How The Recent Stimulus Act Impacts Permanent Life Insurance
(Originally published in Forbes)
The recently passed Continuing Appropriations Act of 2021 has brought long awaited and needed economic relief to many Americans. One of these lesser-known changes included a provision impacting section 7702 of the IRS tax code, which lowers the minimum guaranteed growth rate in cash value for a policy from 4% to 2% with a variable rate thereafter. According to US House staff, the 7702 changes were necessary “to reflect economic realities” and give consumers “access to financial security via permanent life-insurance policies.” Following, I will provide some context for the change, what it means, and how it may impact you along with some potential steps you might want to take.
So what is permanent life insurance?
To better understand what permanent life insurance is, let’s talk about its most common alternative - term life insurance. Term life insurance is a policy that pays you a death benefit covering a fixed period of time. You typically pay a fixed premium for that time period (for example 10, 20, or 30 years) in exchange for your beneficiaries receiving a death benefit in the event that you die during that term.
When the term ends, your coverage ends, and the need to pay the premium ends. Factors like age and health primarily determine the premiums paid. Because this is basic pure death benefit coverage with a fixed time limit, the premiums tend to be the lowest.
Permanent Life insurance policies differ for two main reasons. First, they are designed to pay a death benefit to your beneficiaries regardless of when you die, as opposed to a set number of years. Second, they have a tax-privileged savings component attached to the policy so a portion of your premium is set aside to accrue for future use with favorable tax treatment or to help cover future premiums. For these reasons, permanent life insurance is substantially more expensive and may not be for everybody. You can read more about that here and here is a good breakdown on how to determine which is best for you
What does this change mean for you?
As opposed to pure death benefit coverage where individuals look to pay the least amount of premium for the most amount of coverage, permanent life insurance policies are designed to allow you to pay a larger premium for a guaranteed death benefit and a tax-advantaged savings component. That is the piece that you can grow tax deferred. It can also potentially be tapped into, borrowed from, or used to pay future premiums.
Section 7702 was originally enacted to differentiate between genuine life insurance policies and investment vehicles trying to receive advantageous tax treatment by requiring a certain ratio of death benefit for any desired premium amount. According to actuaries, now that the interest rate component in that ratio has been lowered, you can potentially either put more money away for the same death benefit or a potentially lower death benefit. It can also mean lower premiums and more favorable approval odds – again depending on your health, age and other factors. As additional guidance is released and new policies are issued and redesigned, we should have a better idea of how large these changes will be.
Note, that if you currently have a permanent life insurance policy it will not be impacted by these changes. Only newly issued policies (post 12/31/2020) will be impacted by the change. The trade off for current policy holders is that even though they won’t be able to put a larger amount away relative to the death benefit, they will benefit from a policy that will continue to offer them a higher guaranteed minimum interest credit relative to the current change.
What steps should I take now?
If it has been a while (3-5 years) since your last life insurance review or if you’ve done little to no planning, check out these 5 estate planning steps literally everyone needs to take. You’ll first want determine your life insurance needs. You can use a life insurance calculator like this to help you answer that. Second, determine how long you need that coverage for? Third, determine what your budget is from a cash flow perspective.
Then determine what type of policy might be most appropriate for you given your needs and personal financial situation. For most individuals, term life insurance will serve their needs for protection during their most vulnerable years at the most economical cost. For others (admittedly a smaller percentage), they might need something a little more than what term coverage can offer especially if they are maxing out retirement contributions, have high income, are in a high tax bracket, and/or want to make sure a minimum death benefit will always exist for their beneficiaries. Whichever camp you think you are in, consider speaking with a qualified and unbiased financial planner such as a CFP™ professional or a fee-only life insurance advisor for personalized guidance. If a permanent life insurance policy makes sense for you, rest assured that it just got a little easier for you to access these policies and to put even more money away in a tax efficient manner while protecting your beneficiaries for the rest of your life!