit, surviving spouse benefits, child’s benefit, and parent’s benefit. • • • A surviving spouse without dependent children is eligible for Social Security survivor benefits as early as age 60. Survivor benefits are also available to: o A spouse of any age who is caring for children under age 16 o Children under age 18 o Children under age 19 who are full time students o Children at any age if disabled before age 22 and remain disabled A Social Security benefit of 75% of the Primary Insurance Amount (PIA) is given to an underage child of a deceased worker. Disability Benefits • • • • • • Only available to covered workers who are fully insured, as defined by Social Security, at the time of disability. Disability income benefits are paid to the covered worker in the amount of the PIA after a 5-month waiting period. Only available prior to the age of 65 Does not pay partial disability or short-term disability benefits Disability must be total and expected to last 12 months or end in death Benefits include monthly payments to the disabled worker, spousal benefits, and child’s benefits. 50 • Definition of Disability: In order to be considered totally disabled, an individual has to qualify according the following requirements: o o The inability to engage in any gainful work that exists in the national economy The disability must result from a medically determinable physical or mental impairment that is expected to result in early death, or has lasted, or is expected to last for a continuous period of 12 months Retirement Benefits • • • • • • Benefits are only available to covered workers who are fully insured upon retirement. Benefits are paid monthly. If a covered worker retires at the normal retirement age, he will receive 100% of the PIA. If a covered worker retires early at the age of 62, the maximum Social Security benefit is 80% of the PIA. This reduction remains all through retirement. Retirement benefits pay covered retired workers at least 62 years of age, their spouses and other eligible dependents monthly retirement income. Retirement benefits include monthly retirement payments to the covered worker, spousal benefits, and child’s benefits. Black-Out Period • • • • Benefits paid to the surviving spouse of a deceased person who was receiving Social Security. The “black-out period” begins when Social Security survivorship benefits cease. This is when the youngest child turns 16 years old, or immediately if there are no children. The “black-out period” ends when the surviving spouse turns at least 60 years old. 51 Retirement Plans QUALIFIED PLANS VERSUS NONQUALIFIED PLANS Qualified plans are retirement plans that meet federal requirements and receive favorable tax treatment. Qualified plans provide tax benefits and must be approved by the IRS. The plans must be permanent, in writing, communicated to employees, defined contributions or benefits, and cannot favor highly paid employees, executives, or stockholders. The primary type of qualified plans includes defined benefit and defined contribution plans. • To comply with ERISA minimum participation standards, qualified retirement plans must allow the enrollment of all employees over age 21 with one-year experience. • If more than 60% of a qualified retirement plan’s asset are in key employee accounts, the plan is considered “top heavy”. Qualified plans have the following features: • • • • Employer’s contributions are tax-deductible as a business expense. Employee contributions are made with pretax dollars – contributions are not taxed until withdrawn. Interest earned on contributions is tax-deferred until withdrawn upon retirement The annual addition to an employee's account in a qualified retirement plan cannot exceed the maximum limits set by the Internal Revenue Service Nonqualified plans are characterized by the following: • • • • Do not need to be approved by the IRS Can discriminate in favor of certain employees Contributions are not tax-deductible Interest earned on contributions is tax-deferred until withdrawn upon retirement Tax Benefits of Qualified Plans Employer’s contributions are tax-deductible and not treated as taxable income to the employee. Employee contributions are made with pre-tax dollars, and any interest earned on both employer and employee contributions are tax deferred. Employees only pay taxes on amounts at the time of withdrawal. Withdrawals and Taxation Withdrawals by the employee are treated as taxable income. Withdrawals by the employee made prior to age 59 ½ are assessed an additional 10% penalty tax . Distributions are mandatory by April 1st of the year following age 70½, and failure to take the required withdrawal results in a 50% excise tax on those funds. Funds may be withdrawn prior to the employee reaching age 59 ½ without the 10% penalty tax: if the employee dies or becomes disabled; if a loan is taken on the plan’s proceeds; if the withdrawal is the result of a divorce proceeding; if the withdrawal is made to a qualified rollover plan; or if the employee elects to receive annual level payments for the remainder of his life. 52 The Employee Retirement Income Security Act of 1974 (ERISA) ERISA was enacted to provide