Book 2 -- Risk Management // Employee Benefits

Earl is covered by a group long-term disability plan provided by his employer. The premium is $100 per month, of which Earl pays $25 with after-tax dollars and his employer pays the remaining $75. The monthly benefit is $3,000 paid until age 65. In the current year, Earl is injured in an accident and receives long-term disability benefits for 7 months. What amount must he include in his gross income? A)$5,250 B)$0 C)$15,750 D)$21,000

C // Earl receives a total of $21,000 in disability benefits ($3,000 × 7 months). Because his employer paid 75% of the premium, Earl must include 75% of the benefit in his gross income ($21,000 × 75% = $15,750).

Which of the following statements regarding Section 162 executive bonus plans is CORRECT? A) Employer does not receive an income tax deduction when the bonus is paid. B) The company is the policyowner C) Employee has taxable income in the year the bonus is paid, even if the bonus is paid directly to the insurance company to cover the premium on the cash value life insurance policy. D) The plan cannot be discriminatory

C // The employer receives an income tax deduction when the bonus is paid. The plan can be discriminatory and the employee is the policyowner.

Which of the following statements regarding insurance terms is(are) CORRECT? 1. Adverse selection is the likelihood that parties with the greatest probability of loss are more likely to purchase insurance. 2. Death is an example of a static risk. 3. Medicaid is an example of public insurance. 4. An aleatory contract is a contract which can only be accepted or rejected. A)4 only B)1, 2, and 3 C)3 and 4 D)1 and 2

D // Statements 3 and 4 are incorrect. Medicaid is an example of social insurance, not public insurance. An aleatory contract is a contract which the outcome is affected by chance and the dollars exchanged by the parties are unequal. A contract which can only be accepted or rejected is a contract of adhesion.

Ella owns a whole life insurance policy. Her total investment in the contract at the beginning of this year was $10,000. During the year, Ella paid premiums of $1,200 and the policy paid dividends of $300. She left the dividends on deposit with the insurance company, where they earned interest of $12 this year. What amount must Ella include in this year's gross income? A)$312 B)$0 C)$300 D)$12

D // Policy dividends are generally not taxable unless they exceed the policyowner's investment in the policy. If dividends are left on deposit, any interest on the dividends is taxable as ordinary income in the year earned.

Gordon purchases an annual renewable term life insurance policy with a face amount of $100,000. His premium is $600 for the first year. If Gordon renews the policy at the end of the first year, which of the following statements is(are) CORRECT? 1) Gordon must provide evidence of insurability. 2) Gordon's annual premium will remain at $600. 3) The face amount of the policy will still be $100,000. A) 1 and 3 B) 2 only C) 1, 2, and 3 D) 3 only

D // Statement 1 is incorrect because evidence of insurability is not necessary when renewing a term life insurance policy. Statement 2 is incorrect because the premium for a renewable term life insurance policy increases at each renewal.

Which of the following statements regarding rabbi trusts is(are) CORRECT? I. A rabbi trust is a trust established and funded by the employer that is subject to the claims of the employer's creditors (thus escaping current taxation for the executive), but the funds in the trust cannot be used by or revert to the employer. II. A rabbi trust calls for an irrevocable contribution on the employer's part to finance promises under a nonqualified plan and funds held in the trust cannot be reached by the employer's creditors. A)Neither I nor II B)Both I and II C)II only D)I only

D // Statement II is incorrect because it describes a secular trust.

Which of the following statements regarding the requirements for reinstating a lapsed life insurance policy are CORRECT? 1) Evidence of insurability must be provided. 2) All past due premiums must be paid. 3) The policy must not have been surrendered for its cash value. 4) The policy can be reinstated at any time. A) 1, 2, and 3 B) 1 and 3 C) 1 and 2 D) 2, 3, and 4

A // The policy must be reinstated within a certain period, typically three to five years from the lapse date.

Brett buys a 30-year convertible term life insurance policy when he is 25 years old. The face amount is $100,000 with annual premiums of $500. At age 40, he exercises the conversion provision. Which of the following statements regarding the conversion is(are) CORRECT? 1) Brett must provide evidence of insurability to exercise the conversion provision. 2)Brett's premium for the new policy will be based on his current age of 40. 3) Brett's new policy will be a permanent life policy. A) 2 and 3 B) 3 only C) 1 and 2 D) 1, 2, and 3

A

Larry purchased a variable annuity in 2001 and has a modified adjusted gross income (MAGI) of $325,000. The annuity is still in the accumulation period. Larry's basis in the annuity is $50,000, and the contract contains $100,000 in earnings. This year, he withdraws $60,000 from the annuity. Assuming Larry is 45 years old, which of the following statements regarding the tax consequences of this withdrawal is CORRECT? A) Larry must include $60,000 in gross income, pay a penalty of $6,000, and the $60,000 is subject to the 3.8% Medicare contribution tax. B) Larry is not required to include the amount of the withdrawal in gross income but must pay a penalty of $1,000. C) The withdrawal is tax-free and penalty free. D) Larry must include $10,000 in gross income and pay a penalty of $1,000.

A

Theron works part-time delivering pizzas during the summer. One night he is delivering pizzas for his employer when he is involved in an accident with another driver. The other driver, who was seriously injured, sues Theron and the pizza company. The judge finds that the accident was caused solely by Theron's negligence. The judge orders the pizza company to pay the other driver for his injuries and also imposes, as punishment, $1 million in damages. Which of the following statements regarding the outcome of this case is(are) CORRECT? I. The pizza company's liability for Theron's negligence is an example of vicarious liability. II. The $1 million in damages represents punitive damages. A)Both I and II B)II only C)Neither I nor II D)I only

A

Which of the following factors are important to consider when selecting an insurance company to recommend to a client? 1. Adequate surplus reserves 2. Cash flows and liquidity 3. Recent and historical earnings, earnings ability, and earnings stability 4. Management team A)1, 2, 3, and 4 B)2, 3, and 4 C)3 only D)1 and 2

A

Which of the following statements regarding business liability insurance is(are) CORRECT? 1) General business liability is the legal liability arising out of business activities, except auto, motorized vehicle, aircraft, and employee or workers' compensation injuries. 2) Business auto policies provide liability insurance for any negligence as a result of the use of the business automobiles. 3) Professional liability insurance provides coverage for malpractice causing harm or injury to the professional's client. 4) Business liability umbrella policies provide excess coverage on liability beyond the coverage provided in a firm's basic liability policy. A)1, 2, 3, and 4 B)2 and 3 C)4 only D)1 and 2

A

This afternoon, you have a client meeting with Tawni, age 51. She has a nonqualified variable annuity with a considerable amount of unrealized appreciation. Insurance companies are currently offering annuities with numerous investment choices which would provide Tawni with additional portfolio diversification and the potential for greater returns. As a knowledgeable and sophisticated investor, Tawni wants access to these additional investment choices. Based on her research and side-by-side comparisons, she has selected a new variable annuity and wants you to process the paperwork because she is too busy. Tawni also noted her interest in the possibility of moving funds into a variable universal life insurance policy. Based on Tawni's current needs, which of the following statements is (are) CORRECT? 1. Although Tawni delivered clear instructions on processing the transaction, you still need to establish and define the client-planner relationship before completing and submitting any paperwork. 2. Steps in financial planning process should be bypassed to expedite Tawni's request and provide her with the earliest opportunity to implement her investment strategy. 3. The end result may be helping Tawni complete a Section 1035 exchange from her old variable annuity into a new variable annuity. A)1 and 3 B)2 only C)1 and 2 D)3 only

A // A financial planner should establish the client-planner relationship before going any further with the financial planning process. Tawni would create a taxable event if she attempted to exchange the old variable annuity contract for a variable universal life insurance contract.

Which of the following statements regarding risk, maximum possible loss, and probability of occurrence in the future is(are) CORRECT? 1. Liability due to negligence has unlimited potential losses. 2. Premature death generally has a low chance of occurring in the future. 3. A person is more likely to experience premature death than to become disabled in the future. 4. Damages or losses to personal property are limited to the value of the property. A) 1, 2, and 4 B)1, 2, 3, and 4 C)1 only D)2, 3, and 4

A // A person is less likely to experience premature death than to become disabled in the future.

Carol, age 47, is a graphic designer and aspiring entrepreneur. She lives in a 3,000 square foot historic Victorian home for which the replacement cost is much greater than the current market value. Carol's income is largely dependent on bonuses which creates inconsistent cash flows. Her main concern is to make sure that her disabled grandchild, Trevor, will be provided financial support and adequate care in the event of her death. Currently, Carol has custody of Trevor because his mother is in a residential recovery program for substance abuse treatment. Carol hopes that George, the CFP® professional at her local bank, can guide her to an informed decision about insurance policies and coverage, given her various needs. Which of the following recommendations for Carol is(are) CORRECT? 1 - George should recommend a whole life insurance policy to provide the financial support for Trevor in the event that Carol dies prematurely because the flexible premiums will work well with her inconsistent cash flows. 2 - George should verify that Carol has an HO-5 homeowners insurance policy. 3 - George should recommend a personal liability umbrella policy (PLUP). 4 - George should recommend a universal life insurance policy to provide the financial support for Trevor in the event that Carol dies prematurely because the flexible premiums will work well with her inconsistent cash flows. A) 3 and 4 B) 1 only C) 1, 2, and 3 D) 2, 3, and 4

A // A universal life insurance policy would help Carol fulfill her permanent life insurance needs and provide flexibility to vary her future premiums and death benefit. A whole life insurance policy would not provide her with flexibility. George should verify that Carol has an HO-8 policy which is specifically designed for older Victorian homes where the replacement value is greater than the current value. Generally, clients should own a personal liability umbrella policy (PLUP)

Which of the following are risk exposures that may indicate a need for life insurance on a primary income earner? 1) Final expenses 2) Debts and mortgages 3) Education costs 4) Support of elderly parents A) 1, 2, 3, and 4 B) 1 and 4 C) 2, 3, and 4 D) 1 and 2

A // All of these are risk exposures. Other risk exposures include dependents' need for income and the funding of family goals.

