At the beginning of the year, the tax law surrounding life insurance policies was shifted. Now, as we approach 2022, all life insurance companies will be shifting new policies to reflect these changes to IRS rule 7702. We’re here to break down what’s happening, and how it will affect the business you write.
MEC Limits and Section 7702
7702 refers to the section of the IRS tax codes enacted in 1984, that outlines how life insurance should be treated from a tax standpoint. The most important point of the code to note is the MEC limit. This governs how much someone can fund a life insurance policy before it loses its tax advantages and becomes a Modified Endowment Contract.
Previously, the MEC limit was something called the 7-pay test. If someone could fully fund a policy in seven payments or less, it would be considered a MEC. Now, those limits are shifting.
So How is IRS Rule 7702 Changing?
Another major shift of Section 7702 is what the minimum guaranteed cash value can be for determining maximum cash values. Previously, the minimum rate was 4%. This is because in the current low interest rate environment we’re in, a high minimum may make it difficult for insurance companies to sustain cash value accumulations.
While the minimum has been lowered to 2%, this isn’t necessarily a bad thing. In fact, if you consider that it allows companies to continue to make conservative financial decisions, it actually bodes well for the longevity of the life insurance industry.
How Insurance Companies Make Money
Life insurance companies make conservative investments in bonds. This means that if bond yields are low due to a low interest rate environment, profits are also likely to be lower. When companies must still pay a minimum of 4%, this is unsustainable in the long run. And we don’t know how long we’ll be in this low interest rate environment.
Lowering the minimum allows insurance companies to continue conservative investments, while also paying dividends at a sustainable rate. This can go a long way to keeping companies from de-mutualizing, like Ohio National earlier this year.
This is a push that insurance companies sought to be able to provide the best insurance products possible. We’re confident in this decision because it will give insurance companies the flexibility to navigate the current economy.
Additionally, just because there’s a new minimum interest rate, does not prohibit insurance companies from paying more. In fact, being conservative with dividends now while rates are low, has the potential to improve dividend projections in the future.
Is There a Maximum Interest Rate?
For the year 2022, life insurance companies have the flexibility to determine a guaranteed interest rate between 2% and 3.75%. You’ll see these changes reflected in new policy illustrations by January if you aren’t already seeing them. This specified range of interest rates may adjust in the coming years.
In-force policies will not be affected.
How Will this Rate Affect New Policies?
It’s likely that each company will approach new product design differently. This means for concrete answers, you’ll work with your carriers to learn more about new whole life insurance products. However, there are some changes you are likely to see across the board, in some capacity.
- Higher premiums for a given death benefit
- More cash value for a given death benefit
- Higher MEC limits for a given death benefit
Essentially, this confirms what we’ve known to be true for some time: premium builds cash value. When your client pays their premium, it’s as if they’re writing a check to a savings account. While premiums may be higher for a given death benefit, clients will also see this reflected in their cash value build-up. This can be great for clients who are interested in using their cash value while they’re living.
A higher MEC limit also means that clients can put more money into PUAs without losing tax advantages.
The downside is that if you have clients who want to focus more on death benefit, they may have to rely more on term or convertible term insurance to reach Human Life Value.
7702 and Life Insurance: Same Great Guarantees
All in all, we’re pleased with the outcomes of the 7702 update so far and think that things will work out for the better. We’ll continue to monitor what’s happening and bring you what we know. At the end of the day, just know that the whole life insurance product continues to be a solid, certain product with guaranteed cash value growth, a guaranteed death benefit, and guaranteed level premiums. This is really the strength of the whole life product.
For more insights on whole life insurance and other financial products and strategies, we encourage you to attend Truth Training. In 3 days, you’ll learn how to use the Truth Concepts calculator suite, and share your knowledge with clients.