5 Alternatives to Current Assumption Whole Life (CAWL) Insurance

Knowing the advantages of any given policy is a vital step in making the right decision. However, disadvantages should also be addressed to help make the most educated decision. Below are 5 common alternatives to a Current Assumption Whole Life Policy.

  1. Traditional Participating Whole Life Insurance – CAWL has many of the features of traditional whole life. Also, many participating whole life policies now offered are essentially a type of current assumption policy, with current mortality and expense experience as well as interest reflected in the level of dividends paid.
  2. Universal Life – UL and CAWL are both “unbundled” current assumption policies. In most respects, CAWL can be described as a form of fixed premium universal life.
  3. Variable Life (VL) – If a VL policyowner selects a portfolio of investments within the policy that is similar to the general investment portfolio of the insurance company (mostly long-term bonds and mortgages), the policyowner can expect investment performance and cash value accumulations to be similar to that of CAWL.
  4. A combination of a level-premium deferred annuity and decreasing term insurance – Cash values accumulate in both annuities and CAWL policies on a tax-deferred basis. Therefore, a combination of a level premium deferred annuity and a decreasing term policy can provide levels of tax-preferred cash accumulation and death benefits similar to a CAWL policy. Some important differences exist, however. The tax rules treat withdrawals, lifetime distributions, or loans from each arrangement differently. Although most CAWL policies do not permit withdrawals, as such, except to the extent of excess cash values, a policyowner is taxed on amounts withdrawn or partial surrenders under the cost recovery rule. That is, the policyowner includes the amounts in taxable income only to the extent they exceed the investment in the contract. In contrast, the owner of an annuity is taxed on such nonannuity distributions under the interest-first rule. In other words, nonannuity distributions are fully taxable until the annuity owner recovers the entire amount in the contract in excess of the investment in the contract. So, in the case of nonannuity distributions, with the CAWL the policyowner generally recovers all nontaxable basis first, then taxable gain. With the annuity contract, the owner generally recovers all taxable gain in excess of basis first, then nontaxable basis. In addition, nonannuity distributions from an annuity contract received before age 59½ may be subject to a 10 percent penalty tax. Also, while loans from life insurance policies are not subject to tax, loans from annuities, if permitted, are treated as distributions and taxed under the interest-first rule. That is, loan proceeds are subject to regular income tax and may be subject to the 10 percent penalty tax. Also, loan provisions of deferred annuity contracts generally are more restrictive than those of life insurance policies. The annuity/term combination will require increasing premiums over the years for the term coverage. In addition, the mortality charges for term insurance coverage typically are higher than the mortality charges in a CAWL policy. Finally, the death proceeds from the insurance policy generally may pass to the beneficiary entirely income and estate tax-free—regardless of whom the beneficiary is—if the policyowner has no incidents of ownership in the policy. In contrast, the beneficiary still will have to pay tax on the gains in the annuity contract and only will avoid estate taxation if the beneficiary is the annuitant’s spouse and they can take advantage of the estate tax marital deduction.
  5. A combination of investments in tax-free municipal bonds and decreasing term insurance – This combination can create a cash accumulation and death benefit similar to a level death benefit CAWL policy. Similar to the cash values in a life insurance policy, municipal bond owners may use the bonds as collateral for loans without any adverse income tax consequences. However, interest paid on debt secured by municipal bonds generally is not tax deductible. Although not the general rule, in some cases, the interest paid on life insurance policy loans may be tax deductible. The life insurance policy transfers the death benefits by operation of the contract, which avoids probate. In contrast, municipal bonds are part of the probate estate and pass by will. Once again, if the policyowner has no incidents of ownership, the death proceeds escape estate tax. The municipal bonds will avoid estate tax only if they are left to the spouse who takes advantage of the estate tax marital deduction.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM

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