"NEED TO KNOW' CALCULATIONS

Question 1

How do you calculate the Modal Factor?

Answer 1

Annual Premium x Modal Factor (Semi-Annually, Quarterly, Monthly) = Monthly Premiums

[Ref. 3.2.3.4]

Question 2

How do you calculate the Net Amount at Risk ?

Answer 2

• Death Benefit – Investment Account Value

(ex. Pratik owns a UL policy with a death benefit of $500,000 and an account value of $128,000. The current NAAR of his policy is $372,000, calculated as ($500,000 – $128,000).

Question 3

Simplify Yearly Renewable Term (YRT)

Answer 3

• The Cost of Insurance (COI) expressed as a dollar amount per $1,000 of risk.

(Ex. Pratik’s policy has a COI of $18.57. NAAR is $372,000. The insurance company would make a mortality deduction of $6,908 from his account, calculated as ($18.57 × $372,000 ÷ $1,000).

Question 4

What are the calculations for a policy gain?

Answer 4

Policy gain = proceeds of disposition – adjusted cost basis (ACB)

(e.g., Brian surrendered his whole life insurance policy and received proceeds of $46,000. The insurance company advised him that his adjusted cost basis (ACB) was $20,000, so he had a policy gain of $26,000 and 100% of this was taxable. Policy gain = $46,000 – $20,000 = $26,000

Question 5

Adjusted Cost Basis Calculations

Last Acquired Polices (G1, G2, G3) (Participating & Non-Participating) before & after December 1st 1982 key points

Answer 5

Policies prior to Dec. 2nd 1982 (G1)

(Non-participating)
CSV — Premium = ACB

(Participating Policies)
Premium — Dividends = ACB
—————————————————————-

Policies post Dec. 1st 1982 (G2 & G3)

(Non-Participating)
Premiums — NCPI = ACB

(Participating)
Premiums — NCPI — dividends = ACB

Question 6

What are the calculations of a full surrender?

Answer 6

CSV — ACB = Policy Gain
($24,00 - $10,00 = $14,000)

Policy Gain x MTR = Tax Payable
(14,000 x 35% = $4,900)

CSV — MTR = After Tax Funds
$24,000 — $4,900 = $19,000

[Ref.7.3.1]

Question 7

What are the calculations for a PARTIAL surrender?

Answer 7

CSV = $24,000
ACB = $10,000
FA = $200,000

(Reducing $200,000 to $150,00 for example)

1. Face Amount — Reduced Coverage ÷ Face amount = Percentage%
   ($200,000 — $150,000 ÷ $200,000 = 25%)
2. Percentage% x ACB = Prorated ACB
   (25% x $10,000 = $2,500)
3. Percentage% x CSV = Prorated CSV
   (25% x $24,000 = $6,000)
4. Prorated CSV — Prorated ACB = Policy Gain
   ($6,000 — $2,500 = $3,500)
5. Policy Gain x MTR = Tax Payment
   ($3,500 x 35% = $1,225)
6. Policy Gain — Tax Payment = After Tax Gain
   ($3,500 — $1225 = $2,275)

[Ref.7.4.1]

Question 8

What are the calculations for a policy withdrawal?

Answer 8

FA = $200,000
ACB = $65,000
CSV = $80,000

1. Amount withdrawn ÷ CSV x ACB = Prorated ACB
   (($40,000 ÷ $80,000) x $6500) = $32,500
2. Amount withdrawn — Prorated ACB = Policy Gain
   $40,000 —32,500 = $7500
3. Policy Gain x MTR = Tax Payable
   $7,500 x 35% = $2,625
4. Policy Gain — Tax Payable = After Tax Funds
   $7,500 — $2,625 = $2875

[Ref. 7.4.2]

Question 9

TRUE OR FALSE?

If the policyholder takes out a policy loan that is less than the adjusted cost basis (ACB), he will not have a policy gain, but the ACB will be reduced by the amount of the loan.

Answer 9

TRUE

• (e.g., Alicia’s ACB is $10,000. If she only took out a policy loan of $4,000, the policy’s ACB would be reduced to $6,000.

New ACB = $10,000 – $4,000 = $6,000

(She would not have to report a policy gain)

Question 10

What happens when the policyholder takes out a policy loan that is greater than the policy’s ACB?

Answer 10

If a policyholder takes out a policy loan that is greater than the policy’s ACB, he will have a policy gain equal to the amount of the loan, minus the ACB. The ACB of the policy will be reduced to zero.

• (e.g., Alicia’s ACB is $10,000.
• Suppose that she instead takes out a policy loan of $19,000. She would have a policy gain of $9,000 and $3,150 in tax payable).
• (Policy gain = $19,000 – $10,000 = $9,000)
• Tax payable = $9,000 × 35%)
• Her policy would now have an ACB of $0.

Question 11

What happens when you repay a policy loan?

Answer 11

If a policyholder repays a policy loan, he will be able to deduct the repayment from his taxable income, up to the amount of the policy gain he had to report when he took out the loan.

