What Is Life Insurance?
We've received many questions from our HP clients over the years regarding life insurance. Life insurance, sometimes called liquidity insurance or a clean-up fund, is a contract under which one party (the insured and/or owner) makes payments (premiums) to another party (the insurer) for a specified term. In return, the insurer pays the insured's estate or a third party, called the beneficiary, an agreed amount in the event of death or some other occurrence. Life insurance is used for many estate planning purposes, but its most valuable purpose is to provide estate liquidity.
Estate liquidity refers to the ability of your estate to pay potential taxes and other costs that arise after your death using cash and cash alternatives. If your property is mostly nonliquid (generally consists of real estate and business interests, for example), your estate may be forced to sell assets to meet its obligations as they become due. This may result in an economic loss and/or the need for your family to sell assets that you intended for them to keep.
Therefore, planning for estate liquidity should be one of your most important estate planning objectives. With life insurance, if you have correctly forecasted the liquidity needs of your estate, the necessary cash will be available precisely when it is needed. The four big questions that you should consider regarding life insurance are: (1) How much do you need? (2) What type of policy is right for you? (3) Who should be the owner and the beneficiaries? (4) Can you meet your other goals for your insurance policy while keeping the proceeds out of your estate?
Is It Life Insurance?
The Internal Revenue Code defines life insurance proceeds as:
- Death benefits paid under regular life insurance contracts
- Death benefits paid under an endowment policy where death occurs prior to maturity of the contract
- Death proceeds of group life
- Proceeds of National Service or U.S. Government Life Insurance
- Paid-up additions and term additions purchased with dividends paid on a policy
- Proceeds payable under a double indemnity provision
- Proceeds paid under an accident policy or accident and health policy
What Is The Role of Life Insurance In Providing Estate Liquidity?
You Complete Arrangements Before Death
You, as the owner or the insured, do all the time-consuming work ahead of time. You contact your insurance agent, make the decisions, fill out the paperwork, undergo the medical exam (if necessary), and pay the premiums in advance of your death. There will not be too much red tape for your family to deal with when you die, which is going to be traumatic enough for them.
Proceeds Available Immediately Upon Death (Or Soon Thereafter)
The proceeds of an insurance policy are paid immediately or soon after the insured dies. Probate, which can take months, is bypassed for the insurance proceeds. This way, estate bills get paid when due, and your family gets the money it needs for day-to-day living expenses. For business owners, it means that there are funds available to keep the business operations continuing.
How Much Do You Need?
When thinking about life insurance to meet estate liquidity needs, the first thing to do we suggest our HP clients do is compute how much life insurance they should buy. You should consider your estate's immediate cash needs at death (to pay any bills you owe and costs incurred because of your death), as well as your family's long-range need for funds to pay daily living expenses and special obligations.
Group or Individual?
Group Life Is an Employment Benefit
There has been growth recently in group life insurance, which is a benefit provided by an employer to an employee. Generally, the premium payer is the business, although some have the employee paying a portion. The beneficiary can be anyone designated by the employee. The main objective is to provide income to the employee's family. If HP offers this benefit, you need to understand the tax ramifications before you decide to go this route or purchase an individual policy instead.
Proceeds May Be Includable In Employee's Estate for Estate Tax Purposes
For estate tax purposes, proceeds of a group life policy may be includable in your estate, depending on the year in which you die. You can remove the proceeds from your estate with an absolute assignment of all 'incidents of ownership' in the policy, provided that you do not directly or indirectly name your estate or personal representative as beneficiary of the policy. However, we'd like our HP clients to be aware that this assignment must occur at least three years before your death to be successful in removing the proceeds from your estate.
What Type of Insurance Policy Should You Buy?
Life Insurance That Meets Your Goals
There are many types of life insurance policies so it's important that these HP employees are prepared to invest some time to understand how they work or seek a life insurance professional for help. However, before you get bogged down in the details, it's good to have some sense of the big picture. Most permanent policies focus on the cash surrender value and how it increases at various performance rates. For our HP clients who are primarily interested in death protection and less interested in investment performance, you may be better off with a term policy or one with minimal investment features.
Life Insurance That Fits
The particular type of policy you choose depends on many things--how large your estate is, what your current financial situation is, what your current age and physical condition are, and what the needs of your survivors will be. What follows is a very brief discussion of some of the policy types available.
