A small tax change is a boon to everlasting life insurance coverage

By Leslie Scism

The big year-end federal legislature package includes a little-noticed revision of tax law that should boost life insurance sales, especially for wealthy Americans.

The law lowers a minimum interest rate that is used to determine whether combined savings and death benefit policies, known as permanent life insurance, are too similar to investments to qualify for tax breaks granted to the insurance. The interest rate floor was introduced in 1984 to sort out policies that were mainly investment vehicles with a thin layer of insurance. By lowering the rate, owners can invest more in the savings portion.

And it makes it easier for insurers to offer policies, as interest rates have fallen so far in the past decade that the 1980s minimum threshold is now well above long-term government bond yields. This has led insurers to warn that they may stop selling some policies.

The reduction in the interest rate took effect on January 1st for new sales.

A US House of Representatives summary said the revision was necessary “to reflect economic realities” and to give consumers “access to financial security through permanent life insurance.”

“It will create some new opportunities for clients,” said Katie Nentwick, executive director of Long Road Risk Management Services LLC in Phoenix, who helps investment advisors organize and manage insurance plans.

Perpetual life insurance holders defer taxes on their investment gains and their beneficiaries receive death benefit tax exempt. The guidelines are designed to last for a buyer’s life, allowing a buyer to raise funds to fund the future cost of the policy and tap before death.

The year-end change by Congress will generally increase the amount of money policyholders can deposit into their so-called cash accounts, although some restrictions remain. This change applies to buyers of all income levels, although wealthier people are typically better able to afford additional payments on a policy.

“With the rise in income tax rates ahead, this is a unique opportunity for high net worth investors and investment advisors,” said Ms. Nentwick. She said it could be months before details of how it will play out as many insurers have to redesign products and seek regulatory approvals.

An analysis by the Joint Tax Committee in May found that the lower interest rate assumptions could cut federal income tax revenues by approximately $ 3.3 billion over a 10 year period.

In establishing the 1984 rule – known as Section 7702 – Congress sought to identify investment products disguised as life insurance, according to industry historians, in order to receive the favorable tax treatment. It could also lead to policyholders falsely putting huge sums of money into policies to avoid tax burdens.

In simple terms, 1984 tax legislation assumed a guaranteed cash value growth rate of 4% for a policy to take advantage of the tax benefits. Industry executives said this rule has become particularly problematic for whole life, a popular subgroup of living life.

Life insurers earn a portion of their profits by investing customers’ premiums until they are needed for payouts, and their investment portfolios are rich in high quality bonds. Insurance portfolio returns have fallen since 10-year treasury yields peaked nearly 16% in the 1980s. The 10-year treasury currently offers a return of just over 1%.

After a pandemic-related dive in early 2020, the American Council of Life Insurers trading group campaigned for Congress to move to a floating rate, said Paul Graham, senior vice president of policy development for the organization. Finseca, a professional association, was one of the lobbyists.

Insurers’ investment returns “fell to the point where they ran into their ability to pay that 4% interest rate on their policies and they faced a dilemma,” said Graham. Without a change in tax law, “all of life as we knew it would be badly affected and possibly no longer exist,” he said.

After the change approved by Congress, the tax rate on tax numbers will be 2% this year and then fluctuate, Graham said.

Some agents and brokers are already talking about sales opportunities.

Anthony Mento, President of LIFE Brokerage LLC in Hammonton, New Jersey, posted a video to agents using his firm’s services. In an interview, he said the change was “a big win for consumers and shippers”.

“The Christmas Miracle of Section 7702,” sums up the lobbying work by Bobby Samuelson, president of Life Innovators LLC, a company that develops life insurance and annuity products. It positions life insurers “to survive and even thrive in a low interest rate environment,” he said.

Write to Leslie Scism at [email protected]

(END) Dow Jones Newswires

Jan 10, 2021 8:14 AM ET (1:14 PM GMT)

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