If he repays more than this amount, the excess will increase the policy’s ACB.

• (e.g., Alicia’s ACB is $10,000 Suppose that she repays $12,000 of her $19,000 policy loan. She would be able to claim a tax deduction of $9,000, which is the amount of the policy gain she had to include in her income as a result of the loan.
• The ACB of her policy would increase to $3,000.
• (ACB calculated as $12,000 – $9,000)).

Question 12

Explain the tax implications on the arms length transfer with a scenario.

Answer 12

Jack owns a policy on his wife Amanda, with face amount $200,000. Jack is also the beneficiary on the policy.

Jack decides one day that he wants to transfer the ownership to his brother Jim (the transfer also could of been a stranger, in other words he’s not transferring to his spouse or children.)

At the time of the assignment, the ACB is $34,000 and CSV is $61,000. After disposing the policy, Jack acquires a policy gain of $27,000 (CSV minus ACB)

He reports the gain on his MTR

Now that Jim owns the policy, his ACB is $61,000 because the tax has always been paid by Jack at his MTR up to the $61,000.

(If Jack was to pass away, Jim would still be the successor owner of the policy and the gain of the disposition will be to jack’s estate).

[Explain this scenario to the client using your own words and examples]

[Ref. hllqp 7.8 -12.7 assignment of policy p1]

Question 13

Illustrate NON-arms length transfer between Policyholder & Spouse.

Answer 13

SPOUSE Non-Arms length transfer

Jack (Policyholder), Amanda (Spouse)
ACB = $34,00
CSV = $61,00

• Rollover applies
• No deemed disposition
• Amanda (Spouse) acquires policy at the same ACB ($34,00) as Jack (Policyholder)
• This transfer has income attribution ( Which means If policyholder is still alive after the transfer and chooses not to opt out of the rollover provision, any policy gains by the spouse will trigger tax implications for Jack the policyholder)
• Opting out of the rollover provision is optional however, there will be a deemed disposition (gain) of $27,000 at the policyholder’s MTR ($27,000 x 35%)
• Amanda (Spouse) will receive the ACB at $61,000 (only if Jack (Policyholder) opts out of the rollover provision if he doesn’t Amanda will receive the ACB at $34,000)

[Explain this scenario to the client using your own words and examples]

DISCLAIMER: Notes are taken from HLLQP course modules. If you have any questions contact your course provider.

Please refer to “need to know videos” on HLLQP for more information. reference video is down below ▼

[Ref. hllqp “need to know videos” 7.8 -12.7 assignment of policy p2]

Question 14

Illustrate NON-arms length transfer between Policyholder & CHILD.

Answer 14

CHILD Non-Arms length Transfer

Mary (Mother/Policyholder), Sarah (Child)
ACB = $16,00
CSV = $24,00

• No deemed disposition
• Has rollover provisions
• Sarah (Daughter) acquires policy at the same ACB ($16,00) as Mary (Policyholder/Mother)
• As the child became an adult (18), The CSV grew to $40,000. If Sarah withdraws, or surrenders the policy, there will be a policy gain (deemed disposition) of $24,000 on her MTR ($24,000 x 25%)
• However, If Sarah (daughter) is still a minor while withdrawing, or surrendering the policy, the gain (deemed disposition) will be taxed on Mary’s (Policyholder/Mother) MTR
• Policy can also be transferred to a Trust on behalf of the child
• However, If the policy gets transferred to the trust there is a deemed disposition and tax implications applied to the policyholder and there will be no rollover provision.
• Opting out of the rollover provision is optional however, there will be a deemed disposition at the policyholder’s MTR ($27,000 x 35%)

[Explain this scenario to the client using your own words and examples]

DISCLAIMER: Notes are taken from HLLQP course modules. If you have any questions contact your course provider.

Please refer to “need to know videos” on HLLQP for more information. reference video is down below ▼

[Ref. hllqp 7.8 -12.7 “Need to know videos” assignment of policy p3]

Question 15

Explain Income Attribution Rule

Answer 15

Taxable income to the transferor spouse even if it is earned and legally belongs to the recipient spouse. Once the transferor spouse dies, the income attribution rules cease to apply.

• (i.e., Noah recently assigned a life insurance policy with a CSV of $85,000 and an ACB of $32,000 to his wife, Eve.
• Suppose that Noah did not opt out of the automatic rollover, and that Eve later
  surrendered the policy when its CSV was $94,000. As a result of the income
  attribution rules, Noah would have to report the resulting policy gain of $62,000.
  (Policy gain = $94,000 – $32,000 = $62,000)

[Explain this scenario to the client using your own words and examples]

Question 16

TRUE OR FALSE?

Upon death, the policyholder will result
a policy gain on the final tax return, equal to the CSV minus its ACB.

Answer 16

TRUE

[Ref. 7.9.1]

Question 17

What are the premium deduction calculations for a business expense on a collateral assignment?