Term
Term (or pure) life insurance is suitable when either: (1) your need for protection is purely temporary, or (2) your need for protection is permanent, but you cannot afford permanent insurance premiums. Term life provides protection for a specified period. At the end of that period, coverage terminates and the policy has no value. However, term life can span the gap between your need for permanent insurance and your financial ability to meet that need.
There are five types of term insurance:
- Annual renewable
- Convertible
- Decreasing
- Level
- Re-entry
Whole Life
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Whole life (or permanent) insurance offers lifetime coverage. The major advantage of whole life over term life is that whole life is a combination savings account and insurance. Principal types of whole life include the following:
- Ordinary level-- First, we're going to explain the ordinary level to our HP clients. Ordinary level whole life is a policy with level premiums, meaning that the amount you pay will not increase. Your premium payment amount is calculated on the assumption that premiums will be paid over your entire life. In many cases, however, policy dividends can be used to pay up the premiums in a shorter period of time. Ordinary level whole life is also referred to as continuous premium whole life.
- Limited pay-- Next, we'd like our HP clients to understand Limited-pay. Limited-pay whole life insurance is a special form of whole life insurance. As such, the policy contains cash values that grow tax-deferred and a certain death benefit. This type of whole-life policy has all the benefits of any other whole life insurance policy, with a shorter time frame for making premium payments. The policy is identified by either the number of annual payments, (e.g., 7, 10, 20, or 30 annual payments) or the age at which it is paid up (at 60, 65, or 70).
- Single premium-- We'd now like to ensure that our clients from HP understand single premium policies. A single premium policy is a type of limited-pay policy that involves the one-time payment of a lump-sum premium, as the name implies. Since single premium whole life represents a substantial amount of money being expended all at once, and since it is computed on the basis that there will be no return on any part of it in the event of your early death, there is only a limited appeal for this type of protection.
Variations of Whole Life
Now that we've gone over the principal types of Whole Life policies, we'd like to also go over some variations with our clients from HP.
- Adjustable life-- The first variation we'd like our HP clients to understand is adjustable life. Adjustable life is a special whole-life policy with initial-level premiums. The policy provides the same guarantees of death benefits and cash values as does a traditional whole-life policy. What makes the adjustable life policy special is that, at specific intervals, the policy allows you to request upward or downward adjustments of premium, death benefit (face amount), or cash value. Increases in the death benefit above a certain percentage or amount usually require medical proof of insurability.
- Current assumption whole life-- Next, we'd like to discuss current assumption whole life with our clients from HP. Current assumption whole life is a variation of traditional whole life somewhere between adjustable life and universal life. A redetermination feature recasts the premium amount and death benefit in response to the most recent interval of experience or time frame. Current assumption whole life is appropriate for those who need the discipline of a fixed-premium design but want to participate, in part, in the positive investment returns beyond the policy's guaranteed interest rate.
Other Types
- Endowment life--An endowment life policy provides death benefits and cash values that increase with duration so that the policy's cash value equals the death benefit at maturity. It also allows the purchaser to specify the maturity date. Full survivorship benefit is payable at a specified time or age. It also provides a death benefit during the accumulation period that is equal to the target accumulation amount. There is no tax-free buildup of a flexible premium endowment policy's cash value so sales of this type are typically limited.
- Variable life--A variable life policy provides no guarantees of interest rate or minimum dollar value. The policyowner is permitted to select among a limited number of investment portfolio choices with death benefits varying as a function of investment performance. Variable life is not a short-term investment vehicle because sales load, mortality charges, and surrender charges significantly reduce gains in the early years.
Caution: We'd like our HP clients to be aware that variable life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company issuing the policy. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. These HP employees should read the prospectus and consider this information carefully before purchasing a variable life insurance policy.
- Universal life-- Universal life offers flexible premiums (such as additional premium payments, skipped premium payments, or below-target premiums). Aggregate payments must be adequate to cover the costs of maintaining the policy. The policyowner determines prefunding. The policyholder can make partial withdrawals from cash value without incurring indebtedness and also has a choice between a level death benefit and an increasing death benefit. With an increasing benefit, as cash value rises, so does the total death benefit. Payment is of both the stated face value and the cash value in return for higher premiums.