John dies owning a $200,000 life insurance policy. He is the insured and his brother, Tom, is the beneficiary. Currently, Tom does not need all the benefits and elects to receive the benefits annually over a 10-year period. As a result, Tom will receive $23,500 annually. How much of this payment is includable in Tom's gross income each year? A) $3,500 B) $1,750 C) $23,500 D) $0

A // Any amounts received above the face amount of $200,000 will be taxable to Tom: $23,500 annual benefit × 10 years = $235,000 total amount received, $235,000 - $200,000 death benefit = $35,000 ÷ 10 = $3,500 per year included in gross income.

Rilee Corporation purchased a $50,000 whole life policy on a key employee, Susan. When Susan terminated employment with the corporation her husband, Ryan purchased the policy from the corporation for $15,000. Ryan designated himself sole beneficiary and had paid premiums of $8,000 by the time his wife died. What are the tax consequences to Ryan upon receipt of the life insurance proceeds? A)Ryan would receive $23,000 tax-free and $27,000 as ordinary income. B)Ryan would receive $15,000 tax-free and $35,000 as ordinary income. C)Ryan would receive $50,000 tax-free. D)Ryan would receive $8,000 tax-free and $42,000 as ordinary income.

A // Because Ryan's purchase of the policy falls under the transfer-for-value rule, the death benefit is included in Ryan's gross income to the extent it exceeds his basis in the contract. Ryan has a basis of $23,000, which represents the $15,000 he paid for the policy plus the additional $8,000 he paid after purchase.

Bud is employed by Big Rig Trucking where he is covered by a preferred provider organization (PPO) plan, a contributory disability income insurance plan, and an annuity pension plan. The disability income insurance plan provides long-term disability income coverage for which Bud is paying $40 per quarter and Big Rig is paying $60 per quarter for a monthly benefit of $1,000. During the current year, Bud was disabled for 5 months and collected disability payments of $1,000 per month for 3 months (he had a 60-day elimination period). Which of the following statements regarding Bud's company benefits in the current year is(are) CORRECT? 1) Bud will have to pay taxes on $1,800 of the disability income benefits for the current year. 2) Because Bud's medical plan with Big Rig is a PPO, he is able to receive care outside of the network of providers for lower deductibles and coinsurance fees. 3) Bud will have to pay taxes on $1,200 of the disability income benefits for the current year. 4) Bud may cover his adult children until they reach age 26 on Big Rig's medical plan. A) 1 and 4 B) 2, 3, and 4 C) 1, 2, and 4 D) 3 only

A // Because the employer pays 60% of the disability income insurance premiums, 60% of the disability income benefits are taxable ($3,000 × 60% = $1,800). A preferred provider organization (PPO) allows members to receive care outside the network of providers; however, the insured will generally face higher deductibles and/or higher coinsurance.

Patrick is covered by a split-dollar life insurance plan using the endorsement method. The plan is funded with a whole life insurance policy with a face amount of $750,000 and a cash value of $200,000. Patrick's employer has paid $150,000 in premiums on the policy. Patrick has named his daughter as residual beneficiary of the policy. Which of the following statements regarding the income tax consequences of this arrangement is CORRECT? A)At Patrick's death, the entire $750,000 death benefit is received income tax free. B)At Patrick's death, the employer must include its share of the death benefit in gross income. C)At Patrick's death, his daughter must include her share of the death benefit in gross income. D)Patrick's employer has received income tax deductions of $150,000 for the premiums paid to date.

A // Both the employer's share and the employee's share of the death benefit under a split-dollar life insurance plan are generally received income tax free. The employer receives no tax deduction for any premium payments under the plan.

Corinne is covered by Medicare Part B. In 2019 she incurs medical expenses of $10,000, consisting of diagnostic tests and physicians' services. What will be her out-of-pocket cost for the expenses, assuming they are covered expenses for purposes of Part B? A)$2,146 B)$2,185 C)$2,000 D)$185

A // Corinne must first pay a deductible of $185 (2019). She must then pay 20% of the remaining expenses ($9,815 × 20% = $1,963) for a total of $2,146 ($185 + $1,963).

Debbie, age 46, works for XYZ Fan Corporation in the warehouse. She earns a salary of $66,000 per year and has a group disability insurance policy that pays 50% of her salary in the event of her total disability. Her company pays 70% of the premium and she pays the remainder. One Wednesday afternoon, while she is driving the forklift, a stack of wood pallets falls on top of her and she becomes permanently disabled. Debbie is in the 24% marginal income tax bracket. Which of the following statements is(are) CORRECT? 1. Debbie's net after tax income would be $27,456 if she became totally disabled for 12 months. 2. Debbie would be taxed on 70% of her disability income benefit received from her group policy. 3. If Debbie receives workers' compensation benefits, she will have to pay federal income tax on those benefits. 4. If Debbie ends up qualifying for Social Security disability benefits, she will become eligible for Medicare benefits after receiving these benefits for at least 12 months. A)1 and 2 B)1, 2, 3, and 4 C)2, 3, and 4 D)1 and 3

A // Debbie's net after tax income if she becomes disabled would be $27,456, calculated as follows:$66,000 × 50% = $33,000 total benefits70% employer paid percentage × $33,000 = $23,100 taxable portion of benefits$23,100 × 24% marginal income tax bracket = $5,544 income tax$33,000 − $5,544 = $27,456 net after-tax income Workers' compensation benefits are received free of federal income tax. Debbie would not be eligible for Medicare benefits until she received Social Security disability benefits for at least 24 months.

All of the following statements regarding whole life insurance are correct EXCEPT: A)if the whole life insurance premiums are to be paid throughout the insured's lifetime, the insurance is known as limited-pay. B)whole life insurance offers permanent protection with cash values, and it can be either participating or nonparticipating. C)whole life insurance provides for the payment of the policy's face amount upon the death of the insured, regardless of when death occurs. D)the protection afforded b

A // If the whole life insurance premiums are to be paid throughout the insured's lifetime, the insurance is known as ordinary life; if the whole life insurance premiums are to be paid only during a specified period, the insurance is designated as limited-pay whole life.

Michelle purchased a $100,000 whole life insurance policy 25 years ago. To date, she has paid $50,000 in total premiums and received $10,000 in dividends. The policy has a cash surrender value (CSV) of $15,000 and is subject to a $30,000 outstanding loan. Michelle was recently referred to Elvis, a CFP® professional, to help her figure out what she should do with this policy. Prior to her meeting with Elvis, another financial planner recommended surrendering the policy and buying an annuity with the proceeds, while an insurance agent suggested purchasing a variable universal life insurance product due to the broad selection of investments. Which of the following statements statements offered by Elvis are CORRECT? 1) Elvis explains to Michelle that her investment in the contract is equal to $40,000. 2) Elvis mentions to Michelle that she cannot transact a Section 1035 exchange from her current life insurance contract into a new life insurance or annuity contract. 3) Elvis states that although Michelle would receive $15,000, she would only be taxed on $5,000 if she decided to surrender the policy. 4) Elvis states that one reason she may consider moving the funds from a whole life insurance policy into a variable universal life insurance policy is the flexibility when it comes to adjusting the premiums and the death benefit. A) 3 and 4 B) 2 and 4 C) 1, 2, and 4 D) 1 and 2

A // Michelle's gain at surrender equals the cash surrender value (CSV) minus the investment in the contract. The investment in the contract equals the premiums paid minus the dividends received minus the outstanding loans or withdrawals. Investment in contract = premiums paid - dividends received - outstanding loans or withdrawals= $50,000 - $10,000 - 30,000= $10,000 Gain at surrender = cash surrender value (CSV) - investment in contract= $15,000 - $10,000= $5,000 She could also transact a tax-free Section 1035 exchange to exchange the policy for another permanent life insurance policy or annuity.

According to NAIC model legislation, which of the following statements regarding long-term care insurance are CORRECT? 1. Contracts must be guaranteed renewable or noncancellable. 2. Applicants must have a 60-day free-look period. 3. Expected loss ratio must be at least 50%. 4. If the policy is a replacement policy, the insurer must waive the time period regarding pre-existing conditions. A)1 and 4 B)1 and 3 C)2, 3, and 4 D)1, 2, and 4

A // NAIC model legislation states that long-term care contracts must be guaranteed renewable or noncancellable. They must have a 30-day free look period and an expected loss ratio of 60%. If the policy is a replacement policy, the insurer must waive the time period regarding pre-existing conditions.

Adam, age 75, has been blind for 2 years. He has trouble walking and is unable to cook for himself. His family has told him that he needs to consider entering an assisted living facility. Would Adam be considered chronically ill under a qualified long-term care policy? A) No, neither sight nor cooking is considered an activity of daily living. B) Yes, he has been unable to perform 2 activities of daily living for over 90 days. C) Yes, as long as he can prove to the insurance company he is unable to perform these tasks. D) No, sight is not considered an activity of daily living, although cooking is.