minimum benefit standards for pension and employee benefits plans, including fiduciary responsibility, reporting and disclosure practices, and vesting rules. The overall purpose of ERISA is to protect the rights of workers covered under an employer sponsored plan. EMPLOYER-SPONSORED PLANS Defined Benefit Plans Defined benefit plans pay a specified benefit amount upon the employee’s retirement. When the term pension is used, it normally is referring to a defined benefit plan. The benefit is based on the employee’s length of service and/or earnings. Defined benefit plans are mostly funded by individual and group deferred annuities. Defined Contribution Plans Defined contribution plans do not specify the exact benefit amount until distribution begins. Three main types of plans are profit-sharing, pension plans, and Money Purchase Plans. The maximum contribution is the lesser of 25% or the employee’s earnings or $57,000 ($63,500 including catch-up contributions) per year. Here are some examples of defined contribution plans: Profit-Sharing Plans A type of retirement plan that sets aside a portion of the firm's net income for distributions to employees who qualify under the plan. Plans must provide participants with the formula the employer uses for contributions. The contributions may vary year to year, and contributions and interest are tax-deferred until withdrawal. Pension Plans Employers contribute to a plan based on the employee’s compensation and years of service, not company profitability or performance. Money Purchase Plans Allow employers to contribute a fixed annual amount, apportioned to each participant, with benefits based on funds in the account upon retirement. Target benefit plans have a target benefit amount. Stock Bonus Plans These plans are similar to a profit-sharing plan, except that contributions by the employer do not depend on profits, and benefits are distributed in the form of company stock. 53 Other Employer-Sponsored Plans Cash or Deferred Arrangement (401(k) Plans) 401(k) plans allow employers to make tax-deferred contributions to the participant, either by placing a cash bonus into the employee’s account on a pre-tax basis or the individual taking a reduced salary with the reduction placed pre-tax in the account. The account’s funds are taxable upon withdrawal. The maximum annual pretax contribution limit is $19,500. Tax-Sheltered Annuity (403(b) Plans) Tax-sheltered annuities are a special class of retirement plans available to employees of certain charitable, educational, or religious organizations. The maximum allowable annual contribution is $19,500. QUALIFIED PLANS FOR SMALL EMPLOYERS Simplified Employee Plans (SEPs) SEP’s are basically an arrangement where an employee (including a self-employed individual) establishes and maintains an IRA to which the employer contributes. Employer contributions are not included in the employee’s gross income. A primary difference between a SEP and an IRA is the much larger amount that can be contributed to an employee’s SEP plan is the lesser of 25% of the employee’s annual compensation, up to a maximum of $57,000. Savings Incentive Match Plan for Employees (SIMPLE) SIMPLE plans are available to small businesses (including tax exempt and government entities) that employ no more than 100 employees who received at least $5,000 in compensation from the employer during the previous year. An employer can choose to make nonelective contributions of 2% of compensation on behalf of each eligible employee. To establish a SIMPLE plan, the employer must not have a qualified plan in place. The limit is $13,500 ($16,500 for age 50 and over). Keogh Plans Keogh or HR-10 plans are for self-employed persons, such as doctors, farmers, lawyers, or other sole- proprietors. Keoghs may be defined contribution or defined benefit plans. Defined contribution Keoghs have a maximum contribution is the lesser of 25% or the employee’s earnings or $57,000 ($63,500 including catch-up contributions) per year. In contrast defined benefit Keoghs have maximum benefits of $230,000 per year. Contributions are taxdeductible, and interest and dividends are tax deferred. The INDIVIDUAL RETIREMENT PLANS IRAs are established by an individual who has earned income to save for retirement. Traditional IRAs Traditional IRAs allow for an individual to contribute a limited amount of money per year, and the interest earned is taxdeferred until withdrawal. Contribution limits are indexed annually, currently at $6,000 per year, with $7,000 for individuals age 50 or older. Some individuals may deduct contributions from their taxes based on their adjusted gross 54 income (AGI), but all withdrawals are taxable income. If an individual or spouse does not have an employer retirement plan, the entire contribution is tax-deductible, regardless of AGI. Withdrawals made prior to age 59 ½ are assessed an additional 10% penalty tax. To avoid penalties, traditional IRA owners must begin to receive payment from their accounts no later than April 1 in the year following the attainment of age 70 ½. Funds may be withdrawn prior to the employee reaching age 59 ½ without paying the 10% penalty tax (but