How to Calculate the Interpolated Terminal Reserve

The interpolated terminal reserve (ITR) is a method used to determine the value of a permanent life insurance policy for tax purposes, and this valuation is not the same as the policy’s cash surrender value. It is most frequently required when a policy is transferred as a gift to another person or when a policy is an asset within a decedent’s estate. The ITR represents the policy’s fair market value on a specific date, such as the date of a gift or death, which falls between the policy’s anniversary dates.

Understanding the Core Components

The calculation of the interpolated terminal reserve relies on two main elements: the terminal reserve itself and any unearned premium. The terminal reserve is the reserve an insurance company is statutorily required to hold to fund its future liability for the policy. This value is calculated by the insurer once per year on the policy’s anniversary date and is similar, but not identical, to the policy’s cash value.

A second component is the unearned premium. This refers to the portion of the most recent premium payment that covers the period of insurance protection extending beyond the valuation date. For example, if a premium was paid for an entire year but the policy is valued for tax purposes six months into that year, half of that premium is considered “unearned.”

Information Required for Calculation

To perform the calculation, specific information must be obtained from the life insurance company on IRS Form 712, Life Insurance Statement. This form must be requested by the policy owner or the executor of an estate. The form will provide the following details:

• The terminal reserve value on the policy anniversary date immediately before the valuation date.
• The terminal reserve value for the policy anniversary immediately following the valuation date.
• The amount of the most recent premium paid and the date it was paid.
• The policy’s annual anniversary date.

The Calculation Method

First, you must determine the increase in the terminal reserve over the policy year. This is done by subtracting the terminal reserve value from the anniversary date preceding the valuation date from the terminal reserve value of the anniversary date succeeding it.

Next, you calculate the portion of the policy year that has elapsed between the last anniversary date and the valuation date. For instance, if the policy anniversary is January 1 and the valuation date is April 1, approximately 90 days have passed out of 365. This is expressed as a fraction or decimal (90/365).

You then multiply the total increase in the terminal reserve for the year by this fraction. This result gives you the prorated increase in the reserve value up to the valuation date. This prorated amount is then added to the terminal reserve value from the beginning of the policy year.

The final step involves accounting for any unearned premium. You must determine what portion of the last premium paid covers the period after the valuation date. For example, if an annual premium of $1,200 was paid on January 1 for the full year and the valuation date is April 1, nine months ($900) are “unearned.” This unearned premium amount is added to the interpolated terminal reserve figure calculated previously.

Reporting the Value

Once the interpolated terminal reserve has been calculated, the resulting value must be reported on the appropriate federal tax return. If the life insurance policy was given as a gift to another individual or to a trust, its value is reported on Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

If the life insurance policy was owned by an individual who has passed away, its value becomes part of their gross estate. In this situation, the executor of the estate must report the interpolated terminal reserve on Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. Specifically, life insurance policies on the decedent’s life are detailed on Schedule D of Form 706.

In both gift and estate tax situations, a completed copy of Form 712, obtained from the insurance company, must be attached to the respective tax return to substantiate the reported value.