New 7702 Rule Excuse for IMOs to Push Level Death Benefit Sales
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The new 7702 rule change is one of the most dramatic tax code changes in decades that affects Cash Value Life (CVL) insurance.
Section 7702 defines the MEC (Modified Endowment Contract) test. The MEC test sets the minimum death benefit (hereinafter “DB”) that must be purchased in order to avoid the CVL policy from becoming a MEC. If the policy is a MEC, you can’t take tax-free loans from the policy.
7702 rule change—In short, the 7702 change lowered the amount of the required DB to avoid becoming a MEC by approximately 50%.
That’s awesome, right? Policies will have lower expenses, more cash, and more tax-free borrowing.
What about commissions? Because commissions are paid based on the first year DB, they would be reduced by 50%.
Industry quandary—some companies have rolled out new 7702 products and some have not. Companies are struggling to figure out how to create a competitive product and still keep the commission high enough to keep an agent’s interest.
IMOs know how to keep commissions high!
Can you imagine an IMO generating 50% less commission on their CVL book of business? It would be financially devastating. The solution….
Level Death Benefit Sales
95% of the time, the way to design a CVL policy to have the best outcome for a client is to use an increasing DB through the premium payment period.
Level DB minimum non-MEC sales are NOT what’s best for the client because they are buying way more first year DB than is required under the MEC rules (pre- or post-7702 rule change).
Rule of thumb for level vs. increasing DB
- Tax-free borrowing reduced by 7-15% depending on the policy when using a level DB.
- Commissions are 100%+ higher with a level DB illustration.
Let’s see how financially harmful this is in the following example:
Assume the borrowing from a policy is $50,000 a year in retirement for 25 years vs. $45,000 when using a level DB vs. increasing DB. The agent’s commission goes from $3,000 to $6,000 using level.
So, the agent made an extra $3,000 a year on the sale and the client borrowed $5,000 less per year each year for 25 years ($125,000 less in total).
IMO Sales Trick
It’s a very simple trick to get an agent to go peddle level death benefit sales. The IMO convinces the agent that the client needs the DB.
The agent did a “needs analysis” and determined that the client needed a DB that was about the same as it would be for a level DB illustration. It’s a win-win. The agent and the IMO double their commissions and the client gets the death benefit he/she “needs.”
Total crap! This sales pitch is total crap. You know what it cost for a 15-year level term to fill in the gap between the increasing DB amount and a level DB amount? $640 a year.
The question is, would a client pay $640 a year for 15 years to be able to borrow out an extra $5,000 tax-free a year more from their CVL policy for 25 years?
It’s a no brainer, but the agent AND the IMO make significantly less commissions.
By the way, I used 15-year term because by the 15th year the increasing IUL DB will catch up to where the total death benefit would have been when starting with the level DB from year one.
What can be learned from this newsletter?
- The new 7702 change is awesome for clients and makes CVL even more viable.
- Most IMOs are NOT looking out for your best interest or that of your clients.
- Level DB illustrations are code for screwing clients and maximizing commissions.
Roccy DeFrancesco, JD, CAPP, CMP
Founder, The Wealth Preservation Institute
Co-Founder, The Asset Protection Society