Tax on ROP?

[Robert Barney]

Here are the footnotes we produce on a software utility we call Return of Premium Analysis:

When examining a Return of Premium feature there are other issues which you need to explore. For example:​

1. If you die before the end of the level payment period your beneficiary will receive the death benefit, but what happens to the additional money that you were paying for the Return of Premium feature? ** Many policies pay nothing additional on death despite the fact that you paid extra money for the feature. If that is the case you would have been further ahead with the basic policy.​

2. If you quit the policy before the end of the level period, there may be NO return of premium whatsoever. Some policies offer interim Return of Premium values; others do not. **​

3. Taxation. Part or all of the amount of your Return of Premium MAY BE tax-free. If so, in order to replicate a tax-free result outside the Return of Premium policy you would need an "after-tax" rate of return of 4.98%. To achieve this, you would need an even higher "before-tax" rate of return. The amount of that return would be based upon your personal income tax rate and the type of outside investment selected.​

** It is highly recommended that you obtain a company generated Return of Premium policy illustration in order to confirm the contractual values that are in your Return of Premium policy.​

I've attached a PDF file sample of the analysis, so you can see what it looks like.

I should note that the 4.98 percent reference in item 3 is based upon the actual calculation in the sample PDF file I attached. I have seen results lower than 4.98%, and I have seen higher results. It depends on the two specific products you are actually comparing.

 

[table83]

Just keep the dang policy. Don't worry about the inflation. It's not worried about you. When you make more money later buy some more then. BTW congratulations.

Thanks so much! I'm keeping the policy.

 

[briko3]

Taking off the waiver of premium rider (which I assume isn't included in the ROP?) you have about a 4.5% tax free return. Not bad. Just make sure you keep the policy for 30 years. Congrats on the baby..my wife is expecting as well

 

[vivamita]

Its not taxable. Its after tax money.

 

[WinoBlues]

Thanks so much! I'm keeping the policy.

If you like the Company, trust the agent and are comfortable with the amount and premium, keeping the policy a good move.

However, being an agent I have to throw my two cents in. My recommendation would have been: Cincinnati Life $600,000.00 30 year ROP w/WP and $20,000 of child rider and of course the terminal illness rider. @ $68.91 per month. Pays if you live, die or something in between. The disability wavier and the Terminal illness rider could mean the difference of having the coverage after a long illness/disability or dying with out. The child rider is important of course if the child were to die prematurely. But maybe as important is the insurability and convertibility offered by the rider. ( just converted a severely disabled 25 year old, std) On the ROP, At age 55 cash equals $24,808 ~or~ even better (my opinion only) a paid up insurance policy of $76,200. The other option would have been leave you at $500,000. and put $100,000 on Mom with the same riders.

Congratulations on your pending dadhood.

 

[bryan36]

Its not taxable. Its after tax money.

Just because it is after-tax money that pays the premium does not mean that the ROP will be tax-free. to my knowledge there is also no definitive case law in this area.

The part that everyone assumes makes this tax-free is that the dollars that pay the ROP premium are post-tax dollars. But don't forget that mutual fund investments you buy with post-tax dollars that create gains are also post-tax dollars. But when you make money on a mutual fund and cash it in, you sure as heck owe some tax on that.

With a ROP policy, there are TWO components: the pure, levelized COI and the extra that you pay on top of that. Assume a 20-year non-ROP policy costs $2100 and a 20-year ROP policy costs $4,000. If you live to the end of the 20-year term period and receive $80,000 back, the IRS could argue that you owe taxes on the difference between $4,000 and $2,100. If you don't believe me, then check out the article here.

Since these products are so new, there probably haven't been many -- or possibly even any -- "claims" paid to someone who has outlived the term period. Until either the Service renders an opinion prior to that point OR until the next 5-10 years elapses and THEN the Service renders an opinion, to say definitively that it is tax-free is setting yourself up for a potential disaster in my opinion.

It's possible that nothing may ever come of this. But there are plenty of attorneys working at the IRS who are former insurance company attorneys. It may just be possible that this may throw a huge wrinkle into these policies 5, 10, 15, 20 years from now.



go to peter katt's website (it won't allow me to do it here) and look under "Life Insurance Perspectives" Volume 7 Number 5.

 

[table83]

With a ROP policy, there are TWO components: the pure, levelized COI and the extra that you pay on top of that. Assume a 20-year non-ROP policy costs $2100 and a 20-year ROP policy costs $4,000. If you live to the end of the 20-year term period and receive $80,000 back, the IRS could argue that you owe taxes on the difference between $4,000 and $2,100. If you don't believe me, then check out the article here.