A // Neither sight nor cooking is considered an activity of daily living (ADL). The Health Insurance Portability and Accountability Act (HIPAA) requires that qualified long-term care policies define chronically ill as being unable to perform 2 of the 6 ADLs. The 6 ADLs are eating, bathing, dressing, transferring from bed to chair, using the toilet, and maintaining continence.

Mr. and Mrs. Smith were recently divorced. The divorce decree required Mr. Smith to transfer a $250,000 life insurance policy on his life to Mrs. Smith and continue paying the policy premiums. The cash surrender value (CSV) of the policy at the time of the transfer was $100,000. Mrs. Smith named herself as beneficiary of the policy after the transfer. Which of the following statements regarding the income tax consequences of this transfer is (are) CORRECT? I. Mrs. Smith recognizes taxable income as a result of the transfer. II. When Mr. Smith dies, the $250,000 death benefit will be taxable to Mrs. Smith. A)Neither I nor II B)II only C)I only D)Both I and II

A // Neither statement I nor II is correct. A transfer of an insurance policy incident to a divorce does not result in taxation for either spouse, and the payment of the death benefit remains tax-free.

Diana has a personal automobile policy (PAP) covering her automobile. On August 1 of this year, she buys a new van that weighs 9,000 pounds. She uses the van as a delivery vehicle for the catering business she operates from her home. Which of the following statements regarding the PAP coverage for Diana's new van is(are) CORRECT? 1) The new van is automatically covered under Diana's PAP for 30 days. 2) The new van is permanently covered under Diana's PAP if she notifies her insurance company within 30 days. 3) The new van is not covered under Diana's PAP regardless of whether Diana notifies her insurance company. A) 3 only B) 1 only C) 1 and 2 D) 2 only

A // Only statement 3 is correct. The van is not eligible for coverage under Diana's PAP (even though it weighs less than 10,000 pounds) because it is being used as a delivery vehicle.

Aimee is the vice president and major shareholder of Peak, Inc. She owns a life insurance policy with a face amount of $1 million on her own life. Peak, Inc. adopts an entity purchase (stock redemption) buy-sell agreement and, as part of the agreement, the corporation buys Aimee's life insurance policy for $200,000 and names itself as beneficiary. The corporation pays $100,000 in premiums on the policy before Aimee dies. When Aimee dies, what amount of the $1 million death benefit is subject to income tax? A) $0 B) $1 million C) $900,000 D) $700,000

A // Peak's purchase of the policy from Aimee is not subject to the transfer-for-value rule because the transferee (Peak) is a corporation in which the insured is an officer or shareholder. Therefore, the entire death benefit remains tax-free.

Ronald, age 65, is enrolled in Medicare and has a health savings account (HSA) with single coverage. What is the maximum monthly contribution he can make to his HSA in 2019? A)$0 B)$575.00 plus catch-up contribution of $83.33 C)$287.50 plus catch-up contribution of $83.33 D)$287.50

A // People who have enrolled in Medicare at age (65) are no longer eligible to make HSA contributions. If Ronald chooses not to enroll in Medicare and meets all of the other requirements, such as being enrolled in a high deductible health insurance plan, he may still be able to make contributions to his health savings account.

Ted is seriously ill, and a doctor has certified that he is expected to die within 24 months. He owns a whole life insurance policy with a face amount of $500,000 and a cash surrender value (CSV) of $150,000. Ted's investment in the policy is $120,000. He sells the insurance policy to a qualified viatical agreement company for $200,000. Ted dies 17 months later. The viatical agreement company paid premiums of $10,000 on the policy before Ted died. Which of the following statements regarding the income tax consequences of this transaction is(are) CORRECT? 1. Ted receives the $200,000 payment from the viatical agreement company income tax-free. 2. Ted must pay income tax on $80,000 of the $200,000 payment received from the viatical agreement company. 3. The viatical agreement company must include $290,000 of the $500,000 death benefit in gross income. A)1 and 3 B)2 only C)2 and 3 D)1 only

A // Statement 1 is correct. Ted receives the payment from the viatical agreement company free of income tax because a doctor certified that he was expected to die within 24 months. Statement 3 is correct. The viatical agreement company's basis in the policy was $210,000 ($200,000 purchase price + $10,000 paid in premiums). The remaining $290,000 of the $500,000 death benefit is taxable income to the corporation.

Janelle is 65 years old. She has been a stay-at-home parent throughout her career and has accumulated only 10 quarters of Medicare-covered employment. Her husband, Kenny, is also 65 years old. Kenny has worked, full-time, as an engineer for 42 years and has over 40 quarters of Medicare-covered employment. Which of the following statements regarding Janelle's situation is(are) CORRECT? 1) Janelle is eligible for Medicare Part A. 2) Janelle must pay a monthly premium to enroll in Medicare Part A. 3) Janelle must pay a monthly premium to enroll in Medicare Part B. A)1 and 3 B)1, 2, and 3 C)1 and 2 D)3 only

A // Statement 1 is correct; Janelle is eligible for Medicare Part A because she is 65 years old. Statement 2 is incorrect; although Janelle has fewer than 40 quarters of covered employment, she does not have to pay a Part A premium because her husband has at least 40 quarters of coverage. Statement 3 is correct; enrollment in Part B requires the payment of a monthly premium.

Melody works for a company that granted her both incentive stock options (ISOs) and nonqualified stock options (NQSOs). Which of the following statements regarding these stock options are CORRECT? 1) When ISOs are exercised, the bargain element is included in Melody's gross income, but she receives a credit against her alternative minimum tax liability. 2) When NQSOs are exercised, the bargain element is considered W-2 compensation income and will be subject to Social Security (FICA) taxes. 3) A cashless exercise of the ISOs may result in a disqualifying disposition, causing Melody to recognize ordinary income. 4) A cashless exercise of the NQSO allows Melody to receive a 15% discount on the purchase price of the employer stock. A)2 and 3 B)3 and 4 C)1 and 2 D)1, 2, and 4

A // Statement 1 is incorrect because the bargain element of an ISO is not included in gross income upon exercise. In addition, the exercise of an ISO will result in a positive AMT adjustment, not a credit against AMT. Statement 2 is correct. Statement 3 is correct. With a cashless exercise, some or all of the option shares are sold to pay taxes. If ISO shares are sold within one year of exercise, a disqualifying disposition has occurred. Therefore, the shares sold are taxed as nonqualified stock options, resulting in ordinary income (not subject to FICA withholding) in the year of exercise. Statement 4 is incorrect. A cashless exercise allows an employee to exercise options without having to put up the cash required.

Luke has a personal automobile policy (PAP) insuring his SUV. His policy limits under Part A are 250/500/50, and his coverage under Part B is $5,000 per person. He does not carry coverage under Part C or Part D. One afternoon, he is driving with 3 of his friends as passengers when the SUV is struck by a hit-and-run vehicle. Luke and his friends all suffer bodily injuries which result in medical expenses of $7,000 each, for a total of $28,000. Luke's SUV also sustains damage of $5,000. The accident is determined not to have been Luke's fault. Which of the following statements regarding Luke's coverage under his PAP for this accident is(are) CORRECT? 1) Luke's PAP does not cover any of the medical expenses resulting from this accident because the accident was not his fault. 2) Luke's PAP covers $20,000 of the $28,000 in medical expenses. 3) Luke's PAP fully covers the damage to his SUV. A)2 only B)1 only C)1 and 3 D)2 and 3

A // Statement 1 is incorrect; Luke's coverage under Part B will cover up to $5,000 in medical expenses for each occupant of the SUV even though the accident was not his fault. Statement 2 is correct because Part B coverage will cover $5,000 of each occupant's medical expenses, for a total of $20,000. Statement 3 is incorrect; the damage to Luke's SUV is not covered because he does not have coverage under Part C (uninsured motorist) or Part D (physical damage).

Which of the following represent 2 of the 6 activities of daily living (ADLs) required to qualify for benefits from a long-term care insurance policy? A)Eating and bathing B)Bathing and cleaning the house C)Eating and driving a car D)Using the toilet and using the computer

A // To receive benefits from a long-term care insurance policy, the insured must be chronically ill. Chronically ill is defined as being unable to perform, without substantial assistance, two of six activities of daily living (ADLs) for at least 90 days. The ADLs include eating, bathing, dressing, transferring from bed to chair, using the toilet, and continence (i.e., the ability to control one's bowel and bladder). Substantial services are required to protect the individual because of substantial cognitive impairment.

Ed is a full-time employee of the General Company. General has 18 full-time employees and 6 part-time employees. The company provides a group health insurance plan for full-time employees and the normal group rate for the plan is $1,000 per month per employee. Ed and his wife are both covered by the plan. If Ed dies, which of the following statements regarding continuation of coverage under COBRA is(are) CORRECT? 1. Ed's wife is eligible for continuation coverage for a maximum of 18 months. 2. To receive coverage, Ed's wife must elect coverage within 30 days of Ed's death. 3. General Company may charge Ed's wife up to $1,020 per month for the coverage. A)3 only B)2 only C)1 and 3 D)1 and 2

A // Statement 1 is incorrect; the term of coverage is 36 months if the qualifying event is the death of the covered employee. Statement 2 is incorrect; to receive coverage, Ed's wife must elect coverage within 60 days of Ed's death. Statement 3 is correct; the employer may charge up to 102% of normal group rates for coverage.

