What are the options to avoid a MEC after issue

[SParker]

Hi All

What are the options for the policyholder to avoid a MEC once a policy has been issued? Especially for Penn's WL products if you are familiar.

Can the policyholder purchase term upon notification that the policy will soon become a MEC?

Will the insurance company refund some of the premiums in order to avoid a MEC situation for the policyholder?

Or just have the policyholder exercise a RPU?

What do you advise your clients do when his policy is at risk of becoming a MEC?

Thanks

 

[Allen Trent]

Hi All

What are the options for the policyholder to avoid a MEC once a policy has been issued? Especially for Penn's WL products if you are familiar.

Can the policyholder purchase term upon notification that the policy will soon become a MEC? Unlikely that you can modify an already existing policy to add more coverage such as term to the already active policy as that will likely be consider a material change by the IRS tests. even it is permitted, some policy contracts don't allow changes except for the anniversary date of the policy. there are new regulations effective 1/1/2020 which may prohibit any policies issued prior to 1/1/2020 from having various changes made to existing policies. contact Penn & ask them what will happen to keep a MEC

Will the insurance company refund some of the premiums in order to avoid a MEC situation for the policyholder? this is the most common. Carrier usually notifies client they are violating one or several of the IRS premiums tests & tell the client premiums can be refunded to avoid violation of the guideline premiums

Or just have the policyholder exercise a RPU? that is not necessarily a solution for avoiding a MEC. electing RPU can actually cause a policy to MEC. Because you are reducing the face of the policy when you elect RPU, you can actually have a policy violate premium guidelines if they have not even previously violated the premium guidelines. if say a $1M policy was bought & max IRS premiums paid based on $1m policy & then a policy elects RPU say for a $400k, there may have been way too much premium paid into a $400k RPU policy. this is a very, very rare situation & not something that can be figured out in advance.

Also, many times when you elect RPU, you could make the cash in the policy less liquid. if my policy after 10 years has say $50k in the base policy & $150k in PUAR funds, I would have $150k of more liquid money available to be pulled out because it is PUAR funds. If I elect RPU, many contracts state that RPU utilizes all the net cash value (both the base & PUAR cash values) to elect RPU. this would mean all $200k net cash value elects a RPU policy & all $200k is trapped in the based policy only accessible by loans. the only PUAR values after that would be whatever grows from that date forward when dividends buy more PUAR values after electing RPU

What do you advise your clients do when his policy is at risk of becoming a MEC? 1. - if they want the funds to be accessible & used for supplemental retirement funding:
1- I suggest to have the excess refunded to keep it from being a MEC

2. if the client is older & doesn't need the cash value & the policy is for death benefit, I would say they could leave the extra money in the policy & permit it to be MEC.

Thanks

 

[SParker]

@Allen Trent Thanks Allen, appreciate the advice as always...very helpful

So it's not the end of the world. If the policyholder chooses to have the excess premiums refunded, he can still keep the policy in force, it's just that the DB and CV will be smaller, correct?

In such a scenario, once the excess prem has been refunded for a particular year due to risk of becoming MEC, then all subsequent premiums will be reduced accordingly? Or do subsequent premiums revert to what it used to be according to the original illustration at issue?

 

[Allen Trent]

just that the DB and CV will be smaller, correct?

Face amount of the policy won't change & even the extra face bought from PUAR won't be "smaller than it was", it just won't be allowed to buy an even larger extra amount without letting it MEC. But the IR premium room should allow more than enough unless you are looking at young children policies where the IRS room doesn't permit a great deal of extra premium. A UL/IUL can sometimes fit more money in for those cases because the increasing death benefit option can open more IRS premium room.

once the excess prem has been refunded for a particular year due to risk of becoming MEC, then all subsequent premiums will be reduced accordingly? Or do subsequent premiums revert to what it used to be according to the original