Since these products are so new, there probably haven't been many -- or possibly even any -- "claims" paid to someone who has outlived the term period. Until either the Service renders an opinion prior to that point OR until the next 5-10 years elapses and THEN the Service renders an opinion, to say definitively that it is tax-free is setting yourself up for a potential disaster in my opinion.

This is the huge dilema about this type of insurance. Well lets hear it from the forum. Has anyone at all had someone collect on a ROP policy? Was it taxed?

Clearly there must be an answer, that was offered when the option was first offered. I do not believe that people just havn't collected on the type of policy so there is no answer yet. This probably is not a case law type of question honestly. It will fall more under the tax laws.

If no one has an answer I will call the IRS myself and find out!

I would think that the answer would be no, but I'm not sure. Please let me know because it changes everything in my excel model.
- - - - - - - - - - - - - - - - - -

If you like the Company, trust the agent and are comfortable with the amount and premium, keeping the policy a good move.

However, being an agent I have to throw my two cents in. My recommendation would have been: Cincinnati Life $600,000.00 30 year ROP w/WP and $20,000 of child rider and of course the terminal illness rider. @ $68.91 per month. Pays if you live, die or something in between. The disability wavier and the Terminal illness rider could mean the difference of having the coverage after a long illness/disability or dying with out. The child rider is important of course if the child were to die prematurely. But maybe as important is the insurability and convertibility offered by the rider. ( just converted a severely disabled 25 year old, std) On the ROP, At age 55 cash equals $24,808 ~or~ even better (my opinion only) a paid up insurance policy of $76,200. The other option would have been leave you at $500,000. and put $100,000 on Mom with the same riders.

Congratulations on your pending dadhood.

Thank you for your reply. This is exactly the type of answer that I was looking for. What do you mean, "Pays if you live, die or something in between"? I honeslty expect to live a very long life, and never use my insurance.

Also if this pays if I live doesn't that put it into the MEC category and automatically make it taxable, and therfore not really as effecient as what I have?

I would love a paid up insurance, but that is really out of the question at this point in my life because a house any my retirement will come first.

Also is there a good forum about the importance of ratings.
The reason I went with state farm in the first place was not because it was the best priced, but because our economy is shady and they have the best rates for such good ratings. I am worried about switching to something like Cincinnati Life who doesn't have as good of ratings.

This forum has been great! Thanks for all the imput from everyone.

 

[atlantainsguy]

ROP is not taxable at the end of the term period for the same reason par WL dividends are not taxable -- after-tax money is used to pay the premium.

When before-tax money is used such as an IRA or 401(k), then it's taxable at distribution.

atlantainsguy

 

[WinoBlues]

"Pays if you live, die or something in between"? = Insurance guy speak. In this I mean if you live it will pay/return to you $24,808. at the end of thirty years. If you die they will pay your beneficiary $600,000.00 . Something in between? = If you are diagnosed to be terminally ill they will pay/accelerate you a portion (50% to max of $250,000) of the death benefit. And/also if you become disabiled for 6 months or more, the Company will waive the monthly premium till you go back to work.

"I honeslty expect to live a very long life, and never use my insurance."
The odds are in your favor. If you win and live past the 30 yrs. do you expect to want any coverage, for your wife, kids, grand kids, or final expenses? In 30 yrs, who knows?

"I would love a paid up insurance, but that is really out of the question at this point in my life because a house any my retirement will come first."
In this case, the paid up reduced policy of $76,200.00 is in lieu of the ROP at the end of 30yrs.

"I am worried about switching to something like Cincinnati Life who doesn't have as good of ratings."
Another reason for you to keep State Farm. The extra cost and lower coverage is out weighed by the differance in ratings and your piece of mind. Rememmber, this plan cost Less than the State Farm policy. BTW, my wife has the 20yr version of this Cincinnati plan. Our current plan is for her to live past the 20 yrs, take the reduced paid up policy till she kicks.

One more thought, go back to your State Farm guy and have him add the Waiver(must have) and the child rider. It is all about the what ifs that do not fit on an excel spread sheet.

Alot of people spend more time researching a new Plasma TV or cable package than their Life Insurance.

 

[Robert Barney]

But if the insured/owner, while alive, withdraws more cash than the premiums they paid in, isn't that excess over premiums taxable?