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What Is It?

A modified life policy is a whole life policy with a modified premium schedule. Typically, premium payments are reduced during the first few years of the policy. For instance, a modified-three policy provides for a lower, fixed premium during the first 3 years, with an increase to a higher fixed annual premium thereafter. The lower initial premiums may be attractive to younger insurance shoppers who are just starting out with their careers. Another modified life policy with similar appeal is a modified 5-and-10 policy. Lower, fixed premiums are due during the first 5 years, with slightly higher annual premiums due during the next 5 years. At the 10-year mark, the premium goes up again and remains fixed for the duration.

Tip: Less common are modified life policies with a higher premium payment in early years, with a lower fixed payment thereafter.

When Can You Use It?

If you are insurable and qualify for a whole life policy, you can ask your insurer about a modified life policy and potentially lower your premiums for the first few years.

What Are The Strengths of Modified Life Policies?

Lower Premiums in Early Years

Especially if you are young or just starting on your career path, you may appreciate the opportunity to get your life insurance plan in place at a lower initial cost to you. A modified life plan will give you all the advantages of a comparable whole life policy but will go easier on your wallet while you are getting established, paying off student loan debts, putting a down payment on a house, and climbing the corporate ladder. Even if you are not just starting out, the money saved during the early years of the policy can be put to work in other investments or spent on goods and services.

What Are The Tradeoffs of Modified Life Policies?

You May Be Able To Get the Same Coverage with More Flexibility

If you buy a modified-three policy, your premiums will go up after three years. If you buy a one-year renewable term policy, you may get the same coverage, perhaps at a lower price, and you can convert the policy to a typical whole life policy whenever you want. Your premium will go up when you convert, but you get to decide when that happens. You are not locked into the automatic increase date that accompanies a modified life policy. You can convert to whole life after 1 year, after 10 years, or any other time. Using this strategy, you have the flexibility to determine when you can afford to pay the increased whole life premium.

What Are The Income Tax Considerations?

Premium Payments Not Deductible

Life insurance premium payments are generally not tax-deductible expenses.

Policy Loan Proceeds Generally Not Taxable

When you take out a loan against your life insurance policy (with the exception of a policy classified as a modified endowment contract), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of the premiums you have paid in.

Caution: If you cancel your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest).

Policy Loan Interest Not Deductible

Interest you pay on a policy loan is generally not a tax-deductible expense (under certain circumstances, interest on loans used for business or investment purposes may be deductible).

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Policy Cancellation May Be Taxable

If you cancel (surrender) your policy for cash, the gain on the policy is subject to federal income tax. The gain on a canceled policy is the difference between the net cash value and loan forgiveness amounts and your policy basis.

Caution: You may be subject to surrender charges. Check your policy.

Caution: Policy fees and expenses are usually charged against the policy in the first few years. As a result, policy surrenders during the first few years of the policy may provide little cash value.

Caution: If you surrender your policy while there is a loan balance outstanding, you could be subject to income tax on the amount of the loan (plus any accrued but unpaid interest).

Policy Lapse May Be Taxable

If you allow your policy to lapse, you could be subject to income tax even if you don't receive any cash from the policy. A policy lapse can occur when you stop paying premiums and don't have cash values available that can be used to pay the premiums. If you have an outstanding policy loan, it is possible you could be subject to tax on the amount of the loan plus any accrued but unpaid interest.

Death Benefits Generally Not Subject To Federal Income Tax

Policy death benefits are generally not subject to federal income tax. One notable exception is when the policy has been sold or otherwise transferred for valuable consideration by one policyowner to another, subjecting it to the transfer-for-value rule.

What Are The Gift And Estate Tax Considerations?

Policy Proceeds Not Considered Gift to Beneficiary

When the proceeds of your life insurance policy are paid to a beneficiary, they are not treated as a gift for gift tax purposes.

Policy Premium Payments Generally Not Subject To Gift Tax

When you are the owner of a policy on your own life, with another party as the beneficiary, premium payments made by you are not considered a gift to the beneficiary for gift tax purposes. If, however, someone else pays the premiums on a policy you own, then the premium payments are considered a gift to you and may be subject to gift tax. However, policy premiums generally qualify for the federal annual gift tax exclusion.

Policy Proceeds Included In Estate Value in Some Cases

The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate or executor. Incidents of ownership include (among other things) the right to change the beneficiary, take out policy loans, or surrender the policy for cash.

Policy Proceeds Often Exempt From State Inheritance Tax

In many states, life insurance proceeds are exempt from state inheritance taxes.



This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.


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