Doug has a personal automobile policy (PAP) covering his automobile. His Part A policy limits are 200/300/50 and his Part B coverage is $10,000 per person. He does not have Part D coverage. One winter night, Doug and his wife are driving home from dinner when Doug takes his eyes off the road and drives into an unoccupied parked car. The other car sustains $20,000 in damages as a result of the collision. Doug and his wife both suffer bodily injuries and incur medical bills of $15,000 each. Doug's car suffers $10,000 in property damage. Which of the following statements regarding Doug's coverage under his PAP for this accident is(are) CORRECT? 1) Doug's PAP covers all of the $30,000 in medical bills. 2) Doug's PAP covers the $20,000 in damages to the other car. 3) Doug's PAP covers the $10,000 in property damage to his car. A)2 only B)1 and 3 C)2 and 3 D)1 and 2

A // Statement 2 is correct because the $20,000 in property damage to the other car falls within Doug's $50,000 policy limit for property damage under Part A - Liability Coverage. Statement 1 is incorrect because the coverage for the $30,000 is medical bills for Doug and his wife is limited to $10,000 per person under Part B - Medical Payments Coverage. Statement 3 is also incorrect; the damage to Doug's car is not covered because he does not have coverage under Part D - Damage to Your Auto Coverage.

Sherri received enough incentive stock options (ISOs) to purchase 10,000 shares of Dupre Co. stock at $10 per share. One year later, Sherri exercised all of the options when the market price of the stock was $25 per share. Sherri sold the 10,000 shares of Dupre Co. stock for $100 per share 2 years after exercise. Which of the following statements about these transactions is(are) CORRECT? 1. The grant of options is not a taxable event. 2. Sherri will pay income tax on a gain of $15 per share at exercise. 3. Sherri will have a positive AMT adjustment of $150,000 upon exercise. 4. At sale, Sherri's adjusted taxable basis equals $10 per share. A) 1, 3, and 4 B) 1 and 2 C) 2 and 3 D) 1, 2, and 3

A // Statement 2 is incorrect. The exercise of ISOs does not incur any regular income tax liability. Statement 3 is correct. Sherri has a positive AMT adjustment of $150,000 [($25 − 10) × 10,000] upon exercise of the ISOs. Statement 4 is correct. Sherri's adjusted tax basis is equal to the grant price, or $10 per share.

Yvonne is a full-time accountant for the DEF Company. DEF has 25 full-time employees and provides a group health plan for its full-time employees. Yvonne and her two children, ages 6 and 9, are covered by the plan. This year, DEF terminates Yvonne's employment after discovering she has been embezzling company funds. Which of the following statements regarding Yvonne's eligibility for COBRA continuation coverage is CORRECT? A)Neither Yvonne nor her children are eligible for continuation coverage because Yvonne's employment was terminated for gross misconduct. B)Yvonne is not eligible for continuation coverage because her employment was terminated for gross misconduct, but her children are eligible for continuation coverage for up to 29 months. C)Yvonne is not eligible for continuation coverage because her employment was terminated for gross misconduct, but her children are eligible for coverage until they reach age 19. D)Yvonne and her children are eligible for continuation coverage for up to 18 months.

A // Termination of employment for gross misconduct is not a qualifying event for purposes of COBRA, so neither Yvonne nor her children are eligible for continuation coverage.

Sheldon owns a life insurance policy. His investment in the contract is $50,000 and the cash surrender value (CSV) is $75,000. This year, he surrendered the policy in exchange for a lump-sum cash payment of $75,000 and later used the funds to purchase a portfolio of mutual funds. Which of the following statements is(are) CORRECT? 1) Sheldon will have to report $25,000 as ordinary income as a result of this transaction. 2) Sheldon could have transacted a Section 1035 exchange into a variable annuity and continued the tax deferred growth on his funds. 3) Sheldon has to report a long-term capital gain of $25,000 as a result of this transaction. A)1 and 2 B)3 only C)1 only D)2 and 3

A // The cash surrender value (CSV) minus the investment in the contract equals the gain at surrender ($75,000 - $50,000 = $25,000 gain taxed as ordinary income).

Which of the following statements regarding the tax issues of nonqualified retirement plans is NOT correct? A)The deduction for the employer can occur at any time, regardless of when the inclusion of income occurs for the executive employee. B)Funds that are deemed to be constructively received are required to be reported as taxable income by the executive. C)If there is a substantial risk of forfeiture, the deferred compensation will not be treated as constructively received and there will be no current taxable income to the executive. D)Because an unfunded promise to pay an executive has an element of risk, there is no current taxation to the executive.

A // The deduction for the employer is not available until the compensation is included in the executive's income.

Tammy recently left Aaron Developers to take a job as an executive with a competitor. Her new employer offers some of the executives the right to purchase company stock by issuing options to the executives each year. The executives typically receive incentive stock options (ISOs) and nonqualified stock options as part of their compensation package. This year, Tammy received a package consisting solely of ISOs. Which of the following statements regarding Tammy's ISOs is(are) CORRECT? 1) If Tammy is still in possession of any ISOs as she nears retirement, she must exercise them within 3 months from her date of retirement or termination. 2) The maximum value of incentive stock options (ISOs) which may first become exercisable in any one year is $100,000 (stock is valued on the grant date). 3) If Tammy sells shares of stock acquired through the exercise of these ISOs within 1 year from the date of exercise or 2 years from the date of the grant, the gain is considered W-2 compensation income not subject to payroll tax. 4) The expiration date on any ISOs granted to Tammy cannot exceed 2 years from the date of the grant. A) 1, 2, and 3 B) 1 only C) 2, 3, and 4 D) 1, 2, 3, and 4

A // The expiration date cannot exceed 10 years from the date of the grant.

Josephine, age 56, is a surgeon at the local hospital with an annual salary of $300,000. Which of the following disability policies would be appropriate for Josephine? A)Short-term, own occupation B)Long-term, own occupation C)Short-term, any occupation D)Long-term, any occupation

B // Josephine needs a long-term, own occupation (own occ) disability insurance policy. As a surgeon, her income is $300,000 and she is unlikely to earn this salary in another occupation.

Martin passed away at age 48. He owned a modified endowment contract (MEC) which had a cost basis of $77,000 and a face amount of $200,000. How is the death benefit taxed to the sole primary beneficiary on Martin's MEC? A)$123,000 is taxed as ordinary income. B)The entire $200,000 is tax-free. C)$123,000 is taxed as long-term capital gain. D)The entire $200,000 is taxable as ordinary income.

B // The death benefit for a MEC is taxed the same as any life insurance contract death benefit. Generally, the benefit is received income tax-free unless there was a transfer-for-value.

Rank the following permanent life insurance products by cost of the first-year premium, from lowest to highest: 1- Ordinary whole life 2- Single premium 3- life10-year 4- pay20-year pay A) 1, 4, 2, 3 B) 1, 4, 3, 2 C) 1, 3, 4, 2 D) 1, 2, 3, 4

B

Which of the following statements regarding Section 162 executive bonus plans is(are) CORRECT? 1. The employer, corporation, or other entity pays a bonus to the executive for the purpose of purchasing cash value life insurance policy. 2. The executive is the policyowner, the insured, and the person who designates the beneficiary. 3. The plan cannot be discriminatory. 4. The employer has an income tax deduction when the bonus is paid. A)2, 3, and 4 B)1, 2, and 4 C)1 only D)1, 2, 3, and 4

B // A Section 162 executive bonus plan can be discriminatory.

Generally, which type of insurance policy is appropriate for any client during any life cycle phase? A) Long-term care insurance B) Personal liability umbrella policy (PLUP) C) Disability insurance D) Collision coverage on an automobile

B // A personal liability umbrella policy (PLUP) is a useful insurance product that provides additional protection during any life cycle phase. Wealthy clients can purchase PLUPs to protect their assets from negligence law suits, while lower to moderate income earners could purchase PLUPs to protect their future wages from being garnished in similar law suits.

Which of the following statements regarding rabbi trusts is NOT correct? A)A single rabbi trust can be used to fund the assets of multiple deferred compensation plans sponsored either by a single employer or by an employer and its subsidiaries. B)The rabbi trust calls for an irrevocable employer contribution to finance promises under a nonqualified plan, but funds held in the trust cannot be reached by the employer's creditors. C)A rabbi trust can have a springing irrevocability provision, protecting an executive's rights in the case of a management takeover. D)A rabbi trust is an employer funded trust that is subject to the claims of the employer's creditors (thus escaping current taxation for the executive), but the funds in the trust cannot be used by or revert to the employer.

B // A trust in which the assets cannot be reached by the employer's creditors is a secular trust.

All of the following statements regarding the legal characteristics of insurance contracts are correct EXCEPT: A) insurance contracts are conditional, (i.e. the failure of one party to perform relieves the other party of his or her obligation). B) generally, when the terms of the policy are ambiguous, obscure, or susceptible to more than one interpretation, the construction most favorable to the insurer will prevail. C) most property, liability, and health insurance contracts are considered contracts of indemnity. D) the insurance contract is personal and follows the person rather than the property.

B // Because the insurer has the advantage in drafting the agreement and is expected to clearly represent the intent of the parties, it is generally held that when the terms of the policy are ambiguous, obscure, or susceptible to more than one interpretation, the construction most favorable to the policyowner will prevail.

