Guaranteed 10-Pay Whole Life Insurance Contracts

G. Dean Goodwin, CLUT, AEPT
Published Date:
May 1, 2014

Most advisors and clients utilize the benefits of life insurance for the traditional purposes of replacing income or providing liquidity to pay estate taxes through the income tax-free death benefit; however, permanent insurance is often perceived as being expensive and not providing a competitive rate of return compared to other asset classes. In addition, years of low interest rates have adversely impacted the performance of both universal and whole life policies. Product design and carrier selection may also be a contributing factor, because life insurance is typically purchased with the intent to buy the most amount of coverage for the least amount of premium Premium offsets, vanish premiums, blending term to reduce premiums, and unrealistic carrier mortality assumptions and dividend projections all contribute to this common perception.

In order to provide policyholders with a sense of certainty, a number of mutual insurance companies have introduced guaranteed 10-pay whole life contracts that are contractually paid up with 10 years of premium payments, regardless of dividend performance. This eliminates the risk of vanishing premiums, premium offsets, and blending designs that depend on the performance of the carrier’s dividend interest crediting rate.

Tax Rates and Tax-Free Municipal Bonds

The federal government expects that the new 3.8% Medicare surtax will raise twice as much revenue this year as the federal estate tax. While it is estimated that approximately 3.7 million taxpayers will be impacted in 2013, that figure could rise to more than 7 million in the next decade because the tax is not indexed for inflation. The new Medicare surtax, coupled with the tax increases enacted by the passage of the American Taxpayer Relief Act (ATRA), effective Jan. 1, 2013, has increased the top marginal rate for interest income on bonds to 43.4%, excluding state income taxes. Consequently, the combined top marginal rate on unearned income could exceed 50% in some jurisdictions.

It is estimated that there is currently more than $3.7 trillion (mostly individuals) invested in the municipal bond market. Such individuals are looking for both tax-free income and safe return of principal. But the tax advantage of owning a municipal bond has changed. Unfunded pension liabilities, coupled with a shortfall in contributions, have caused concern among investors and regulators. In addition, when interest rates increase and the price of the bond falls below par, holding the bond to maturity creates a capital gain taxed as ordinary income. Individuals currently relying on municipal bonds should consider the 10-pay whole life policy.

Tax and Investment Diversification

The Deficit Reduction Act of 1984 (DEFRA) and the Technical and Miscellaneous Revenue Act of 1988 (TAMRA) define how life insurance policies can be funded and taxed; however, they are regulated under IRC sections 7702 and 7702A. If a life insurance contract fails to meet the 7-pay test or exceeds the limits defined under TAMRA, the policy becomes a Modified Endowment Contract (MEC), and many of the tax benefits are lost. (Essentially, this means that too much cash is accumulating within the life insurance policy and, therefore, distributions, withdrawals, or dividends become taxable as ordinary income.)

Tax-free income requires the following:

  • Withdrawals do not exceed basis.
  • The policy remains in force until death.
  • Withdrawals taken during the first 15 policy years do not occur at the time of any reduction of benefits.
  • The policy does not become an MEC.

Because 10-pay whole life contracts were designed and registered with state insurance regulators to be contractually paid-up in 10 years, they do not result in the reduction of benefits, thereby creating a MEC and losing some of the tax benefits. The policyholder or owner can take withdrawals and dividends in year 11. The cash value of a whole life policy is a noncorrelated asset and is not subject to claims of creditors in 43 states, including New York. It is also not subject to short-term interest rates, nor to the fluctuations of the equity markets.

The 10-pay contract purchases the least amount of initial life insurance and allows the most amount of premium dollars allowed by the law to keep the policy from becoming a MEC. This has the added benefit of enhancing the future dividend performance, because there will never be any additional premiums paid into the policy.

Exploring the Options of the 10-Pay Policy

Life insurance. This option reflects using dividends to purchase paid-up additions and increasing the amount of life insurance in force each year. Although contractual guarantees with 10-pay contracts underwritten by mutual companies are essentially the same, there can be a substantial difference in the dividend interest crediting rates, which will make a difference in the performance over the life of the policy.

Dividends paid in cash. This option changes the dividend option in year 11—after the policy is contractually paid up—from purchasing paid-up additions to having the dividends paid in cash. The guaranteed death benefit remains in place and the cash value continues to increase. Historical data reflects that there is a direct correlation between the interest rate environment and dividends issued by mutual companies. For healthy individuals under age 65, this option can produce approximately the same amount of tax-free income as today’s municipal bond portfolios, but with substantially more cash value than bonds held to maturity. Unlike bond portfolios that have risks if interest rates increase, historical evidence shows that these dividends increase in a rising interest environment

Tax-free loans. This option maximizes retirement income through the surrender of paid-up additions and loans taken against the policy; it will reduce both the cash surrender value and the death benefit. Because the policy is paid up and no additional premiums are ever needed to keep the policy in force, the policy can never lapse.

Long-term care rider. Some companies offer a long-term care (LTC) rider, which allows reimbursement for LTC expenses after meeting two of the six activities of daily living (ADL) requirements. There is a cost to the rider through a reduction of the initial death benefit, but many advisors recommend this rider rather than purchasing an individual LTC policy. Unlike an individual LTC policy that may never be used and where premiums are not guaranteed, those insured under an LTC rider will either be reimbursed for LTC expenses, receive tax-free retirement income, or pass along tax-free life insurance to named beneficiaries for wealth replacement.

Tax-Free Income for Trust Beneficiaries: New Tax Rates for Nongrantor Trusts

Because nongrantor trusts and estates do not receive the benefits of graduated income tax rates, unearned income from bond portfolios (interest) greater than $12,150 will be taxed at 43.4%, excluding state income taxes. A trustee with a long-term insurance/investment horizon who wants to have a myriad of options in the future would be well served to consider having the trust purchase 10-pay whole life contracts on the lives of the beneficiaries.

G. Dean Goodwin, CLUT, AEPTG. Dean Goodwin, CLUT, AEPT, is the founder of Granville Associates, an independent firm that provides insurance funding for nonqualified deferred compensation plans for corporate executives and estate planning for high-net-worth families. Granville Associates recently merged with InterContinental Insurance Brokers LLC, with offices in the financial district in downtown Boston. Mr. Goodwin worked with Citizens Financial Group (CFG) and the Royal Bank of Scotland (RBS) in the initial development and implementation of premium financing arrangements, used to maximize wealth transfer by leveraging gift tax exemptions and creating tax-free liquidity for GST transfer trusts and intentionally defective grantor trusts. He received a BS in Economics from Villanova University, his CLUT from the American College, and his AEPT designation from the National Association of Estate Planners & Councils. He can be reached by email at, and the company’s new website is

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