the interest is still taxable) to the following: death, disability, first-time homebuyers up to $10,000, education (no dollar maximum), health insurance premiums if unemployed, qualified medical expenses. Roth IRAs Roth IRAs are designed so that withdrawals are received income tax-free. Contributions to Roth IRAs are subject to the same limits as traditional IRAs but are not tax-deductible. Interest on contributions is not taxable as long as the withdrawal is a qualified distribution. Qualified distributions must occur after five years in the event of death or disability of the individual, up to $10,000 for first-time homebuyers, or at the age of 59 ½. A person may contribute the lesser of $6,000 or 100% of earned income per year (age 50 and above is $7,000). This is a combined limitation of all IRAs owned. Rollovers • • • • • Rollovers are a transfer of funds from one IRA or qualified plan to another. Rollovers are subjected to 20% withholding tax if eligible rollover funds are received personally by a participant in a qualified plan, unless the funds are deposited into a new IRA or qualified plan within 60 days of distribution. Funds that are transferred directly from one qualified IRA to another qualified IRA are not subject to this withholding tax. This also includes a trustee-to-trustee transfer of rollover funds instead of personally receiving the funds and then rolling them over. This election permits the participant to avoid mandatory income tax withholding on the amount transferred. A surviving spouse who inherits IRA benefits from a deceased spouse's qualified plan is eligible to establish a rollover IRA in their own name. Rollover contributions to an individual retirement annuity (IRA) are unlimited by dollar amount FEDERAL PENSION ACT OF 2006 • This law sets forth standards for funding, participating, vesting, disclosure, and tax treatment of retirement plans. • This Act improves the pension system and encourages employees to increase contributions to their employer-sponsored retirement plans. The provisions of the act have two main goals: addressing employers pension funds and assisting employees who are saving for retirement. • It addresses employer responsibilities by requiring additional premiums for underfunded plans. It does this by requiring employers to obtain accurate assessments of the pension’s financial obligations. It also closes loopholes by which underfunded plans skip payments and prevents employers with under- funded plans from promising extra benefits without first funding those benefits. • It helps employees who save for retirement through qualified plans by: allowing employers to automatically enroll employees in defined compensation plans; provide more accurate information about accounts; increase access to professional advice about investments; allow for direct deposit of income tax refunds into 55 IRA’s; allow active military to make early penalty-free withdrawals; increase limits on contributions to all qualified plans; and provide for better portability for those plans. 1035 EXCHANGES All of the following are types of insurance policy exchanges that can be made without current taxation: • The exchange of a life insurance policy for an annuity • An annuity exchanged for another annuity contract • A life insurance policy exchanged for another life policy the exchange of an annuity for a life insurance policy is NOT permitted 56 Uses of Life Insurance The valuable role that life insurance plays in providing a death benefit is easily recognized. What is often overlooked or not understood are the many “living benefits” of life insurance-especially whole life insurance. Life insurance creates an immediate estate by paying a death benefit whenever the insured dies. The cash value feature of permanent insurance and the owner's right to borrow from the cash value make these policies an important source of funds to meet living needs. This section reviews the more common uses of life insurance in meeting individual needs as well as business needs, not only at the death of the policyowner, but also during the owner's life. DETERMINING THE PROPER INSURANCE AMOUNTS 1. Human Life Value Approach: Calculates the amount of money a person is expected to earn over his lifetime to determine the face amount of life insurance needed, thereby placing a dollar value on the life of an individual. 2. Needs Approach: A method of life insurance planning which identifies the obligations of an individual and the individual’s dependents. This approach determines the total funds available to a family from all sources and subtracts the amount needed to meet their financial objectives. It takes into consideration: • Final Expense Fund • • Housing Fund Education Fund • • Monthly Income Emergency Fund • • • • Income Needs if Disabled or Ill Retirement Income Estate Conservation (using life insurance to enable heirs to pay estate taxes) NEEDS include ANY (ONE or THING) depending on that person, charity, child, pet ►The needs approach to personal life insurance planning may involve creating a lump sum to provide for such things as education, retirement, and charitable ►The needs approach to personal