Brandi is facing a risk which has the potential for a high severity of loss but has a low probability of occurring in the future. Which risk management technique would be appropriate for Brandi to manage this risk? A)Avoid the risk B)Transfer the risk to an insurance company C)Retain the risk D)Reduce the risk

B // Brandi should transfer this risk to an insurance company. Insurance is designed to manage risks which have a potentially high severity of loss and low probability of occurring in the future.

Which of the following statements regarding a flexible spending account (FSA) provided to an employee are CORRECT? 1. Employee contributions to the account will not be subject to federal income taxes. 2. Employee contributions to the account will not be subject to Social Security taxes. 3. A flexible spending account is a cafeteria plan funded through employee salary reductions. 4. Amounts in an employee's account can be used to make contributions to a health savings account for the employee. A) 1 and 4 B) 1, 2, and 3 C) 2, 3, and 4 D) 1 and 3

B // Contributions are not subject to federal income tax or Social Security tax. An FSA is a type of cafeteria plan and is therefore subject to complex rules regarding discrimination. Benefits under an FSA cannot be used for health savings account contributions.

Scott has an HO-3 homeowners policy on his house. The dwelling is insured for $200,000. One evening, two friends are visiting Scott's house. As they are walking up Scott's sidewalk, one of the friends trips while clowning around and breaks his ankle, incurring emergency room expenses of $5,000. The injured friend acknowledges that the accident occurred through no fault of Scott's. Which of the following statements regarding coverage for this accident under Scott's HO-3 policy is CORRECT? A) Scott's HO-3 policy provides no coverage because the accident was not his fault. B) Scott's HO-3 policy covers up to $1,000 of the friend's medical expenses. C) Scott's HO-3 policy covers up to $2,500 of the friend's medical expenses. D) Scott's HO-3 policy covers the entire $5,000 of the friend's medical expenses.

B // Coverage F (medical payments to others) of a homeowners policy pays up to $1,000 for medical expenses incurred by someone who is injured on the insured premises, even if the insured is not at fault. Coverage E (personal liability) applies only when the insured is legally liable.

Grant, age 50, has a life insurance policy with a $500,000 face amount and a cash value of $200,000. The face amount will remain constant for Grant's life, but no further premiums are due once Grant reaches age 65. This year, Grant receives a policy dividend of $100. What type of life insurance policy does Grant own? A)Nonparticipating limited pay whole life B)Participating limited pay whole life C)Level term life insurance policy D)Term life to age 65

B // Grant's policy is a participating limited pay whole life policy. The fact that George received a policy dividend indicates he has a participating policy. The fact that no further premiums are due once he reaches age 65 indicates he has a limited pay whole life policy. The policy is not a term life insurance policy because it has a cash value.

This year, the XYZ Corporation pays premiums of $10,000 on a $500,000 life insurance policy covering one of its executives. During the year, the cash value of the policy increases by $3,000. The beneficiary of the policy is the executive's estate. Which of the following statements regarding the income tax consequences of this arrangement is CORRECT? A) XYZ may deduct $7,000; the executive must include $13,000 in gross income. B) XYZ may deduct $10,000; the executive must include $10,000 in gross income. C) XYZ may deduct nothing; the executive includes nothing in gross income. D) XYZ may deduct $10,000; the executive must include $13,000 in gross income.

B // If a corporation pays the premium on a policy covering an employee and the corporation is not a beneficiary, the premium is considered compensation to the employee and is deductible by the corporation. The increase in cash value of a life insurance policy accumulates tax-free as long as it is not withdrawn.

Jane is an agent for the ABC Life Insurance Company. Her agency agreement authorizes her to solicit insurance applications, collect initial premium payments, and issue conditional receipts. When Jane issues a conditional receipt, she is exercising what type of authority? A) Vicarious authority B) Express authority C) Implied authority D) Apparent authority

B // Jane exercises express authority when she issues a conditional receipt because the authority to issue conditional receipts is expressly stated in her agency agreement.

John Smith has a major medical policy with a $500 deductible and an 80/20 coinsurance provision, with a maximum out of pocket (MOOP) of $8,000. What amount will the insurer pay if John incurs $30,500 of covered medical expenses? A)$22,500 B)$24,000 C)$6,500 D)$30,000

B // John pays the $500 deductible, leaving a balance of $30,000. Then he pays 20% of this amount, or $6,000, for a total of $6,500. The insurer pays the remaining $24,000.

Susie owns a high performance sports car valued at $80,000. What is the maximum loss which could result from Susie driving carelessly in inclement weather conditions and causing an accident with another car valued at $20,000? A) $100,000 B) Unlimited C) $20,000 D) $80,000

B // Liability due to negligence has an unlimited possible loss. Susie could be sued for driving recklessly given the weather conditions and causing injuries and medical expenses, along with punitive damages. There is no limit to how much she may be required to pay through her insurance coverage, her assets, or garnished wages. Susie should consider purchasing a personal liability umbrella policy (PLUP) to help insure against large liability claims.

Samantha has a homeowners policy. Her dog bites the mailman and he incurs emergency room expenses of $600. What is the consequence of this event? A) There is no coverage under this policy because pets are excluded. B) Medical payments coverage is applicable, and liability coverage is applicable if Samantha is held legally liable. C) Samantha needed a personal liability umbrella policy (PLUP) for coverage of this type of risk. D) Only medical payments coverage applies, not liability coverage.

B // Medical payments coverage under Section II of a homeowners policy applies regardless of whether the insured is legally liable. Personal liability coverage applies if the insured is legally liable.

Madison is covered by her husband's employer-sponsored group health plan. Her husband dies in an accident on July 15 and she elects COBRA coverage on September 12. Which of the following statements regarding Madison's coverage under COBRA is(are) CORRECT? 1) Madison has missed the deadline for electing COBRA coverage. 2) Madison has until October 27 to pay the premium for the period of COBRA coverage prior to September 12. 3) Madison is eligible for up to 36 months of coverage. 4) Madison must pay the entire cost of her COBRA coverage. A) 3 and 4 B) 2, 3, and 4 C) 2 and 4 D) 1 only

B // Only statement 1 is incorrect; Madison met the 60-day deadline for electing COBRA coverage following her husband's death on July 15.

Which of the following are reasons an employer might favor a nonqualified plan over a qualified plan? 1) A nonqualified plan has more design flexibility. 2) A nonqualified plan typically has lower administrative costs. 3) Nonqualified plans typically allow the employer an immediate income tax deduction. 4) Employers can generally exclude rank-and-file employees from a nonqualified plan. A)3 only B)1, 2, and 4 C)1 and 4 D)1 and 2

B // Only statement 3 is incorrect. Nonqualified plans do not allow the employer to take an income tax deduction until the employee recognizes the income on his tax return.

Which of the following statements about long-term and short-term disability insurance contracts is(are) CORRECT? 1. Short-term disability coverage generally provides coverage for up to two years. 2. Long-term disability coverage generally provides benefits for two or more years or until the insured reaches a certain age, typically 65. 3. Short-term disability coverage generally provides coverage for up to six months. 4. Long-term disability coverage generally provides benefits for at least 10 or more years or until the insured reaches a certain age. A)2 only B)1 and 2 C)1 only D)3 and 4

B // Short-term disability coverage generally provides coverage for up to two years. Long-term disability coverage generally provides benefits for two or more years or until the insured reaches a certain age, typically 65.

Daryl is involved in an automobile accident that seriously injures the driver of the other car. Daryl was later determined to be intoxicated at the time of the accident. As a result of the accident, the other driver incurs medical bills of $100,000 and physical rehabilitation expenses of $20,000. In addition, the other driver's car suffers $15,000 in damage. At trial, the judge finds that the accident was caused by Daryl's negligence. The judge orders Daryl to pay the other driver's medical bills, rehabilitation expenses, and car repair expenses. The judge also awards $500,000 for the other driver's pain and suffering and imposes $10 million in damages as punishment, for a total of $10,635,000 in damages. Of the $10,635,000, what amount represents special damages? A) $515,000 B) $135,000 C) $120,000 D) $10,635,000

B // Special damages represent compensation for measurable losses, such as medical bills. In this case, the special damages are $135,000 ($100,000 medical bills + $20,000 rehabilitation expenses + $15,000 damage to the car).

Brian, age 63, is covered by a health savings account (HSA). This year he contributes $1,000 to the HSA and his employer contributes $2,000. Brian also takes a distribution of $3,000 to pay for qualified medical expenses. Which of the following statements regarding the income tax consequences of these transactions is(are) CORRECT? 1) Brian may take an above-the-line tax deduction of $1,000 for his own contribution. 2) Brian must include the $3,000 distribution in his gross income. 3) Brian must include the employer's $2,000 contribution in his gross income. A) 2 and 3 B) 1 only C) 2 only D) 1 and 3

B // Statement 1 is correct. Statement 2 is incorrect because HSA distributions used to pay for qualified medical expenses are excluded from gross income. Statement 3 is incorrect because employer contributions to an HSA are excluded from employee gross income.

The Andersons own an equity-indexed annuity with a cap rate of 9%, a floor of 3%, and a participation rate of 90%. If the underlying index increases by 13% this year, what interest rate will be credited to their annuity? A) 11.7% B)9% C)13% D)8.1%

B // The cap rate represents the maximum rate of interest that will be credited to an equity-indexed annuity, regardless of the participation rate and actual return of the index. Because the Andersons' cap rate is 9%, the maximum return that can be credited to their annuity is 9%.