Sometimes violating premium room can simply be paying premium too soon before the anniversary date. Example I paid my premium 3 days after anniversary in year 5, but paid 3 weeks early 49 weeks later still in year 5. Once any money is refunded, it likely has no problem with the IRS premium calculation. I think you are asking if the carrier will allow the max to go into PUAR again if not put in before. Each carrier has rules on minimum & maximums you can put in PUAR to keep people from putting none in & then want to do the max years later when they find out they are insurable. You will have to ask them if you are allowed to increase a PUAR deposit in the future over & above the amount you did to the prior year. Many only let you put in again what you already did. Many have a baseline that says you can always put 1x the base policy prem in PUAR as long as you have not failed to put 0 in PUAR for say 5 straight years. Essentially they have a max & min & also an end point the rider would end for failure to utilize it for a period of time

 

[Lloyds of Lubbock]

If a client sends excess premium(PUA) to a carrier,
The carrier will send a letter to the client and agent stating the money will cause a MEC.
The client has 30-60 day (not sure) to take back the excess.
Face amount reductions or RPU in the first seven years are tricky.
If you run a policy status, it will generally tell you:
1. How much money you can contribute before becoming a MEC.
2. The amount you can reduce the face amount so as not to create a MEC.
Another problem is if you overfund a policy, in the first 15 years a substantial withdrawal can create a MEC.
This is easily solveable by telling your clients tha max withdrawal they can take out each year.
If you do create MEC and you have a rider such as an LTC rider, the premium attributed to that rider is a distribution and is taxable.
If you do create a MEC and you think I will just go to a bank a collateralize a loan: The annual cash value growth on a collateralized MEC is taxable.
This does not mean creating a MEC is always bad, you just should know what you are getting into.

 

[Allen Trent]

If a client sends excess premium(PUA) to a carrier,
The carrier will send a letter to the client and agent stating the money will cause a MEC.
The client has 30-60 day (not sure) to take back the excess.
Face amount reductions or RPU in the first seven years are tricky.
If you run a policy status, it will generally tell you:
1. How much money you can contribute before becoming a MEC.
2. The amount you can reduce the face amount so as not to create a MEC.
Another problem is if you overfund a policy, in the first 15 years a substantial withdrawal can create a MEC.
This is easily solveable by telling your clients tha max withdrawal they can take out each year.
If you do create MEC and you have a rider such as an LTC rider, the premium attributed to that rider is a distribution and is taxable.
If you do create a MEC and you think I will just go to a bank a collateralize a loan: The annual cash value growth on a collateralized MEC is taxable.
This does not mean creating a MEC is always bad, you just should know what you are getting into.

Great stuff. Few, if any, agents realize that using a life policy as collateral is a taxable situation when the policy is a MEC.

 

[Allen Trent]

If you do create MEC and you have a rider such as an LTC rider, the premium attributed to that rider is a distribution and is taxable.

Is that always true? For instance, if you accelerate the death benefit for chronic illness or terminal illness it was always my understanding that it is it tax-free because you are merely processing a death claim prior to death.

or maybe you are speaking in terms of the annual premiums paid into those riders not so much at the time of claim. I always understood that only the base counts insured coveragea cost counts as premium/cost basis into a contract. The other riders such as spousal riders and child riders and extra riders do not count as investment into the contract for calculation of cost basis and gain, "ie adjusted cost basis"

 

[Lloyds of Lubbock]

I should be more specific.
I am doing a rollover of a policy that is a MEC.
The new policy is also a MEC and it includes a premium paying LTC rider.
It is a 10 pay and I am offsetting the premium years 2-10.
The dividends paying for the rider are considered a distribution.
Its an odd situation, but if you create mec and offset your premium any premium for applicable riders that are offset will be considered a distribution.
When I was running an illustration, I could not understand why I had outlay when I offset in year 1.
The outlay was the tax. Sorry for confusion

 

[Allen Trent]

I should be more specific.
I am doing a rollover of a policy that is a MEC.
The new policy is also a MEC and it includes a premium paying LTC rider.
It is a 10 pay and I am offsetting the premium years 2-10.
The dividends paying for the rider are considered a distribution.
Its an odd situation, but if you create mec and offset your premium any premium for applicable riders that are offset will be considered a distribution.
When I was running an illustration, I could not understand why I had outlay when I offset in year 1.
The outlay was the tax. Sorry for confusion

excellent--that makes. basically client is taking distributions to cover the costs of the added benefits.

good stuff