Why is this Topic Important to Wealth Managers? Provides an introduction into the Internal Revenue Code so that tomorrow’s blogticle about specific sections of the Code may be better understood, in particular the taxation of life insurance companies.

How are the laws related to tax organized or in other words, what’s the general process in finding an answer to a tax question?

All federal laws of the United States arise out of the Constitution.  The Constitution has granted Congress certain enumerated powers, such as the power to regulate commerce among the several states.  Congress also has the power to create laws that are necessary and proper in governing based on its listed powers.  All powers not granted to the Federal government are reserved by the States through the 10^th Amendment – meaning only the States may enact laws in those areas (al least this is how it is supposed to work).

Once Congress passes a necessary and proper law to carry out its enumerated powers, that law becomes a United States Statute, or a Statute already existing is either amended or deleted.  The Statutes of the United States are called the United States “Code”.

The United States Code is divided into 50 different titles.  Title 26 is perhaps the most infamous, being the “Internal Revenue Code”.  The Internal Revenue Code, or Title 26 of the United States Code is further delineated, into Subtitles, Chapters, Subchapters, Parts, and finally Sections and Subsections.

Congress has delegated the power of enforcement of these laws, which lies with the executive branch, of Title 26 to the Secretary of Treasury to create Regulations or Administrative Interpretations of the Statutes.  The regulations are not in and of themselves laws but rather, direction from the Secretary of interpretation of the laws.  The regulations have legal authority, which means they may be presented in court.  In almost all tax cases, there is some Statute, that is called into question, therefore the Court’s exclusive job is to rule on interpretation of the Statute as it applies to the situation before the court, not to overrule any statute, unless it found the law unconstitutional.  Therefore, additional law is generated by courts’ interpreting Statutes.  This is known as “case law”.

Let’s look at a simple example to illustrate the concept.  To determine how much tax an individual will pay on a certain transaction say, the receipt of life insurance payments as a beneficiary of a policy. Where do we start?  It is generally unquestioned that since the issue is about taxes we can look in Title 26 of the United States Code to find out what amounts paid to the taxpayer are taxable as income.

Moreover, Subtitle A of Title 26 is entitled “Income Taxes”, so that is a natural place to continue looking to see what taxes will be owed, if any on this payment.  Within Chapter 1 “Normal Taxes”, Subchapter A is called “Determination of Tax Liability”.  Determination of tax liability sounds on point in consideration of what we’re trying to accomplish.  In that Subchapter, Part 1 concerns “Tax on Individuals”.  Here is where we will start.  Section 1 is titled, “Tax Imposed”, and states “There is hereby imposed on the taxable income of” and lists the different filing statuses and applicable rates.

A question should then naturally arise, if there is a tax imposed, what is it imposed on?  The answer is nearby.  The wording of the statute says there will be imposition of tax on the “taxable income” of different filing statuses.  Well we might want to know then what taxable income means for federal legal purposes.  Looking in the index, or though a common search, one will find that Part I of  Subchapter B “Computation of Taxable Income”, is entitled “Definition of Gross Income, Adjusted Gross Income, Taxable Income, Ect.”.  So there it is, and if we look at the sections under Part 1 of Subchapter B, we will see Section 63’s title of “Taxable Income Defined.”

Section 63 (a) states, in part, “the term ‘taxable income’ means gross income minus the deductions allowed.”  Well it would certainly be helpful to know then what “gross income” means.  Not too far away, in the same Part, one can find in Section 61, which is entitled, “Gross income defined”.  Section 61(a) states in part, “Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:

…
(3) Gains derived from dealings in property.”  Life insurance contracts are property, generally.

Notwithstanding the meaning of “all income from whatever source derived” we know if some item is “otherwise” excepted in Subtitle A, “Income Taxes”, that such item would not be included in gross income.  Further, if the item is not included in gross income, it will not be included in taxable income, and even further, if the item is not included in taxable income, the imposition of a tax on such item does not apply.

We now must look in Subtitle A to see what, if any items are excepted.  Part III of Subchapter B, is conveniently enough titled “Items Specifically Excluded From Gross Income.”  The first Section of this Part is entitled “Certain Death Benefits”.  Payments from a life insurance contract to a beneficiary is on point with this Section, so it should be read.  Section 101 states, in pertinent part, “gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.” So if life insurance payments are not included in gross income, the life insurance payments are not taxable income, and therefore are not subject to an imposition of income tax, or in other words – no tax is due.