Mr. and Mrs. Wood have an HO-3 homeowners policy on their home. Their home is insured under the policy for $500,000. The Woods have 2 detached garages, each with a replacement cost of $30,000. Mr. Wood uses one of the garages to store an antique automobile he plans to restore someday and Mrs. Wood uses the other garage to make pottery, which she does strictly as a hobby. How much coverage do the Woods have under Coverage B of their homeowners policy? A)$30,000 B)$50,000 C)$60,000 D)$45,000

B // The coverage under Coverage B of a homeowners policy is 10% of the coverage on the dwelling. Neither garage falls under an exclusion to Coverage B, so the Woods' coverage is $50,000.

Dan's employer has 100 employees, 20 of whom are key employees. The employer maintains a group term life insurance plan which covers 75 total employees, including 70 non-key employees. Dan is not a key employee and is provided with $100,000 in group term life insurance coverage under the plan. The cost of $1,000 of protection per month for someone in Dan's age bracket is $0.43 and Dan contributes $120 annually toward the cost of the coverage. As a result of his group term life insurance coverage, what amount is included in Dan's annual gross income? A)$0 B)$138 C)$258 D)$120

B // The employer's plan is nondiscriminatory because it covers at least 70% of all employees and at least 85% of the 80 non-key employees. As a result, the plan is eligible for the $50,000 exclusion for group term life insurance coverage. Dan must include the cost of his excess group term life insurance in his gross income. Dan's excess coverage is $50,000 ($100,000 − $50,000). The monthly cost of his excess coverage is $21.50 (50 × $0.43), and the annual cost is $258 ($21.50 × 12). The annual cost of the excess coverage less Dan's contribution is $138 ($258 − $120).

Which of the following statements regarding the need for disability insurance is(are) CORRECT? 1) Disability insurance replaces lost income when a person becomes disabled. 2) A disability may be more of a financial hardship than premature death because increased expenses often accompany the loss of income. 3) The probability of becoming disabled is less than the probability of premature death. 4) If a disability arises from a work-related accident or illness, benefits to the injured employees are generally paid by workers' compensation. A) 2, 3, and 4 B) 1, 2, and 4 C) 3 only D) 1, 2, 3, and 4

B // The probability of becoming disabled is greater than the probability of premature death.

Debbie, a CFP® professional, has an appointment with Jack this afternoon. Jack is a knowledgeable, astute investor and is considering purchasing a permanent life insurance policy. He wants to achieve tax-deferred stock market-like returns. He is also looking for a policy with flexible premiums and an adjustable death benefit. Which of the following statements on permanent life insurance products and their key features is(are) CORRECT? 1. Variable life insurance will give Jack the ability to adjust the premiums and death benefit as needed in the future. 2. Variable universal life insurance will give Jack the ability to adjust the premiums and the death benefit as needed in the future. 3. Both variable life insurance and variable universal life insurance will give Jack the potential to achieve tax-deferred stock market-like returns. 4. Variable life insurance provides a guaranteed minimum death benefit which can increase based on favorable investment performance of the subaccounts, but cannot fall below the face value. A)1, 3, and 4 B)2, 3, and 4 C)2 and 3 D)4 only

B // Variable universal life insurance will give Jack the ability to adjust the premiums and the death benefit as needed in the future. Variable life insurance has level premiums and provides a guaranteed minimum death benefit which can increase based on favorable investment performance of the subaccounts, but cannot fall below the face value.

Joe, 55 years old with a modified adjusted gross income (MAGI) of $80,000, believes he owns a modified endowment contract (MEC). His basis in the policy is $40,000 and the cash value is $60,000. On his 56th birthday, Joe wants to go to Hawaii and borrow $10,000 of the cash value. Joe is in the 24% tax bracket. Which of the following statements is(are) CORRECT? 1. Assuming Joe owns a MEC, his tax liability for the $10,000 loan is $3,400. 2. If Joe actually owns a whole life insurance policy, his current tax liability for the $10,000 loan is $0. 3. If Joe is incorrect, and instead, he owns a nonqualified annuity, his tax liability will be $0. A)1, 2, and 3 B)1 and 2 C)1 and 3 D)3 only

B // When a withdrawal or loan is obtained from a modified endowment contract (MEC), the taxpayer must pay taxes on the loan amount on a last-in, first-out (LIFO) basis. The withdrawal is first credited to the excess of the cash value over the basis and that money is taxable as ordinary income. In addition, taxpayers under age 59½ who take withdrawals from a MEC must pay a 10% penalty on those taxable withdrawals. Joe's total tax liability will be 34% of his loan, or $3,400. If Joe owns a nonqualified annuity, he will owe the same amount of tax as he would on the MEC.

Justin has an HO-5 homeowners policy. The dwelling is insured for $150,000. He keeps personal property valued at $20,000 in a lake cottage, where he spends his summer weekends. What amount of coverage does Justin have on the personal property he keeps at the lake cottage? A)$10,000 B)$7,500 C)$15,000 D)$20,000

B // When personal property is located at another residence of the insured (e.g., a vacation home), the coverage on that property is limited to the greater of $1,000 or 10% of the Coverage C insurance. Because Justin's dwelling is insured for $150,000, his coverage under Coverage C is $75,000 and the personal property at the cottage is insured for $7,500 ($75,000 × 10%).

Which of the following are examples of risk management techniques available to clients? 1) Avoiding a particular risk by refusing to participate in the activity. 2) Transferring a risk to the insurance company through an insurance contract. 3) Exercising risk retention by installing a smoke alarm. 4) Utilizing the risk reduction technique by increasing a deductible on an automobile insurance policy. A) 1, 2, and 3 B) 1, 2, 3, and 4 C) 2, 3, and 4 D) 1 and 2

D

Which of the following is(are) characteristics of a personal liability umbrella policy (PLUP)? 1. The policy provides excess liability insurance coverage over and above the basic underlying insurance contracts. 2. Coverage is broad and includes protection against certain losses not covered by the underlying insurance contracts. 3. Coverage is expensive. 4. Coverage is at least as broad as the underlying liability coverage but also covers personal injury liability. A)3 only B)1, 2, 3, and 4 C)1, 2, and 4 D)1 and 2

C // Coverage under a PLUP is inexpensive.

Doug is a full-time employee of the XYZ Company. XYZ provides a group health insurance plan for its employees, their spouses, and dependents. Doug and his wife, Alberta, are covered by the plan. This year, Doug and Alberta finalized their divorce and Alberta is no longer eligible for coverage under the group plan as Doug's spouse. Which of the following statements regarding Alberta's eligibility for continuation of coverage under COBRA is(are) CORRECT? 1) Alberta is eligible for up to 36 months of continuation coverage. 2) To receive continuation of coverage, Alberta must elect coverage within 60 days of the divorce. 3) To receive continuation of coverage, Alberta must pay a premium within 45 days after electing to receive coverage. A)1 only B)2 only C)1, 2, and 3 D)2 and 3

C

Tim is a shareholder in a small corporation and his modified adjusted gross income (MAGI) is over $300,000. He owns a life insurance policy with a face amount of $200,000 on his own life. His investment in the policy is $75,000. The corporation adopts a cross-purchase buy-sell agreement and, as part of the agreement, one of the other shareholders buys Tim's policy for $100,000 and names himself as beneficiary. The other shareholder, who has a MAGI over $400,000, pays $20,000 in premiums on the policy before Tim dies. Which of the following statements regarding the income tax consequences of this transaction is CORRECT? A)Both Tim and the co-shareholder will include nothing in gross income. B)Tim must include nothing in gross income; the co-shareholder must include $80,000 in gross income and is not subject to the Medicare 3.8% contribution tax. C)Tim must include $25,000 in gross income; the co-shareholder must include $80,000 in gross income and both of the gains are subject to the 3.8% Medicare contribution tax. D)Tim must include $25,000 in gross income and is subject to the 3.8% Medicare contribution tax; the co-shareholder must include nothing in gross income and is not subject to the Medicare 3.8% contribution tax.

C

Which of the following are employer objectives that can be achieved by including a forfeiture provision in a company's nonqualified retirement plan? 1) To discourage key executives from leaving the company prematurely, a golden handcuffs provision can be incorporated into the plan specifying that substantial benefits will be forfeited if service is voluntarily terminated prior to normal retirement age. 2) To prevent a decrease in revenue and to ensure a smooth transition in company leadership, a nonqualified deferred compensation plan can require a key executive to provide consulting services after retirement or forfeit any benefit under the plan. 3) To discourage former employees from leaving the business and going to work for a competitor, a non-compete provision can require the forfeiture of nonqualified benefits if the employee enters into competition with the employer. A) 1 only B) 1 and 3 C) 1, 2, and 3 D) 2 and 3

C

Which of the following statements regarding constructive receipt in a nonqualified retirement plan is(are) CORRECT? I. Constructive receipt occurs if the deferred compensation is credited to an executive's account, set apart for the executive, or made available to the executive so that he may draw upon it anytime or could draw on it if notice of intention to draw had been given. II. Constructive receipt does not occur if the deferred compensation is subject to substantial limitations or restrictions, or if the election to defer compensation is a mere promise to pay, not represented by notes or secured in any way. A)Neither I nor II B)I only C)Both I and II D)II only

C

Which of the following statements regarding key employee life insurance is(are) CORRECT? 1) Key employee life insurance covers employees who are considered critical to the success of a business and whose death might cause a significant financial loss to the company. 2) Businesses have an insurable interest in key employees. 3) The business owns the policy, pays the premiums, and is the beneficiary. 4) Premiums are not tax-deductible, but the death benefit is received by the business income tax free. A) 1 and 2 B) 1, 2, and 3 C) 1, 2, 3, and 4 D) 4 only

C

Steve purchased a house for $750,000. The house has a replacement cost of $1 million and is covered for fire related perils by ABC Insurance Company up to $425,000, with an 80% coinsurance provision and a $5,000 deductible. A fire caused $400,000 in covered damage. Calculate the amount ABC Insurance company will pay for this loss. A)$185,000 B)$197,000 C)$207,500 D)$200,000

C // (Amt of insurance carried ÷ Amt of insurance required) × Amt of loss - Deductible = Amt paid($425,000 ÷ $800,000) × $400,000 - $5,000 = $207,500

Over the past 20 years, Green Corporation stock has grown at an average rate of 15% annually. The management of the corporation wants to provide a benefit to all employees that will permit the employees to take advantage of this growth. However, they do not want to give the employees any control of the company. Which of the following arrangements would be the most appropriate for Green Corporation? A)Employee stock purchase plan B)Restricted stock plan C)Phantom stock plan D)Incentive stock options

C // A phantom stock plan is the most appropriate arrangement because a phantom stock plan credits an employee's account with units that mirror the stock value. However, the employees never actually receive any stock in the company. All of the other choices are incorrect, because they would result in the employee receiving stock (and possible control) of the company.

