After an insurance policy’s 10th year, it must pass three tests to remain classified for protection, not investment, known collectively as the Exempt Test.
Here’s how you can ensure your clients pass the test.
Pre, and annual test
The law says an insurance company must test the policy when it’s issued, and then on every policy anniversary. It must not have an excess amount (based on the maximum tax accrual rules, or MTAR, limits) of contributions growing tax-free.
Insurers are contractually obliged to ensure a policy retains its tax-exempt status. To do that, they’re allowed to increase the face amount of the policy by as much as 8% each year to shelter the additional amount of cash—but will charge additional premiums.
If that still doesn’t do the trick, the insurer must refund excess investment contributions to the policy owner.
And if, when the insurer performs the test in the following year, the investment portion amount falls below the threshold, the insurer can reduce coverage. Your client’s premiums will fall accordingly.
You can indicate on the contract that you want this to happen automatically. But if your client is uninsurable past a certain threshold, allow increases (but not decreases) in the policy’s coverage—this can give her an 8% bump in coverage that she needs.
On the policy’s 10th anniversary, and every third year after, the insurer must perform an additional test. It’s called the anti-dump-in or 250% test, and it’s intended to restrict contributions larger than 250% of the policy’s accumulated value after the seventh policy anniversary.
This keeps clients from putting inordinate amounts of money into their policies to grow tax-free, which could happen if a client wins the lottery or experiences some other windfall.
Keep insurance returns tax-free >