Term Life Insurance

A convertible term life insurance policy gives the insured the right to

1. A.convert the accumulated cash value of the policy into a paid-up annuity at any point.Wrong. Level term coverage builds no cash value, so there is nothing available to convert into a paid-up benefit.
2. B.compel the insurer to continue the term coverage at the premium originally quoted.Wrong. That is renewability, and even then the renewal premium is recalculated at the attained age of the insured.
3. C.exchange the policy for permanent coverage without furnishing new evidence of insurability.Correct. The exchange rests on the original underwriting class, which is precisely what protects an insured whose health has since worsened.
4. D.receive part of the face amount while still living, once a qualifying illness is diagnosed.Wrong. That describes an accelerated death benefit rider, an unrelated provision addressing terminal or chronic illness.

Why: Convertibility is the contractual right to exchange term coverage for a permanent policy issued by the same insurer without proving insurability again. Its value is greatest to an insured whose health has deteriorated since the term policy was written, because the new permanent policy is issued on the basis of the original underwriting class rather than current health. Renewability is a different feature entirely, extending term coverage at a premium reset to attained age. If the insured were required to submit to new underwriting, the provision would give nothing beyond what any applicant already has.

A term life insurance policy:

1. A.Builds no cash value and covers only the termCorrect - pure, temporary protection.
2. B.Builds large cash valueTerm accumulates nothing. Every premium dollar goes toward the cost of protection for the stated period, which is why it is priced far below permanent coverage.
3. C.Pays dividendsDividends arise on a participating policy issued by a mutual insurer and represent returned surplus. A term policy carries no such participation feature.
4. D.Lasts for the insured's whole lifeThis describes permanent coverage. Term ends when the stated period runs out, and an insured who outlives it is left with nothing in force.

Why: Term life builds no cash value and provides coverage only for the stated term.

Camila Restrepo, 34, buys a 20-year level term life insurance policy with a $750,000 death benefit. Fifteen years later she asks her adviser how much she could borrow against the policy's accumulated value. The correct answer is:

1. A.The full $750,000 death benefit, since level term policies are fully paid up after 15 yearsLevel term is never paid up. The coverage ends at the end of the term with no residual value.
2. B.Up to the total premiums she has paid over the 15 years, less any policy feesPremiums paid are not a cash value. They purchased coverage for the years that have elapsed.
3. C.Up to 90% of the policy's cash surrender value, which accumulates in every life policyCash surrender value is a feature of permanent policies, not of term coverage.
4. D.Nothing, because term insurance builds no cash value and provides only a death benefit during the termCorrect. There is no cash value in a term policy, so there is nothing to borrow against.

Why: Term insurance is pure death benefit protection for a stated period. It builds no cash value, so there is nothing to borrow against, nothing to surrender, and no living benefit if the insured outlives the term. Level term simply means the premium and death benefit stay level during the term; it does not mean value accumulates. The clue is that she is asking about accumulated value in a term policy. Permanent policies such as whole life or universal life are where cash value builds. Review term versus permanent insurance.

Gwendolyn Estrada dies owning a $2,000,000 term life insurance policy on her own life. She had always retained the right to change the beneficiary. Her son receives the $2,000,000. The correct tax treatment is:

1. A.Taxable to the son only on the portion exceeding the premiums Gwendolyn paidThat gain-over-basis approach applies to a policy surrendered during life, not to a death benefit.
2. B.Taxable to the son as ordinary income, with the estate receiving an offsetting deductionDeath benefits are generally not income to the beneficiary, and no such offsetting deduction exists.
3. C.Income tax free to the son and excluded from her gross estate, because life insurance proceeds bypass the estate entirelyNaming a beneficiary avoids probate, which is where this idea comes from, but it does not remove the proceeds from the taxable estate.
4. D.Income tax free to the son, but the $2,000,000 is included in Gwendolyn's gross estate because she held an incident of ownershipCorrect. The two tax systems are separate, and the retained right to change the beneficiary is a classic incident of ownership.

Why: A life insurance death benefit paid because of the insured's death is generally not subject to income tax for the beneficiary. That is a separate question from the estate tax. Because Gwendolyn kept the right to change the beneficiary, she held an incident of ownership in the policy, so the full $2,000,000 is included in her gross estate for estate tax purposes. The clue is her retained right to change the beneficiary. Review income tax versus estate tax treatment of life insurance.