John, age 29, and Susie, age 28, have recently married and are meeting with their CFP® professional to review their risk management plan. Currently, they have a mortgage in excess of $200,000 and drive new luxury cars. Both John and Susie have one young child from a prior marriage. Which of the following types of insurance should John and Susie consider to be their lowest priority? A) Collision and liability insurance for their luxury cars B) Homeowners insurance C) Long-term care insurance D) Life insurance

C // Along with their mortgage, John and Susie both have a young child from a prior marriage and a luxury car. At this point in their lives, life insurance, homeowners insurance, and auto insurance should take priority over long-term care insurance. Typically, long-term care insurance is not a necessary part of a couple's risk management plan until they are middle aged or above, between 40 to 50 years old.

Which of the following scenarios is subject to current year taxation under the economic benefit or constructive receipt rules? A) ABC Corporation buys life insurance on the lives of its key executives to fund their nonqualified plan, which contains a golden handcuffs provision. ABC owns the policies, pays the premiums, and is the beneficiary of the policies. ABC has direct control over the cash values in the policies and can divert these funds to business use, if desired. B) JKL Corporation awards the CEO with restricted stock options that vest in three years. C) DEF Corporation makes a bonus available to its officers that can be taken as current income or deferred by leaving the funds in an irrevocable trust in which the officers are the beneficiaries. D) GHI Corporation transfers assets to an irrevocable trust in which a key executive is the beneficiary. The trust is subject to the claims of the employer's creditors.

C // Because DEF's officers have the option of receiving the bonuses immediately, they are in constructive receipt of the cash and the bonuses are included in their gross incomes. ABC Corporation owns and controls the life insurance policies and cash values; therefore, there is no constructive receipt or economic benefit to the plan participants. The trust that GHI transfers assets to meets the requirements of a valid rabbi trust. The funds placed in the trust are not included in the employee's gross income. The participants involved in the JKL Corporation stock options are not subject to federal income taxes under the economic benefit rule (IRC Section 83).

Kenneth exercised incentive stock options (ISOs) granted by his employer. The ISOs were granted over 2 years ago and he is now selling the stock 6 months after the options were exercised. Which of the following statements about Kenneth's transactions is(are) CORRECT? 1) The gain is considered W-2 compensation income, subject to payroll taxes. 2) The gain is considered a long-term capital gain. 3) The gain is considered W-2 compensation income, not subject to payroll taxes. 4) The ISOs Kenneth received needed to be a part of a written plan approved by the stockholders. A)2 only B)3 only C)3 and 4 D)1 and 4

C // Because Kenneth did not wait more than 1 year after the date of exercise, the gain is W-2 compensation income, but is not subject to payroll taxes. If Kenneth had waited more than 1 year after the date of exercise and 2 years from the grant date to sell the stock, the gain would be treated as a long-term capital gain.

Which of the following statements regarding a health savings account (HSA) are CORRECT? 1) Health savings accounts are not available for self-employed individuals. 2) Health savings accounts are used to pay unreimbursed qualified health care expenses of the account holder, the account holder's spouse, or the account holder's dependents. 3) Contributions to a health savings account are subject to an annual limit. 4) Distributions from a health savings account that are not used for qualifying medical expenses are subject to income tax and a penalty, regardless of the account holder's age. A)1, 2, and 3 B)2, 3, and 4 C)2 and 3 D)1 and 4

C // HSAs are available for self-employed individuals. Distributions not used for medical expenses are taxable and subject to a 20% penalty tax, unless they are made after the account beneficiary's death, disability, or attaining age 65.

Which of the following statements pertaining to qualified annuities and nonqualified annuities are CORRECT? 1. Qualified annuities are derived from a qualified plan and may or may not have a cost basis. 2. Nonqualified annuities are annuities purchased with at least some after-tax dollars that are not sourced from a qualified plan annuity. 3. If the distribution from the nonqualified annuity is not annuitized over the owner/annuitant's life expectancy, the first in, first out (FIFO) tax rule applies. 4. Premature distributions on a qualified or nonqualified annuity (before age 59½) are subject to a 10% penalty. A)1 and 3 B)1, 2, and 3 C)1, 2, and 4 D)2 and 4

C // If the distribution from the nonqualified annuity is not annuitized over the owner/annuitant's life expectancy, the last in, first out (LIFO) tax rule applies.

Which of the following actions would help reduce an insurance premium? 1. Increasing the deductible on a property and casualty policy. 2. Decreasing the length of the elimination period for a disability or long-term care policy. 3. Improving your health and diet for a health insurance policy. 4. Choosing a safer occupation for a disability insurance policy. A)1 and 2 B)1, 2, 3, and 4 C)1, 3, and 4 D)3 and 4

C // Increasing the length of the elimination period for a disability or long-term care insurance policy will help reduce the premium.

Trish, age 57, owns a modified endowment contract (MEC). Her investment in the contract equals $35,000 and the policy has a cash surrender value (CSV) of $50,000. This year, she takes a policy loan of $25,000 from the policy. Assuming Trish's marginal income tax rate is 24%, what are the income tax consequences of this loan? A) Trish will owe no income tax and no penalty. B Trish will owe income tax of $7,000 plus a penalty of $700. C) Trish will owe income tax of $3,600 plus a penalty of $1,500. D) Trish will owe income tax of $7,000 but no penalty.

C // Loans from MECs are taxed on a last in, first out (LIFO) basis. Trish will owe income tax of $3,600 ($15,000 × 24%) on the gain ($50,000 cash surrender value (CSV) − $35,000 investment in contract = $15,000 taxable gain). She will also owe a 10% penalty on the $15,000 taxable gain because the policy is a MEC and she is younger than 59½ years old.

Which of the following types of property is(are) excluded from personal property coverage under Coverage C of a homeowners policy? 1. Pets 2. Property belonging to tenants who are not related to the insured 3. Credit cards 4. Cash A)2 only B)3 and 4 C)1, 2, and 3 D)1 only

C // Pets, property belonging to tenants who are not related to the insured, and credit cards are all excluded. Cash is not excluded but coverage is limited to $200.

Sandy, age 50, has a single-coverage health plan with a deductible of $1,700 and a maximum out-of-pocket of $10,000 for 2019. Today is June 1, 2019 and Sandy wants to establish a health savings account (HSA). Her employer does not offer an HSA. Which of the following statements regarding Sandy's situation is CORRECT? A) Sandy is eligible for an HSA because her health plan is a high-deductible health plan. B) Sandy can establish an HSA on June 1, but her maximum contribution will be limited to a prorated amount. C) Sandy is not eligible to establish an HSA because her health plan's maximum out-of-pocket is over the $6,750 limit for 2019. D) Sandy is not eligible for an HSA because HSAs must be employer-sponsored.

C // Sandy's health plan does not qualify as a high-deductible health plan for 2019 because the plan's maximum annual out-of-pocket is over the $6,750 limit. The plan does not have to be employer-sponsored.

Shelley is a full-time employee of Topper, Inc. Topper has 15 full-time employees and provides a group health plan for its full-time employees. Shelley, her husband, and their three children are covered by the plan. Because of a slowdown in business, Topper reduces Shelley's status to part-time, causing her to lose eligibility for the health plan. Which of the following statements regarding Shelley's eligibility for continuation coverage under COBRA is CORRECT? A)Shelley is eligible for continuation coverage for up to 18 months. B)Shelley is eligible for continuation coverage for up to 29 months. C)Shelley is not eligible for continuation coverage. D)Shelley is eligible for continuation coverage for up to 36 months.

C // Shelley is not eligible for continuation coverage under COBRA. Topper does not have at least 20 full-time employees, so the health plan is not subject to the COBRA requirements.

Mr. and Mrs. Concepcion have an HO-6 homeowners policy covering their condo. Their coverage under Coverage C is $100,000. One day while they are at work, their plumbing freezes and their unit is uninhabitable due to water damage. They are forced to move into an apartment for 6 weeks while their unit is repaired. Which of the following statements regarding the Concepcions' coverage under their HO-6 policy is(are) CORRECT? I. The water damage is not covered under the Concepcions' HO-6 policy. II. The HO-6 policy provides the Concepcions with loss of use coverage of up to $40,000. A)Both I and II B)I only C)II only D)Neither I nor II

C // Statement I is incorrect; frozen plumbing is a covered peril under an HO-6 policy. Statement II is correct; an HO-6 policy provides for loss of use coverage equal to 40% of the amount of Coverage C coverage.

