Life Insurance is a popular investment vehicle for Credit Unions looking to offset employee benefit expenses or to provide retirement benefits to key leaders. 2021 has brought a monumental and fundamental change to life insurance, creating a substantial opportunity for Credit Unions in particular.
As we rang in the new year the COVID relief bill, the Consolidated Appropriations Act of 2021 (HR 133) was signed into law. To the surprise of many, buried in that Act was a game-changing concession on IRS Section 7702, permitting insurance companies to reduce their minimum interest rate from 4% to 2% and allowing for dynamic adjustments thereafter to align with general interest rates. This fundamental assumption allows insurance carriers to build more efficient products, reducing the required face amount (death benefit) for every dollar of premium paid in.
Here’s a quick history lesson to help you understand:
Prior to 1984, life insurance enjoyed tax-free death benefits and tax-free gains regardless of the extent of the policy’s cash value growth. As a result, many people used life insurance as a tax shelter for investments, rather than for death benefit protection.
When Section 7702 was signed into law it drew clear lines between life insurance and investments, and further stipulated that cash value gains would be taxed as income upon withdrawal from the contract. Ultimately the definition of life insurance became subject to certain “tests” which differentiate real-life insurance policies from investment vehicles. The most recent IRS Section 7702 rule change passed in December 2020 affects these “tests” for satisfying the definition of life insurance, and narrows the required “corridor” between cash value growth and death benefit.
So how does it work?
Under the new 7702 rule, a dollar of premium now potentially buys less insurance coverage at policy issue, and lowers the insurance charges in the life insurance contract. This structure makes the life insurance contract more efficient and it provides a potential for higher cash value accumulation and death benefits.
For example, suppose you drive a car with a 10 gallon tank traveling an average of 20 miles per gallon (MPG). With a full tank, you could drive 200 miles. Now, (because of these 7702 changes) assume the engines in new cars have become more efficient. Given these changes, your potential MPG average is now 25 miles per gallon. With a 10 gallon tank, you could drive 250 miles.
Section 7702 changes will impact new life insurance policies similarly. These changes will reduce the traditional charges and cost structures within the life insurance contract and will allow for improved accumulation potential. As a result, life insurance just became a more attractive wealth creation vehicle, especially when accumulating assets for retirement.
What does this mean for your Credit Union?
Credit Unions may consider evaluating existing insurance contracts in light of these changes to section 7702, as well as seize opportunities for both investments and the provision of employee retirement benefits.
We Can Help
TriscendNP is dedicated to offering objective guidance and unrivaled plan administration services so that your life insurance policies and related plans stay on track and your objectives are achieved. Let us guide you and your organization through a disciplined decision-making process. Contact us for a plan analysis today!