IRS Rules on Life & Health Rider

Copyright 2009 National Underwriters Company All Rights Reserved Tax Facts News

March 2009

HEALTH INSURANCE, LIFE INSURANCE; Pg. 6

752 words

IRS Rules on Life & Health Rider

Recently the Service privately ruled on the tax treatment of an accelerated life and health rider under Code Section 104(a)(3).

The contracts under review were individual, non-participating, flexible premium adjustable life insurance policies. The rider would allow the policy owner to make an election to accelerate the receipt of all or a portion of the death benefit under the contract to which the rider was attached if the insured person ever became critically ill. The rider would pay a benefit to the owner during the insured's lifetime if the insured were ever diagnosed by a physician as having a qualifying covered condition (with the covered conditions being defined in the rider). Payment of the rider benefit would reduce the death benefit payable under the contract. The contract would terminate if the death benefit payable were ever reduced to zero upon payment of the covered condition benefit. The rider would not provide any cash value or loan value. The insurance company represented that the contract and the rider would be purchased with after-tax monies (i.e., no premiums would be deductible by the owner or attributable to contributions by an employer of an owner that would not be includible in the gross income of the owner). The insurance company also represented that the rider would not be a qualified additional benefit under the Code.

The insurance company requested a ruling whether the rider benefit would be fully excludable from the recipient's gross income under Code Section 104(a)(3), which provides that gross income generally does not include amounts received through accident or health insurance for personal injuries or sickness other than amounts received by an employee to the extent that such amounts are (1) attributable to contributions by the employer which were not included in the gross income of the employee, or (2) paid by the employer).

Initially, the Service noted that for a policy to qualify as a life insurance contract for federal income tax purposes, it must be a life insurance contract under the applicable law and must satisfy either (1) the cash value accumulation test, or (2) the guideline premium test. To meet the cash value accumulation test, the "cash surrender value" of a contract at any time cannot, by the contract's own terms, be capable of exceeding the "net single premium" that would have to be paid at that time for the "future benefits" under the contract. The "net single premium" must be computed using: (1) an interest rate that is the greater of an annual effective rate of 4% or the rate or rates "guaranteed" on issuance of the contract; (2) reasonable mortality charges that do not exceed the mortality charges specified in the prevailing Commissioners' standard tables; and (3) for qualified additional benefits, any reasonable charges (other than mortality charges) for such benefits to the extent that those charges are reasonably expected to be actually paid. "Cash surrender value" is defined as the "cash value" (i.e., the amount to which a policyholder is entitled upon surrender of the contract or against which the policyholder can borrow) of a contract without regard to any surrender charge, policy loan, or reasonable termination dividend. The computational rules for determining of the amount of "future benefits" taken into account in calculating the "net single premium" are as follows:

(A) the death benefit (and any qualified additional benefit) must be deemed not to increase,

(B) the maturity date, including the date on which any benefit described in (C), below, is payable, must be deemed to be no earlier than the day on which the insured attains age 95, and no later than the day on which the insured attains age 100,

(C) the death benefits must be deemed to be provided until the maturity date determined taking into account (B), above, and

(D) the amount of any endowment benefit (or sum of endowment benefits), including any cash surrender value on the maturity date, determined by taking into account (B), above, must be deemed not to exceed the least amount payable as a death benefit at any time under the contract.

Based on the taxpayer's representations and the legal authority cited above, the Service concluded that: (1) the rider would be treated as accident or health insurance; and (2) the benefits received under the rider would be excludable from the recipient's gross income under Code Section 104(a)(3) as long as the benefits were attributable to the recipient's after-tax contributions. SEK

May 19, 2009