Don’t Put Off Your Decision to Buy Life Insurance
2016 is an opportune year to buy life insurance. New laws affecting the taxation of life insurance come into effect on January 1, 2017. After this date new policies will not perform as well as they do currently.
The good news is that the proceeds of life insurance policies paid at death still remain tax free. What has been affected is the amount of cash value that may accrue in a policy and the tax-free distribution of death proceeds from a life insurance policy owned in a corporation.
How will this impact your existing and future policies?
Adjustment to the Maximum Tax Actuarial Reserve
Whole Life and Universal Life policies are valuable vehicles in which to accumulate cash value. The limit of how much can be invested is governed by the Maximum Tax Actuarial Reserve (MTAR). If the cash value ever exceeds the MTAR limit, the policy is deemed to be “offside” and will be subject to accrual taxation.
After December 31, 2016, an adjustment will be made to the MTAR which will see a reduction in the long term tax-exempt room of the investment portion of life insurance policies. There will actually be more accumulation room in the early years, but less room in later years.
As a consequence of this adjustment, it will take longer to quick pay or pre-pay a permanent life policy than it does currently. Today, you can fully pay for life coverage in as little as four to five years. After this year, the minimum payment period will increase to eight years.
Requirement to use a more current mortality table
In an effort to bring consistency to all insurers the new legislation mandates that, for the purpose of the exempt test, all the factors determining MTAR are regulated and the same for all. One of these factors is the net cost of pure insurance (NCPI) which is the tax cost of the life insurance for each year. Simply put, it is a factor of the amount at risk and a prescribed mortality rate.
The legislation which is being modified as of January 1, 2017 was originally introduced in 1982. Today, people are living longer and that is to be reflected in the new mortality table which will be used for exempt test purposes starting in 2017. As a result, the NCPI will be reduced.
This means any policy issued after December 31, 2016 that is assigned to a lending institution for a business or investment loan will have a lower collateral insurance deduction. Policies issued after 2016 that are substandard due to medical or other reasons will now receive a higher NCPI. Previously, substandard extras were not recognized.
Impact on Adjusted Cost Basis and Capital Dividend Account
NCPI is a factor used to determine the Adjusted Cost Basis of a policy. ACB is important in calculating how much cash value can be withdrawn from a policy before it is subject to tax. Similarly, any remaining ACB reduces the amount of life insurance proceeds that can be distributed tax free by the corporation to its shareholders (by precisely the amount of the ACB). With the reduction in NCPI, those policies issued January 1, 2017 or later will take longer for their ACB’s to decline to zero.
The good news is that the ACB will still go to zero eventually, before the life insured reaches the normal age of mortality. It will simply take a few years longer for a whole life policy (and a lot longer for a universal life policy).
What steps should you take before the end of this year?
Given these changes it may be time to get together to review your circumstances to make sure you do not miss out on this closing window of opportunity. Please feel free to share this information with anyone you think will benefit from this information.
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