- Joint first to die--Joint first to die covers two or more individuals and pays a death benefit when the first death occurs. The policy may be either a term, universal, variable, or whole-life policy. Generally, joint first to die is used by business partners to cover the life of each partner. On the death of the first partner, the surviving partners receive funds with which to purchase the deceased partner's partnership interest.
- Joint second to die (or survivorship) -- Joint second to die or survivorship policies insure two or more lives under one contract.
The death benefit is paid at the second death. The policy may be either a term, universal, variable, or whole-life policy.
Who Should Be The Owner And Beneficiaries (Or, How Do You Keep The Proceeds Out of Your Estate For Federal Gift And Estate Tax Purposes)?
Funds Used For Taxes Do Not Reach Your Beneficiaries
Why is it important to understand the federal gift and estate tax ramifications of life insurance? Because funds used to pay taxes (your estate may also be subject to state death taxes) are funds that don't go to your beneficiaries. To get the most out of your dollar, it is often best to keep the proceeds from being subject to potential taxation.
Proceeds Are Generally Subject to Federal Gift and Estate Tax
Life insurance may be includable in your gross estate for federal gift and estate tax purposes if: (1) the proceeds are payable to or for the benefit of your estate, or (2) you possessed 'incidents of ownership' in the policy at the time of your death or at any time during the three years prior to your death, or (3) you transferred ownership of a policy within three years of your death, and (4) estate taxes are imposed in the year in which you die. In addition, the value of life insurance you own on another person's life at the time of your death may be includable in your gross estate for tax purposes.
Therefore, to avoid federal gift and estate tax, we suggest these HP clients do not:
- Make the proceeds payable to your estate
- Make the proceeds payable to your personal representative (executor)
- Own the policy or any 'incidents of ownership' in the policy
- Transfer an existing policy to a new owner within three years of your death (you may need a crystal ball for this one)
- Make the proceeds payable to a beneficiary to satisfy a debt
- Make the proceeds payable to a beneficiary under an agreement requiring the beneficiary to pay death taxes or other estate debts or expenses
- Make the proceeds payable to a beneficiary to pay alimony or support
Technical Note: We'd like our clients from HP to note that incidents of ownership is a legal term. It means any right to benefit economically or control the policy, such as: (1) retaining the right to change beneficiaries, (2) retaining the right to borrow on its cash value or pledge it for a loan, (3) retaining the right to surrender or cancel the policy, (4) retaining the right to assign the policy, (5) retaining the right to elect or revoke a settlement option, (6) retaining the right to get the policy back, or (7) retaining the right to convert group coverage to an individual policy.
Tip: In the case that the named beneficiary dies, it's important that these HP employees be sure to name another so that the proceeds do not go to your estate.
Tip: The owner of the policy can be either another individual or a trust.
Caution: It's important that these clients from HP to remember that your estate may also be subject to state death taxes.
What About Income Taxes?
Proceeds Are Exempt From Income Taxes
Generally, proceeds are exempt from income taxes and are excludable from the gross income of the beneficiary (with a few exceptions). Only interest paid on proceeds retained by the insurer after your death is taxable to the beneficiaries, unless there has been a transfer for value of the policy. Therefore, we'd like to remind these HP employees to not be too concerned about income taxes depleting the insurance funds.
Transfer-For-Value Rule
If you sell your life insurance policy to another owner, the proceeds will be taxable income to the new owner except to the extent of the new owner's investment in the contract. This rule does not apply to any of the following:
- Transfers to a partner
- Transfers to a partnership (in which you are a partner)
- Transfers to a corporation in which you are a shareholder or officer
- Transfers in which the basis is tacked
Technical Note: The tacked-basis exception means that the transferee takes a carryover basis from you. It commonly applies when property is a gift.
How does HP Inc. ensure that the pension plan benefits will remain stable and secure for employees in the future, and what measures are being implemented to mitigate financial volatility associated with these benefits? Employees of HP Inc. should be particularly aware of how the transition of their pension payments to Prudential will affect their financial security and what protections are in place to ensure that these payments are maintained without disruption.
HP Inc. ensures pension plan benefits remain stable and secure by transferring the payment obligations to Prudential, a highly-rated insurance company selected through a careful review by an Independent Fiduciary. This move is aimed at reducing financial volatility associated with HP's pension obligations while maintaining the same benefit amount for retirees. Prudential's established financial stability provides additional security to employees(HP Inc_November 1 2021_…).