In this simple example, there was no need to examine the Regulations or any court cases, as our issue was straightforward.  However, most issues will involve additional questions which then the practitioner will look to further sources, i.e., regulations and case law, to determine the answer to the question presented.

For further explanatory discussion of the structure and sources of federal tax law, please see the AdvisorFX Main Library Section 50.6  Sources And Structure Of Federal Tax Law: A—Sources And Structure Of Federal Tax Law

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

The Wall Street Reform Act expressly gives the SEC the power to prohibit or restrict mandatory securities arbitration agreements.

The analysis by our Experts Robert Bloink and William Byrnes is located at AdvisorFX Journal Mandatory Securities Arbitration Clauses on the Chopping Block

After reading the analysis, we invite your questions and comments about indexed annuities by posting them below, or by calling the Panel of Experts.

by Robert Bloink, JD, LLM and William H. Byrnes, JD, LLM

Is there any harm in walking away from a policy without receiving confirmation that the policy was cancelled by the carrier?

Walking away from a policy without following the cancellation procedure specified in the contract may not be enough to terminate the policy and could come back to bite the insured years down the road. We find a poignant example of the dangers of failing to properly cancel a policy in a recent Tax Court case that considered whether taxpayers were correctly taxed on a cancelled policy loan when the couple did not specifically authorize the loan and believed that the policy had been cancelled for more than twenty years. [Feder v. Commissioner of Internal Revenue, T.C. Memo. 2012-10(2012)].

As we have seen, if a policy is terminated and a policy loan forgiven, the insured will be on the hook for the amount of debt that is cancelled, less their investment in the contract. What is unique about this case is that the Feders were not aware that the policy was still in existence or that they had taken a policy loan, as the loan was automatically funded due to a clause in the contract that kicked in when the couple stopped making premium payments.

Taxpayers are usually taken aback by the tax liability when their policy is cancelled with an outstanding loan, but the Feders had twice the surprise because they weren’t aware that the loan had been made or that the policy was even in existence.

For a complete discussion of the long-lost policy see Advisor’s Journal.

For previous coverage of the income taxation of policy loans in Advisor’s Journal, see When Are Policy Loans Taxable? (CC 11-122).

For in-depth analysis of the income taxation of life insurance, see Advisor’s Main Library: Life Insurance and Annuities.

Copyright 2000-2012 by The National Underwriter Company. All Rights Reserved.

Pop quiz: What life insurance or annuity product has recently been alternatively classified by the states as a fixed annuity, variable annuity, financial guaranty insurance, and a derivative? If you answered “contingent annuity,” you are one of a minority of advisors who has heard of them and understands state regulators’ confusion about how the products should be classified.

Contingent annuities, often portrayed as “group annuities,” are a standalone guaranteed lifetime withdrawal benefit (GLWB) contract that is offered to mutual fund investors. Under a contingent annuity, the investor pays a fee equal to a percentage of the account value. The contract covers only investments that meet the insurer’s criteria. At a set age, the investor may begin making “systematic withdrawals” equal to a particular percentage of account value. The size of the withdrawals depends on the gender and age of the investor. In the event that the covered account’s value is exhausted, the contingent annuity will kick in and the investor will continue to receive payments in the same amount as the systematic withdrawals until he dies.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of annuities in Advisor’s Journal, see Annuities and Inflation Risk (CC 11-172).

Why is this Topic Important to Financial Professionals? A basic understanding of reinsurance will help the financial professional better understand how alternative risk transfer structures can benefit clients.  Exposure to the concepts allows fundamental understanding that enables advanced planning.

Reinsurance as defined by Black’s Law Dictionary means, “[i]nsurance of all or part of one insurer’s risk by a second insurer, who accepts the risk in exchange for a percentage of the original premium.”[1] Or in other words, “[r]einsurance is a transaction in which one insurance company indemnifies, for a premium, another insurance company against all or part of the loss that it may sustain under its policy or policies of insurance.”[2]

What are some common examples of reinsurance structures?

• Excess lines coverage, in that the risk from the first layer of coverage (let’s say up to $100,000) could be held by one insurer while the excess for a claim of over the threshold could be covered by another insurer, in essence, the first insurer has reinsured the risk of over $100,000 to another party.
• Fronting-“[a]rrangements by which an insurer, for a specified fee or premium, issues its policies to cover certain risks underwritten or otherwise managed by another insurer or reinsurer.  The insurer then transfers all, or substantially all, of the liabilities thereunder to such insurers by means of reinsurance.”[3]

How does reinsurance relate to small business and alternative risk transfer prerogatives?