Answer 17

Face Amount ÷ Loan Amount = Percentage%
($500,000 / $200,000 = 40%)

Percentage x NCPI = Deduction
(40% × $3,200 = $1,280)

(That’s the deduction as a business expense when you acquire this loan)

Question 18

How do you calculate CANCELLATION of a WHL or UL policy

Answer 18

CSV = $50,000
Premiums = $2,800

1. Month of cancelling ÷ Annual year x Annual premium = Return of premium
   (9 ÷ 12 x $2,800) = $2,100
2. CSV + Return of premium
   ($50,000 + $2,100)

(Refer to Section 12.5)

Question 19

What are the calculations for capital gains tax?

Answer 19

FMV — ACB = Capital Gain
($2,400,000,000 — $200,000,000 = $1,200,000)

Capital Gain x 50% = Tax Liability
(1,2000,000) × 50% = $600,000)

[Ref. 8.2.3.2]

Question 20

How do you calculate the odds of death?

Answer 20

• Odds are simply calculated by dividing 1 by the probability of death.
• (Example) according to the general statistics for all Canadians, a man who just turned 30 has a probability of dying before his next birthday of 0.104%
• To many people, that seems to be a very low number. However, when expressed as odds, this means that one out of every 962 men who have just turned 30 years old will die before their 31st birthday. (1 ÷ 0.1045%)

Question 21

Explain the capitalization of lost income and it’s calculation

Answer 21

The insurance need is determined by calculating the amount of capital that would have to be invested to generate the lost income.

• Annual income ÷ rate of return = Capitalized value
  ($8,400/month × 12 months) ÷ 5% = $2,016,000)
• This suggests that he should have about $2 million in life insurance.

Question 22

What are the calculations for an after tax rate using a capitalization of income approach?

Answer 22

Rate of return × (1 – tax rate) = After-tax rate of return
5% × (1 – 25%) = 3.75%

• (This means that, using the replacement of income approach, adjusted for
  income taxes, Derek would need $2,688,000 in life insurance, calculated as):

($8,400/month × 12 months) ÷ 3.75% $2,688,000

Question 23

What are the calculations for inflation using a capitalization of income approach?

Answer 23

(1 + return) ÷ (1 + inflation rate) - 1 = Inflation-adjusted rate of return

• If the inflation rate is 2% per year and the investment return is 5% per year, the
  inflation-adjusted rate of return is 2.94% calculated as:
• 1. (1 + 0.05) ÷ (1 + 0.02) – 1 = 0.0294
• 2. ($8,400/month × 12 months) ÷ 2.94% = $3,428,571

Question 24

What are the calculations for income taxes and inflation simultaneously using the capitalization of income approach?

Answer 24

(1 + after-tax return) ÷ (1 + inflation rate) -1= After-tax, after inflation rate of return

• (example) was determined that if the investment return is 5% per year and taxes are 25%, the after-tax rate of return is 3.75%. If the inflation rate is 2%,
  the after-tax, after-inflation rate of return is 1.71%, calculated as:
• 1. (1 + 0.0375) ÷ (1 + 0.02) – 1 = 0.0171
• 2. ($8,400 per month × 12 months) ÷ 1.71% = $5,894,737

Question 25

What is an **income shortfall**?

Answer 25

If the **income is less than the expenses**, then an income shortfall exists **expenses – income = shortfall** - *Factoring in the CPP survivor benefits ($675 monthly for Becky and $265 monthly for each Anya and Robbie, if Derek dies, the family would experience a shortfall of $2,945 per month, calculated as: **$2,945 = $4,150 – ($675 + $265 + $265)*** | [Ref. 11.3.3]

Question 26

**Explain** the capital drawdown method

Answer 26

A Practical approach for needs that have a **limited duration** by **multiplying the annual shortfall** by the number of years the shortfall is expected

Question 27

How do you **calculate** a *shortfall in capital?*

Answer 27

**Total capital needs at death – available assets – existing life insurance = Capital shortfall** - *This shortfall represents the amount of additional insurance that should be acquired. It is normally rounded up to the nearest $10,000 or $50,000 amount.* - *Using a capital needs approach with the capital **drawdown method**, Derek’s capital shortfall is **$754,240**, calculated as: **$754,240 = $1,506,990 – $402,750 – $250,000 – $100,000*** - *Derek should therefore consider acquiring an additional **$760,000** in life insurance.*

Question 28

How do you calculate **accrued interest** on an *outstanding policy loan*?

Answer 28

FA = $500,000 LOAN = $100,000 INTEREST = 4.5% - **FA - LOAN = Death Benefit** Calculation of accrued interest - *This is the original policy loan plus compound interest calculated as*: - *Year 1: **$100,000 + (4.5% × $100,000) = $104,500***; - *Year 2: **$104,500 + (4.5% × $104,500) = $109,202.50**;* - *Year 3: **$109,202.50 + (4.5% × $109,202.50) = $114,116.61**.* As a result, her beneficiary would receive **$385,883** calculated as: **$500,000 – $114,117** | [Ref. 12.10.7]