1035 Tax-Free Exchange - Part 4

The cost of using policy loans has increased. You receive the increased dividend of the upgrade offer only if you also accept higher interest rates on any loan you may take.

If you don't accept the upgrade offer (to retain low interest charges on policy loans), you then accept dividends on a lower scale. Trying to quantify the actual increases in policy loan costs (increased interest costs and/or decreased dividends) as a result of these changes has added to the complexity of managing whole life policies.

On top of the increased costs coming from insurance companies, the Tax Reform Act of 1986 (TRA-86) ruled out deductibility of these policy loan interest charges for both the personal and the corporate borrower, in most cases. For the personal borrower, TRA-86 generally regards interest paid on policy loans as consumer interest, thereby eliminating its deductibility.

Loans to finance investments continue to be deductible to the extent of net investment income. Also, loans on policies held for trade or business purposes on the lives of officers, owners, or employees generate deductible loan interest for businesses on loans aggregating no more than $50,000 per officer, employee, or owner.

TRA-86 grandfathered policies owned for business purposes issued prior to June 21, 1986, and allow businesses to continue to deduct all policy loan interest as they did in the past. For business policies issued after June 20, 1986, only interest on loans up to $50,000 is deductible. The impact of

(1) higher insurance company interest rates on policy loans,

(2) lower dividends on policies with outstanding loans, and

(3) reduction or elimination of policy loan interest deductibility has served to destroy the economic viability of the minimum deposit strategy for paying whole life insurance premiums.