What is the face value of a life insurance policy
A—Definition Of "Life Insurance" For Income Tax Purposes
Code §7702 defines life insurance for federal tax purposes. This definition applies to all policies issued after December 31, 1984. To qualify as life insurance, a policy must meet the definition of life insurance under applicable state (or foreign) law, and must also meet one of two "tax tests:" a cash value accumulation test, or a guideline premium/cash value corridor test. It is not sufficient to meet the test once; it must be met throughout the life of the contract. If a policy fails to meet the state-law-plus-one tax test, it will be separated into its pure insurance and savings portions, and the income earned on the savings portion will be taxable to the policy owner each year, much like a savings account or mutual fund.
A certain class of life insurance contracts are also considered modified endowment contracts. A modified endowment contract is defined as any contract that qualifies as life insurance under Code §7702 but fails to meet a "seven-pay test." For tax purposes, amounts received under a modified endowment contract are treated first as income and then as recovered basis. The rules applicable to modified endowment contracts are discussed below in more detail.
Cash Value Accumulation Test
Under the Cash Value Accumulation test, the cash surrender value of a life insurance policy cannot exceed, at any time, the net single premium that would be required at such time to fund the future benefits (death benefits, endowment benefits, and charges for certain additional benefits, such as disability waiver) of the policy [I.R.C. §7702(b)(1)]. The cash surrender value, for this purpose, is determined without reference to any policy loan, surrender charge, or reasonable termination benefits.
The net single premium is determined by using: 1) an interest rate of 4 percent, or the rate guaranteed in the policy, nonforfeiture values if higher, 2) the mortality charges specified in the contract, if any, and 3) any other charges specified in the contract. If the contract is silent on mortality charges, the charges assumed in computing statutory reserves must be used.
Guideline Premium/Cash Value Corridor Test
The Guideline Premium/Cash Value Corridor test is really two tests combined into one overall test, both halves of which must be satisfied. The "guideline premium" half is met if the aggregate premiums paid to date under the contract do not, at any time, exceed the greater of the "guideline single premium" or the sum of the "guideline level premiums." The guideline single premium is that one-time premium which would fund the future benefits of the contract. Mortality charges are determined in the same manner described earlier, but the interest rate to be used is the greater of 6 percent annually or the rate(s) guaranteed at the inception of the contract.
The "guideline level premium" is that level annual amount which would fund the future benefits of the policy over a period lasting at least until the insured`s 95th birthday. Charges for ancillary benefits should be leveled over the period provided. Mortality charges are determined the same as above; but the interest rate is the higher of 4%percent or the policy guaranteed rate(s).
A policy will satisfy the cash value corridor half of the test if the death benefit available under the policy is at all times no less than the applicable percentage of the cash surrender value in the following table [I.R.C.§7702(d)].
Insured`s ApplicableSource: www.logos4me.com