New Life Insurance Strategies

Tax provisions, particularly the Omnibus Budget Reconciliation Act of 1993 (OBRA), have enhanced permanent life insurance's appeal and the planning strategies it facilitates. One result of OBRA is that life insurance is gaining more attention as a savings and investment vehicle. Unlike other investments, life insurance provides tax-free death benefits; distributions are taxed on a first-in, first-out basis and tax-free loans are available at minimum cost. To help CPAs advise their clients, this article explores some individual and corporate life insurance planning opportunities. THE ADVANTAGES OF VARIABLE LIFE With tax brackets increasing, (OBRA raised the top individual tax rate to 39.6%), variable life insurance deserves another look from CPAs and their clients. Whether or not variable life insurance makes sense as a retirement savings vehicle depends on the insured's health, the policy owner's proximity to retirement and the policy's design. Variable life is a tax-efficient way to generate retirement income. Tax-free income can be taken as withdrawals up to the insured's cost basis in the policy and thereafter through policy loans. Loan interest also can be borrowed from the policy. When an insured dies, the loan is repaid with the tax-free death benefit. Note: Care must be taken not to surrender a policy before death if loans and withdrawals exceed total premiums paid. Any excess will be taxed as income. Variable life insurance's only disadvantage as compared with other savings vehicles (exhibit 1, below, compares some of the characteristics of alternative investments) is that mortality costs are charged against cash values. These costs can be mitigated by minimizing the policy's death benefit, based on guidelines in the Tax Equity and Fiscal Responsibility Act of 1982 and the Tax and Miscellaneous Revenue Act of 1986. (While the calculation is complicated, it is built into most insurance carriers' product illustration software. Nevertheless, in many cases mortality costs actually are covered by the tax savings from deferred interest. THE POPULARITY OF SPLIT-DOLLAR PLANS Split-dollar insurance plans generally are used to provide permanent insurance protection and sometimes post-retirement income. Although these plans have many variations, the most common is the collateral assignment approach. An employer pays the annual premium, and the executive, who owns the policy, collaterally assigns to the company a part of its cash value and death benefit that is equal to its cumulative premium payments. Remaining cash values and death benefits belong to the executive (or his or her beneficiary). Employer-paid premiums are not tax deductible or reportable as income by the executive. However, under revenue ruling 66-110, 1966-1 CB 12, executives must annually report as taxable income a small economic benefit based on the lower of P.S. 58 table rates or alternative term insurance rates applied to his or her portion of the death benefit. Typically, at a designated future date (usually retirement), executives withdraw cash value to repay the corporation for cumulative premium payments. Referred to as a the collateral assignment is released at this time, P.S. 58 income ends, no further premiums are payable and executives can * Continue coverage at the preretirement level. * Reduce coverage and withdraw any cash value. * Surrender the policy for its cash value. At rollout, a corporation's reimbursement is income tax-free as a return of policy basis. Taxation of the policyowner's cash value, however, is unclear because the Internal Revenue Service has not issued a ruling. Some practitioners maintain the cash value is taxable to the policyowner, others believe it is only taxable if the policyowner surrenders the policy or withdraws cash value. With a CPA's advice, policies can be designed around this gray area, based on the parties' objectives. …