Non-traditional risks can commonly be reinsured.  If for example, a business were to form or operate a captive insurance company, the company may still employ a way to “lay-off” some of the risk and liability the insurance company just undertook.  The secondary insurance market, or another name for buying and selling reinsurance, is priced differently than the traditional insurance market.  Some claim that one benefit of alternative risk transfer plans is access to this reinsurance market.

Reinsurance is all about managing the risk appetite of the business though a comprehensive insurance management plan.  “Reinsurance, particularly excess of loss reinsurance,” is generally, “characterized by low claims frequency and high loss severity.”[4] Some benefits reinsurance as it relates to risk management are: [5]

• Limiting Liability – amount of risk retention can be determined and set
• Asset Stabilization- risk of loss transferred to another
• Catastrophe Protection-allows for coverage of large risks though risk sharing
• Increased Capacity / Cash- assigns obligations that may not be funded

[2] Reinsurance Association of America.  “Fundamentals Of Property and Casualty Reinsurance” Introduction To Property And Casualty Reinsurance. http://www.reinsurance.org/i4a/pages/index.cfm?pageid=3310.  Last Accessed 8/26/2010.

[3] Reinsurance Association of America.  “Glossary of Terms” http://www.reinsurance.org/i4a/pages/index.cfm?pageid=3309.  Last Accessed 8/26/2010.

[4] Reinsurance association of America “Fundamentals Of Property and Casualty Reinsurance”.  Pg. 10.

[5] “Fundamentals Of Property and Casualty Reinsurance” Purposes Of Reinsurance.  http://www.reinsurance.org/i4a/pages/index.cfm?pageid=3310.  Last Accessed 8/26/2010.

Robert Bloink, JD, LLM and William H. Byrnes, JD, LLM

If your clients would benefit from a low-cost, term-like product with permanent features, take a look at Term Universal Life (Term UL). But do not make the mistake of assuming that Term UL is your father’s convertible term policy. Gone are the massive premium increases at conversion that cannot be predicted when the term policy is issued. Term UL gives your clients a clear view of future premiums, making the product suitable for long-term planning without the high premiums of other permanent products.

What Is Term UL?

Term UL is a relatively new product that starts as a term policy but automatically converts to a UL policy after the policy’s term phase—be it ten, fifteen, or twenty+ years. Although not every carrier offers Term UL, it is offered by a growing number of carriers, including Genworth Life and Annuity, West Coast Life, and Protective Life.

As the price of term products increases, Term UL is filling the gap by offering lower premiums and permanent features without the uncertainty of convertible term. Regardless of insurability at the time the product converts, the product will convert to a permanent product at a premium rate that the insured is aware of at the time they purchase the contract. Term UL may be a good product for young professionals and entrepreneurs who need term now but are likely to need a permanent life insurance solution down the road. A switch on the policy flips, converting it from an income replacement vehicle to an estate preservation vehicle.

For the complete discussion on Term UL see Advisor’s Journal.

For previous coverage of universal life in Advisor’s Journal, see Can Term Life Coupled with a Mutual Fund Investment Replace a Variable Universal Life Policy? (CC 10-77).

For in-depth analysis of universal life, see Advisor’s Main Library: A—Fundamentals Of Universal Life Insurance.

Your questions and comments are always welcome. Please contact the Panel of Experts.

Copyright 2000-2011 by The National Underwriter Company. All Rights Reserved.

by Prof. Robert Bloink and Prof. William H. Byrnes

Are You Part of “One of the Greatest Scams of Our Time”? You are if you offer investment advice on anything other than a fee-only basis, according to one author. In a scathing attack on the financial advisory industry, Business Insider, Clusterstock contributor Andrew Haigney slammed investment advisory firms, calling their services “one of the greatest scams of our time.”

Haigney said, “The underlying problem is that investment advice has become a ‘product,’ and investment advisers steer prospective clients right into their own products.” The jumping-off point for his argument is a New York Times op-ed by David Swenson, Chief Investment Advisor of Yale University, that pans the mutual fund industry and its “punitive fees.” The conclusion of Mr. Swenson’s argument, and the premise of Andrew Haigney’s article, is that advisors must be scamming their clients if they are not offering them all low-cost index funds.

