
CHANGES TO SECTION 7702 on
life insurance policies
On December 21, 2020, Congress passed the Consolidated Appropriations Act of 2021, which included several updates to Section 7702. These updates will positively impact the life insurance industry through illustrated performance and policy funding.
What is Section 7702? Internal Revenue Code Section 7702 requires a life insurance policy to meet one of two tests (Cash Value Accumulation Test or Guideline Premium Test) to be considered life insurance for federal income tax purposes.
What changes are being made? The biggest change was to the rates that determine whether a policy qualifies as life insurance for federal income tax purposes and if it will be treated as a Modified Endowment Contract (MEC). These changes are intended to bring the rates used in these key calculations in-line with the current interest rate environment. Both indexed universal life and universal life policies will be impacted by this change.
How will these changes impact you and your clients?
1. More premium can be paid into a policy due to increasing limits. These reduced rates allow more premium to be paid into a policy before it becomes a MEC, allowing for more cash value growth potential. 2. The same amount of premium can be put in a policy with a lower specified amount, offering more potential cash value and less net amount at risk for your clients. A lower net amount of risk reduces the cost of insurance which makes the cost of carrying the policy lower when compared to the prior rules.
When will changes be made? North American is actively reviewing the regulations to determine when we will be able to apply the updated rates and allow changes to be made to our currently marketed products. Updates will be shared as they become available. The new regulations will only apply to policies issued January 1, 2021 and later.
In the meantime, please review the Frequently Asked Questions or contact the Life Team for more information on these changes
FREQUENTLY ASKED QUESTIONS
Q. How does the Consolidated Appropriations Act of 2021 impact the life insurance industry?
A. The Consolidated Appropriations Act of 2021 (the “Act”) included a change to Internal Revenue Code Section 7702 rates used in calculating qualification for tax-favored treatment of life insurance. Furthermore, there is also a change to Internal Revenue Code Section 7702A which determines the premium limit used to evaluate whether the policy qualifies as a Modified Endowment Contract (MEC). These changes are intended to align the rates used in these key calculations with the current interest rate environment.
Q. What are the rates that are being changed?
A. Section 7702 requires a life insurance policy to meet one of two tests to be considered life insurance for federal income tax purposes: Cash Value Accumulation Test (CVAT) or the Guideline Premium Test (GPT). There is only one rate used in calculating compliance with CVAT. For GPT, compliance is determined based on the greater of the guideline single premium and the guideline level premium. The calculation of each of these amounts includes a rate that the Act modified as well. Section 7702A defines a premium limit that is used to determine whether a policy is treated as a Modified Endowment Contract. This limit, frequently referred to as the “7-Pay Test”, is determined using the same interest rates used as CVAT in the 7702 calculations described above. Since the interest rate used in the CVAT test is changing, the interest rate used in the 7702A 7-Pay Test calculation is changing as well.
Q. How are the rates being changed by the Act?
A. The Act makes changes in two parts. First, it establishes a new method of setting CVAT, GPT, and 7-Pay Test rates based on existing rate benchmarks. Second, the Act creates a transition rule that applies for an interim period. It is important to note that all of these rates are minimum and the greater of guaranteed policy rates and these rates are used in the actual calculation. The table below shows the change to the minimum rates used in the calculation.
