10. Taxation of life Insurance And Annuities - Premiums And Proceeds
Last-In, First-Out (LIFO)
principle applied to asset management in life insurance products, under which it is assumed that the funds paid into the policy last will be paid out first
Taxable
subject to taxation, payable to state and federal government
Tax deferred
taxes on investments or gains (such as interest or dividends) are paid at a future date instead of in the period in which they are incurred tax
A policyowner cancels his life policy but instructs the insurance company to transfer the cash value of his policy to an annuity. This nontaxable transaction is called
1035 Exchange
An IRA uses immediate annuities to pay out benefits; the IRA owner is nearly 75 years old when he decides to collect distributions. What kind of penalty would the IRA owner pay?
50% tax on the amount not distributed as required
What determines if a life insurance policy is a modified endowment contract?
7 - pay test
What is the name for an overfunded life insurance policy?
A Modified Endowment Contract (MEC)
An applicant buys a nonqualified annuity but dies before the starting date. Which beneficiary would the interest accumulate in the annuity NOT be taxable?
A Spouse.
According to the taxation rules of life insurance policies, how are cash value increases taxed?
Cash value growth is tax deferred.
What is the general taxation rule for death benefits payable to the beneficiary of a life insurance policy?
Death benefits are generally not subject to income taxes.
What is used to name the non taxed return of unused premiums?
Dividend
Why are dividends in life insurance policies not taxable?
Dividends are not considered income for tax purposes; they are a return of unused premiums
In a direct rollover, how is the money transferred from one retirement plan to a new one?
From trustee to Trustee
When would life insurance death benefits be tax-free?
If paid as a lump sum to the beneficiary
If the beneficiary of a life insurance policy receives death benefit payments that consist of principal and interest, which portion, if any, will be taxed?
Interest Only
What portion of a nonqualified annuity payment would be taxed?
Interest earned on the principal
If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a...
Modified Endowment Contract
Is the death benefit of a life insurance policy taxed to the beneficiary if it's received as a lump sum?
No, Lump-sum benefits are received tax free.
What if the following are not tax deductible, not taxable, or taxable: premiums, policy dividends, death benefit, policy loans, excess cash value, interest on dividends.
Not tax deductible: premiums & policy loans Not taxable: Policy dividends & death benefit Taxable: excess cash value & interest on dividends.
Upon surrender of a life insurance policy, what portion of the cash value will be taxed?
Only the portion in excess of the premium paid.
In which of the following instances would the premium be tax deductible?
Premiums paid by an employer on a $30,000 group term life insurance plan for employees.
First-In, First-Out (FIFO)
Principle under which it is assumed that the funds paid into the policy first will be paid out first.
What type of annuity activity will cause immediate taxation of the interested earned?
Surrendering the annuity for cash
Regarding taxation, cash value increases in life insurance policies grow
Tax deferred
During the accumulation period in a nonqualified annuity, what are the tax consequences of a withdrawal?
Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 1/2.
Gross Income
a person's income before taxes or other deductions
Pretax contribution
contribution made before federal and/or state taxes are deducted from earnings
Which portion of an annuity benefit payment will be taxed?
The interest earned on the principal - tax base.
What is the main purpose of the 7-pay test?
To determine if a life insurance policy is a Modified Endowment Contract.
When would life insurance policy proceeds be included in the insured's taxable estate?
When there is an incident of ownership at the time of death.
What are four things to know regarding taxation of Modified Endowment contracts?
Withdrawals are taxable, accumulations are tax deferred, distributions before age 59 1/2 incur 10% penalty on policy gains, policy loans are taxable distributions.
Tax Deductible
a reduction of taxable income, resulting in lower tax liability
Surrender
early termination of a policy by the policyowner