Do not make the mistake of assuming his article is just another expose on the bad behavior of a few advisors. Haigney does not pull any punches, and he is not talking about a few bad apples. He is making broad assertions about the entire industry and all its participants.  Haigney claims that investment advisors do not counsel their “prospective lucrative clients” to invest in low-cost funds.

Many advisors reading Mr. Haigney’s article probably find themselves shouting “fiduciary duty” at their computer screens, but Mr. Haigney foresaw the objection and explained why the fiduciary standard applicable to advice given by RIAs is not all it is claimed to be.

According to Haigney, the lack of a consensus definition of “fiduciary standard” contributes to its downfall. But the fiduciary standard has always been an amorphous concept in British and American law. There cannot be one single, clear definition of fiduciary standard, and that’s the way it should be. Tying the principle down to an “all-encompassing” definition will not catch every possible permutation of behavior, and bad actors will always be able to find a loophole to fit their bad acts through.

Although some specific rules promulgated by FINRA and the SEC define “fiduciary duty,” it must always keep some of its amorphous character. That gives regulators and courts the leeway to halt bad advisor behavior when they see it—regardless of whether a specific rule defines the behavior as a breach.

Mr. Haigney apparently believes the nebulous fiduciary standard is toothless because all conflicts of interest can be disclosed away. According to Mr. Haigney, because disclosures are generally incomprehensible to our clients, the standard is impotent and does not offer a solution to the problems plaguing the investment advisory world.

If client abuse in the name of commissions is rampant in the advisory world, what is to be done about it? Mr. Haigney suggests that investment advisors be required to make side-by-side comparisons between their proprietary portfolio management services and low-cost index funds. We are left wondering how that would work. Would it be enough to show the chart and then explain it away? We can all come up with a hundred reasons why index funds are inappropriate for many of our clients. Should results be compared over a ten-year span? Longer? Shorter? Mr. Haigney’s suggestion sounds simple enough, but the more we dig into it, the more difficult it is to pin down and apply to any practical situation.

If most of the industry is corrupt, where can you turn for unbiased advice? Haigney himself is a managing director of El Cap, a Vermont RIA “that provides investment-consulting services.” As a fee-only—as opposed to fee-based—advisor, he is immune from his own harsh criticisms.

It is not that the premises of Mr. Haigney’s article are invalid—there is undeniably a segment of the financial advice industry that puts commissions before clients. It is the universal scope of his assertions that is questionable. Does he really believe that fee-only advisors pushing low-cost index funds are the best bet for most, if not all, investors?

For a complete discussion of financial advisors go to Advisor’s Journal.  For previous coverage of the fiduciary standard in Advisor’s Journal, see Study Finds that Universal Fiduciary Standard Will Hurt Investors (CC 10-97).

Copyright 2000-2011 by The National Underwriter Company. All Rights Reserved.

Recently, the United Nations published new economic forecasts which reveals that persistent high unemployment, the euro area debt crisis and premature fiscal austerity have already slowed global growth and factor into the possibility of a new recession. The report reveals a “A 64 Million Person Jobs Deficit”. The biggest issue of 2012 is Employment and The Economy in this ever present GFC Global Financial Crisis.

The United Nations report states that: “The rate of unemployment averaged 8.3 per cent in developed countries in 2011, still above the pre-crisis level of 5.8 per cent recorded in 2007. Almost 1/3 of the unemployed in developed countries had been without a job for more than one year, affecting about 15 million workers. Prolonged unemployment tends to have long-lasting detrimental impacts on both the affected workers and the economy at large, as skills of unemployed workers deteriorate, leading to lower earnings for affected individuals and lower productivity growth.”

However, compared to 25 years ago, the ability to find jobs, advertise jobs and seek quality employees is truly a global affair. If you search on Monster.com (Symbol MWW) or Dice.com (symbol DHX), there are hundreds of thousands of jobs listed. Since necessity is the mother of invention, job seekers can look for global jobs, relocate internationally, or even taking a virtual telecommuting job. Either way, job and networking related websites such as LinkedIn (symbol LNKD) and EFinancialCareers will continue to forge ahead in this global headhunting cyberworld.

Personally, as a leader of global financial and management NGO/SRO organizations, I find that 100 percent of our members are what I would call “international”. This means that they will follow the money to New York, Dubai, Hong Kong or Mumbai. The beauty of job search today is that it is truly global. We are also dedicated to helping our members find quality jobs worldwide.