life insurance planning also includes the creation of an emergency reserve fund. This fund is designed primarily to cover the cost of unexpected expenses. ►The "needs approach" in life insurance is most useful in determining how much life insurance a client should apply for. 57 BUSINESS USES OF LIFE INSURANCE Buy-Sell agreements are also known as business continuation agreements and are used to assure the ownership of the business is properly transferred upon the death or disability of an owner or partner. Third-party ownership of life insurance policies is widely used in business insurance and estate-planning situations. Buy-Sell Funding for Sole Proprietors There is a two-step business continuation plan to keep the business running after the proprietor’s death, whereby the employee takes over management of the business: • Buy-Sell Plan: an attorney drafts a buy-sell plan stating the employee’s agreement to purchase the proprietor’s estate and sell the business at a price that has been agreed-upon beforehand. • Insurance Policy: the employee purchases a life insurance policy on the life of the proprietor. The employee is the policyowner, beneficiary, and pays the premiums. Upon the proprietor’s death, the funds from the policy are used to buy the business. Buy-Sell Funding for Partnerships: There are two types of buy-sell agreements for partnerships: cross- purchase plans and entity plans. Cross-purchase plans: In a cross-purchase plan, each partner buys, pays the premiums, and is the beneficiary of a life insurance policy on each of the other partners. The amount of the policy is equivalent to each partner’s share of the business. When one partner dies, each of the other partners receives the death benefit from the life insurance on the deceased partner, which is then used to buy the deceased partner’s ownership of the business. Entity plans: the partnership itself agrees to buy the deceased partner’s share of the business. Entity plans are best for businesses with several partners. In this case, the business purchases, pays the premiums and is the beneficiary of life insurance on each partner. Buy-Sell Funding for Close Corporations: Unlike a partnership, a close corporation (i.e. an incorporated family business) is legally separate from its owners. It exists after one or more owners dies. A close corporation may purchase either buy-sell plans: cross-purchase or entity. The difference is that an entity plan is termed a stock redemption plan for close corporations. Close Corporation Cross-Purchase Plan: Similar to partnership cross-purchase plans, a close corporation cross-purchase plan requires surviving stockholders purchase the deceased stockholder’s interest in the company, and the deceased stockholder’s estate sell the interest to the surviving stockholders. The corporation is not part of the buy-sell plan. Each stockholder owns, pays the premiums and is the beneficiary of life insurance on each of the other stockholders in an amount equal to his share of the corporation’s purchase price. Close Corporation Stock Redemption Plan: Similar to the partnership entity plan, the corporation purchases, is the owner, pays the premiums and is the beneficiary of life insurance policies on each stockholder. The amount of life insurance is equal to each stockholder’s share of the corporation’s purchase price. When a stockholder dies, the corporation purchases, or redeems, the deceased stockholder’s share. 58 Key Person Insurance: The purpose of key person insurance is to prevent the financial loss that may ensue when an owner, officer or manager dies. • It pays for finding and training a replacement if the key employee dies prematurely • The company purchases, owns, pays the premiums and is the beneficiary of the life insurance policy on the key person. • The premiums are not deductible for income purposes. However, the death proceeds received by the business are not taxable. Business Uses of Policy Loans: Policy loans can be used for many business needs, such as to fund buy-sell agreements, deferred compensation for key people, and/or split-dollar arrangements. EMPLOYEE BENEFIT PLANS Deferred Compensation: is an executive benefit an employer can use to pay a highly paid employee at a later date, such as upon disability, retirement, or death. Salary Continuation Plan: works the same as deferred compensation except that the employer funds the plan rather than the employee. The employer establishes an agreement, whereby an employee will continue to receive income payments upon death, disability or retirement. Split-Dollar Plan: is an arrangement where an employer and an employee share in the cost of purchasing a life insurance policy on the employee. It is a method of buying insurance, not an insurance policy itself. Many times, it is a combination of term and whole life insurance. Life Insurance as Property A life insurance policy is a piece of property just like a home. Therefore, the value of this piece of property must be included in the owner’s estate at death and may be estate taxable. The biggest advantage of life insurance as property is that when an insured die, the policy creates an immediate estate.