In 1984, when Section 7702 was enacted, Insurance carriers were required to provide at least 4% guaranteed interest rate of return. This could be net of reasonable carrier expenses. Since the reduction of interest rates (Moody’s AA corporate Bond Yield went from 12% in the 80’s to 2-3%), Section 7702 required from 4% to 2%. So for the same death benefit, carriers could now charge a higher premium.
In order for an insurance policy’s cash value to have preferential tax treatment it must pass the “cash accumulation test” or “guideline premium test” which are defined by the IRS. We will focus on the former.
This “Cash Accumulation Test” is met if the cash surrender value does not exceed the single premium that would have to be paid at such time to fund the policy’s death benefit at life expectancy, based on the minimum guaranteed interest rate in Section 7702. The “Cash Surrender Value” is the actual amount of money you will receive if you choose to terminate a permanent life insurance policy before its maturity date, or before you die. This is different from the insurance policy’s “cash value” which is the total sum compiled in your policy’s cash account.
Could section 7702 interest rates go up? Yes, but these rates are contractual to each policy at issuance, so policies already in effect should not be negatively impacted.
Typically, life insurance provides a federal income tax-free death benefit for your loved ones. It life insurance can also help by providing supplemental income that is usually income tax-free.
In some policies, the death benefit option increases if the cash value does. This may be a requirement for the policy to qualify as “Life Insurance”.
Tax-free benefits while still alive could be for the following:
- Chronic illness
- Cash Value Accumulation could be accessed at any age via Withdrawals or Loans.
- Up to the amount of premiums you’ve paid
If your policy lapses, or it is surrendered, you will need to pay tax on gains made. Any outstanding loan will be deducted from the payout of course.
Loans from life-insurance policy:
- This must be “Whole” life insurance and not “Term” life insurance to be eligible
- There must be interest paid and it is not tax deductible. Interest is paid annually.
- You can take a loan up to the Premiums you have paid into it.
- If you do not repay your loan, then it may become taxable income.
If you would like to discuss this or other tax strategies with a CPA or other Tax expert, please reach out to us via phone at 310-894-3211 or email info@wandercpa.com