As an optimist, I believe the global economy is in great fluctuation. People are retooling on global scale for new jobs and acting on new ideas. The information technology and internet age is expanding from country to country where the Internet bubble is in the past and the real profits flow to successful teams, investors, stakeholders and communities. First it was Silicon Valley, then EU, then China/Asia, and next is India, Arabia and Africa. This could be a sign that it is time for all of us to become global job oriented and for all US companies to be more global-customer oriented. In the financial arena, the worlds’ largest banks are now in Asia and there are banking, tax, risk, and wealth management positions available in major cities around the globe. To Search Global Jobs with eFinancial Careers and the AAFM American Academy of Financial Management, go here: www.AAFM.efinancialcareers.com

There are employment successes made every day, and the 21st century jobs go to those who are aggressive and thinking “outside of the box”. This is why all job seekers should utilize several job search companies, input keywords to receive alerts about jobs that they way, post their resume online with more than one job system and social network, and brand your name and skills. If we master the technology, it can individuals get quality jobs and help companies find the best talent.

UN Report Citation: http://www.slideshare.net/undesa/world-economic-situation-and-prospects-2012-pre-release – Department of Economic and Social Affairs (UN DESA)

By: George Mentz JD, MBA, CWM, MFP – International Lawyer and Award Winning Author

The SEC recently redefined the accredited investor standard that is used to determine whether individuals are permitted to purchase insurance products such as Variable Universal Life (VUL) policies and Variable Annuities (VA) that permit investment in exotic, high-risk products such as hedge funds and private equity. The new definition effectively increases the net worth at which an investor may qualify to purchase these riskier products.

Under the amended rule, an investor’s principal residence is excluded from the net worth calculation. Individuals (or married couples) are qualified as accredited investors under the rule if they have a net worth of at least $1 million, excluding the value of the investors’ principal residence. The rule was motivated in part by inappropriate marketing efforts that may have targeted families that, due to the inflated housing market, were “house rich” but who lacked the investing sophistication to fully understand the exotic products that they were purchasing.

What does the rule mean for your clients and prospects? For starters, the rule will re-establish the cache of private placement insurance products and help move them back into the exclusive realm of the advanced markets producer.

Why is this Topic Important to Financial Professionals? “The ART market unites the risk management and product development skills of financial institutions, insurers and reinsurers with the capital of global investors to give corporate risk managers the best possible means of managing financial and operating risks.” [Source:  Bimaquest - Vol. IV Issue I1, 37, 44.  July 2004.]

What is Alternative Risk Transfer, or ART?

As defined by International Association of Insurance Supervisors, ART means, “[a]ny form of risk transfer that include at least an element of insurance risk, opposed to pure financial risk, other than a pure insurance contract.” [1]

Some distinguishing characteristics, as compared to traditional insurance coverage, may include but are not limited to:[2]

• Untraditional risk funding
• Underwriting income retention
• Varying coverage depending on types of risk a business or individual may be exposed to
• Access to coverage for risks the conventional insurance market may consider uninsurable
• Potential to reinsure certain risks

Why would a business or individual consider ART?

Generally, there are uninsurable risks or risks that are prohibitively expensive to insure through the traditional insurance market that a business may be exposed to by operating in its environment.  These risks pose various threats to the operation of the business, and just as traditional risks such as fire are covered though risk diversification, a business may want to consider the possibility of other detrimental events that could significantly affect its business.

The alternative risk transfer market can be divided into two general categories: “(1) alternative carriers and (2) alternative products.” [3] Examples of the former include:

• Self-insurance arrangements
• Captive insurance companies, which could include, wholly owned insurance subsidiaries, group captive insurance arrangements or some combination or multiple structures.
• Risk retention groups, which are generally formed to, as the name states, retain risk within a group of similar businesses or similar risks.

The other general category may include[4]:

• multiline products
• specialty products written through an insurer such as Lloyds of London
• some derivatives and finite risk products

Generally, the “[i]nsurance industry has realized that though conventional risk transfer solutions are almost always [favored] (when available at viable pricing levels), it becomes essential to investigate the value of non-conventional solutions and to focus on the benefits that can be derived from these solutions.” [5]

[2] Id.

[3] “Alternative Risk Transfer”.  Deepak Godbole.  GeneraI Insurance Corporation of India Bimaquest – Vol. IV Issue I1, 37, 41 July 2004. http://www.niapune.com/pdfs/Bimaquest/Volume-4_Issue%202/godbole.pdf Last accessed 8/24/2010.

[4] Id.

[5] Id. at 39.