Broker Check
THE DETAILS OF  DISTRIBUTION

THE DETAILS OF DISTRIBUTION

| July 06, 2017
Share |

Cash-value life insurance is an ingenious combination of financial and actuarial fundamentals. And because of this creative complexity, insurance companies and financial professionals continue to find new ways to construct and utilize policies. Many of these options may involve a future distribution of cash values.

Because cash-value life insurance is a financial instrument that can be hard to explain in a single conversation with someone who has no previous exposure to it, initial discussions tend to focus on the accumulation mechanics of a policy, while giving less attention to the methods and regulations under which cash values can be distributed. As long as the policy is in the accumulation phase, this ignorance is not an issue. But once a policyowner contemplates a cash-value distribution, it is essential to understand the options for distribution and the subsequent impact they have on the other components of the policy.

What follows are three questions and answers to familiarize you with some of the basics of cash-value distributions.

Q1: Is this a one-time withdrawal or periodic payment?

Cash-value distributions fall into two categories: one-time withdrawals or periodic payments. Besides being available for financial emergencies, one-time distributions might be intended for big-ticket purchases like a car, a home improvement project, or down payment for a business. A series of distributions (monthly, or some other regular period) could provide additional retirement income, cover ongoing long-term expenses, or be payments for an item purchased over time. The amounts and timing of the distributions can influence some of the decisions that follow.

Q2: Will the distribution be classified as a partial surrender or a loan?  

Cash-value life insurance policies typically offer two options for distribution of cash values. One is a partial surrender, in which the owner essentially “sells” a portion of the insurance policy. The owner receives cash, but also reduces the policy’s insurance benefit by a corresponding amount.

Policyowners also have the option of borrowing against the cash values. The insurance company loans the policyowner money, using the cash values as collateral. The terms of repayment are flexible, and determined by the policyowner. Interest accrues against unpaid loan balances, and if this amount exceeds the cash values, the policy may be lapsed or terminated. While outstanding, any loans against a policy decrease both the cash surrender value and the insurance benefit.1

The decision to take a distribution as a partial surrender or loan can depend on several factors, including whether the policyowner intends to eventually return some or all of the distribution to the policy, and whether the distribution is taxable.

Q3: How does a distribution affect the policy?

Remember, a cash-value life insurance policy is a blend of several financial and insurance concepts. When a distribution is taken from a cash-value policy, it can impact other parts of the contract. Such as:

  • The insurance benefit. In general, distributions of any type will diminish the insurance benefit. However, some policies are designed with an increasing benefit during the accumulation phase of the contract, so distributions may simply result in an incremental return to the original benefit.
  • The future accumulation of cash values. If cash values are used to pay accruing interest charges on policy loans, this cost can slow or even reverse the growth of cash values. Similarly, a partial surrender reduces the principal on which many policies calculate their annual dividend payments.
  • The premiums required to keep the policy in force. If a policyowner’s partial surrenders or loans exceed the ongoing costs of maintaining the insurance benefit, higher premiums (or minimum loan payments) may be required to keep the policy in-force.
  • The dividend option. Policies typically permit a variety of dividend options, some of which can be changed during the course of the policy’s life. Depending on the type of distribution, a change in the dividend option may be desirable or necessary.2     
  • The cost basis. For tax purposes, all premiums (including amounts used to purchase paid-up additions to the policy) comprise the basis in the policy. Surrenders reduce this basis, while loans do so only if they remain outstanding for a policy that is terminated prior to the death of the insured. The basis is used to determine whether any portion of a particular distribution is taxable.

If you’ve read this far, the following disclaimer/suggestion should be obvious: The technology that makes complex calculations possible with a keystroke on a laptop has ushered in a new level of creativity by life insurance professionals, especially when it comes to distribution scenarios.

Those who decide to make cash-value life insurance part of their financial portfolio should retain professional assistance for the ongoing management of their policy and the execution of transactions, particularly distributions. 

1 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses or is surrendered, any outstanding loan considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

2 Dividends are not guaranteed. They are declared annually by the insurance company’s board of directors.

This newsletter is prepared by an independent third party for distribution by your Representative(s). Material discussed is meant for general illustration and/or informational purposes only and it is not to be construed as tax, legal or investment advice. Although the information has been gathered from sources believed reliable, please note that individual situations can vary, therefore the information should be relied upon when coordinated with individual professional advice. Links to other sites are for your convenience in locating related information and services. The Representative(s) does not maintain these other sites and has no control over the organizations that maintain the sites or the information, products or services these organizations provide. The Representative(s) expressly disclaims any responsibility for the content, the accuracy of the information or the quality of products or services provided by the organizations that maintain these sites. The Representative(s) does not recommend or endorse these organizations or their products or services in any way. We have not reviewed or approved the above referenced publications nor recommend or endorse them in any way.      

Lifetime Financial Growth, LLC is an Agency of The Guardian Life Insurance Company of America® (Guardian), New York, NY. Securities products and advisory services offered through Park Avenue Securities LLC (PAS), member FINRA, SIPC. PAS is an indirect, wholly-owned subsidiary of Guardian. Lifetime Financial Growth is not an affiliate or subsidiary of PAS or Guardian. © Copyright 2017   2017-41381   Exp. 6/2019                

Share |