What specific details can HP Inc. employees expect to learn in the Welcome Kit from Prudential, and how will these details help them understand their new payment system? HP Inc. pension participants will need to familiarize themselves with the information outlined in the Welcome Kit to make informed decisions regarding their pension benefits going forward.
The Welcome Kit from Prudential will provide HP Inc. employees with instructions to set up an online account, along with details on managing payments, tax withholdings, and other resources. This information will allow employees to familiarize themselves with Prudential’s system and ensure a seamless transition without disruptions(HP Inc_November 1 2021_…).
In what ways does the selection process for Prudential as the insurance provider reflect the commitment of HP Inc. to the well-being of its employees? Understanding the rationale behind this decision will give HP Inc. employees insights into the fiduciary responsibilities and governance processes that protect their retirement benefits.
The selection of Prudential reflects HP Inc.'s commitment to employee well-being, as it involved the Independent Fiduciary conducting an extensive review of insurance providers. Prudential was chosen based on its financial strength and ability to manage pension payments securely, showing HP's focus on protecting retirement benefits(HP Inc_November 1 2021_…).
How will the annuity payments from Prudential differ from the previous pension payments in terms of tax implications and reporting for HP Inc. employees? It is crucial for employees of HP Inc. to comprehend the tax treatment of their new annuity payments to avoid any potential pitfalls in their personal financial planning.
The annuity payments from Prudential will be taxed similarly to the previous pension payments, though employees will receive two separate 1099-R forms for 2021 (one from Fidelity and one from Prudential). For future years, only a single form will be issued. This ensures employees are aware of how to manage tax reporting(HP Inc_November 1 2021_…).
What resources are available to HP Inc. employees seeking assistance regarding their pension benefits, and how can they effectively utilize these resources to address their concerns? Knowing how to access support and guidance will empower HP Inc. employees to manage their retirement benefits proactively.
HP Inc. employees seeking assistance can access live customer support through Fidelity or contact Prudential directly after the transition. Additionally, the Welcome Kit will include important contact information for managing their benefits, making it easy for employees to address concerns(HP Inc_November 1 2021_…).
How can HP Inc. employees verify the financial health and stability of Prudential, and why is this factor important in the context of their pension benefits? Employees must ask how Prudential's financial standing influences their view of long-term pension security and what metrics or ratings they should consider.
HP Inc. employees can verify Prudential’s financial health by reviewing Prudential's annual financial reports, which are publicly available. Prudential’s strong financial ratings were a key factor in its selection, assuring employees of long-term pension security(HP Inc_November 1 2021_…).
What steps should HP Inc. employees take to update their personal information, such as banking details and tax withholding preferences, following the transition to Prudential? Understanding these processes will ensure a smooth continuation of benefits for HP Inc. employees as they adapt to the new system.
Employees do not need to re-submit their personal information to Prudential, as HP will securely transfer all necessary data, including banking and tax withholding preferences. This ensures the continuation of pension payments without the need for employee intervention(HP Inc_November 1 2021_…).
How does HP Inc. plan to address potential changes in the financial landscape that may affect pension benefits, and what role does the insurance contract with Prudential play in this context? HP Inc. employees should be informed about the company's strategic outlook and how it aims to safeguard pension assets against economic uncertainties.
HP Inc. plans to address potential financial changes through its contract with Prudential, which guarantees pension payments will remain the same. Prudential manages these risks as part of its core business, providing added security against economic volatility(HP Inc_November 1 2021_…).
In what circumstances might HP Inc. employees see changes in their net pension payments following the transition to Prudential, despite assurances that payment amounts will remain unchanged? This understanding will help employees manage their expectations regarding future payments and any adjustments they may need to make.
Employees might see changes in their net pension payments due to tax adjustments or changes in withholding instructions, but the gross payment amount will remain unchanged. Any garnishments or other deductions will continue as before, ensuring consistency in payment structure(HP Inc_November 1 2021_…).
How can HP Inc. employees contact the company directly to learn more about the pension transition process, and what channels are available for them to have their questions addressed? Clear communication lines are essential for HP Inc. employees to ensure they receive timely and relevant information regarding their pension situations.
HP Inc. employees can contact the company through the Fidelity support line or directly through Prudential for any questions about the pension transition. The Welcome Kit and other resources will provide contact details, ensuring employees have access to timely support(HP Inc_November 1 2021_…).