Mariel owns a house that has a replacement cost of $300,000. The house is insured under an HO-3 homeowners policy; the coverage on the dwelling is $250,000 with a $1,000 deductible. There are construction materials with a replacement cost of $20,000 on the premises which will be used in the construction of a guest room. A fire destroys the construction materials, does $25,000 in damage to the house, and completely destroys a detached garage that has a replacement cost of $30,000. How much will Mariel recover under the policy? A)$54,000 B)$49,000 C)$69,000 D)$70,000

C // The construction materials are covered under Coverage A of Mariel's policy, and the detached garage is covered up to $25,000 under Coverage B (Coverage B = 10% of Coverage A). Mariel recovers $25,000 for the damage to the house, $20,000 for the damage to the construction materials, and $25,000 for the damage to the garage, minus the $1,000 deductible, for a total of $69,000.

Which of the following statements about annuities is(are) CORRECT? 1) The funds in a fixed annuity are held in the insurance company's general account and the insurance company bears all of the investment risk. 2) The funds in a fixed annuity are held in subaccounts and the owner of the fixed annuity bears all of the investment risk. 3) The fixed annuity is designed for a conservative investor who is more concerned with safety of principal than keeping up with inflation. 4) Annuitization occurs when the annuity owner elects to convert the money in an annuity into a stream of periodic payments. A) 1, 2, and 3 B) 2 and 3 C) 1, 3, and 4 D) 3 only

C // The funds in a fixed annuity are held in the insurance company's general account and the insurance company bears all of the investment risk.

Bruce, a CFP® professional, wrote a life insurance policy on his client, Jenny, and entered a misstated age on her application without seeking verification. With Bruce's help, Jenny applied for a life insurance policy that had an annual premium of $25 per $1,000 for age 40 and $15 per $1,000 for age 35. On the application, Bruce recorded Jenny's age as 35 and processed the application for the purchase of a $20,000 life insurance policy, receiving a check from Jenny for the appropriate annual premium for a 35-year-old. Jenny died unexpectedly one year later at the age of 41. What are the implications assuming the insurance company discovers Jenny misstated her age on the application? 1) The insurance company will pay the full $20,000 death benefit to Jenny's beneficiaries. 2) The insurance company will only pay a death benefit of $12,000. 3) Because Jenny's beneficiaries received significantly less money from the life insurance policy, they may be short on their liquidity needs. 4) Bruce may be held liable for damages if he is deemed to be negligent in taking the application. A)1 and 3 B)2 and 4 C)2, 3, and 4 D)1, 3, and 4

C // The insurance company will reduce the death benefit to reflect the benefit that would have been purchased (using the premiums actually paid) had Jenny been truthful on her application. The $300 annual premium Jenny paid would have purchased $12,000 of life insurance at $25 per $1,000. Bruce may need to use his errors and omissions insurance if he is found to be negligent because Jenny's beneficiaries may be short on their liquidity needs due to the error on the application.

Last week, Robert celebrated his 60th birthday. Under which of the following circumstances would he qualify to receive benefits from his long-term care insurance policy? 1) Robert is unable to eat, dress, or use the toilet without substantial assistance for 30 days. 2) Robert is unable to bathe and transfer from bed to chair without substantial assistance for 90 days. 3) Robert requires substantial assistance with continence and using the toilet for 90 days. 4) Robert is unable to transfer from bed to chair, dress, and control his bowel and bladder for 90 days. A) 1 and 3 B) 4 only C) 2, 3, and 4 D) 3 and 4

C // To receive benefits from a long-term care insurance policy, the insured must be chronically ill. Chronically ill is defined as being unable to perform, without substantial assistance, two of six activities of daily living (ADLs) for at least 90 days. The ADLs include eating, bathing, dressing, transferring from bed to chair, using the toilet, and continence (i.e., the ability to control one's bowel and bladder). Substantial services are required to protect the individual because of substantial cognitive impairment.

Steve purchased a house for $750,000. The house has a replacement cost of $1 million with an 80% coinsurance provision and a $2,000 deductible. What is the minimum amount of coverage Steve should have on the house in order to be fully covered for a partial loss up to the policy limit? A)$850,000. B)$750,000. C)$800,000. D)$1,000,000.

C // Under the coinsurance provision, the amount of coverage required to fully cover a partial loss up to the policy limit would be $800,000, or 80% of $1 million. Financial planners should always recommend that homes be insured for 100% of replacement cost in order to protect against a total loss. Homeowners insurance policies only cover damages up to the policy limit.

The Tops Corporation purchased a variable annuity in 2018 as part of a nonqualified deferred compensation (NQDC) plan for one of its key employees. In 2018 the annuity loses $20,000 in value and in 2019 the annuity gains $25,000 in value. Which of the following statements regarding the income tax treatment of this annuity in 2018 and 2019 is CORRECT? A) The $20,000 loss is deductible as a short-term capital loss, and the $25,000 gain is taxable as a long-term capital gain. B) The $20,000 loss is not deductible, and the $25,000 gain is not taxable. C) The $20,000 loss is deductible as an ordinary loss, and the $25,000 gain is taxable as ordinary income. D) The $20,000 loss is not deductible, and the $25,000 gain is taxable as ordinary income.

C // When a non-natural person such as a corporation owns an annuity, gains on the contract are taxed as ordinary income and losses are treated as ordinary losses.

You have a 35-year-old client with an extremely conservative risk tolerance. He is an attorney specializing in entertainment law and his income for the next ten years will probably be the highest of his career. He wants a life insurance policy that has stability and is guaranteed to be in force until age 95. He is also concerned about the possibility of negligence liability in his business practice. Based on your client's profile and insurance needs, which of the following statements are CORRECT? 1) A whole life insurance policy may be appropriate for this client. 2) This client may be a good candidate for malpractice insurance. 3) Modified whole life insurance may be appropriate for this client. 4) Errors and omissions insurance may be appropriate for this client. A) 1 and 2 B) 2 and 4 C) 1 and 4 D) 2 and 3

C // Whole life insurance is the most appropriate type of coverage for this client. Current cost is not an issue and, in the long run, he will end up paying less for the coverage over his life expectancy. In addition, whole life insurance fits his low risk tolerance. This type of policy has guaranteed costs, a guaranteed death benefit, and guaranteed cash values. Modified whole life insurance is used for individuals who have a long-term insurance need, but cannot initially afford the higher initial cost of traditional whole life. Errors and omissions insurance covers professionals whose negligence primarily causes financial harm, such as accountants, lawyers, and financial planners. Malpractice insurance covers professionals whose negligence primarily causes physical harm, such as physicians, dentists, and physical therapists.

The rule excluding employer-paid health insurance premiums from employee income is applicable to coverage on: 1) The employee, if currently employed. 2) The employee's spouse. 3) The employee's dependents other than a spouse. 4) The employee, if retired. A) 2 only B) 1, 2, and 3 C) 1 and 4 D) 1, 2, 3, and 4

D

Which of the following situations would be covered under Coverage F of a homeowners policy?The insured's maid falls down the stairs of the insured's house.The insured's dog gets loose and bites a child several blocks away.The insured's son is playing basketball on a nearby playground and collides with another player, breaking the player's nose.The insured's daughter falls off a swing set in the insured's back yard and breaks her arm. A)4 only B)1, 2, and 3 C)1 only D)2 and 3

D // Coverage F (medical payments to others) would not cover the insured's maid (Statement 1) because Coverage F generally excludes residence employees. The insured's daughter (Statement 4) would not be covered because Coverage F does not apply to the insured or members of the insured's household. Statements 2 and 3 both describe situations that would be covered by Coverage F.

Which of the following statements regarding the use of a cafeteria plan is(are) CORRECT? 1. Any Section 401(k) plan contribution through the plan will be taxable income to the employee. 2. Employees may take the money allocated to the plan in cash instead of selecting benefits. 3. Cafeteria plans are less complex and less expensive than standard benefit plans. 4. Cafeteria plans must comply with the tax provisions in Section 125 of the Internal Revenue Code (IRC). A)3 only B)1, 2, 3, and 4 C)1 only D)2 and 4

D // A Section 401(k) plan contribution through a cafeteria plan will not necessarily be subject to current income tax. Employees may allocate the benefit dollars to various benefits offered by the employer, or they may take some or all of the money in cash, which is includible in the employee's gross income. Section 125 addresses cafeteria plans, which are more complex and more expensive than standard benefit plans.

A client is buying a home near a hillside. The client is concerned that during heavy rains the neighborhood may be prone to flooding or landslides as a result of runoff from the hill. Which of the following perils would be covered under the client's standard homeowners insurance policy? 1. Landslides or mudflow. 2. Flood, surface water, waves, tidal waves, and overflow of a body of water. 3. Water that backs up through sewers or drains or overflows from a sump. 4. Water damage in the form of burst pipes. A)1 and 3 B)1 and 2 C)2, 3, and 4 D)4 only

D // A standard homeowners insurance policy will not protect the client against mudslides or flooding. Earth movement and water damage are among the eight perils that are excluded from all homeowners policies; however, water damage resulting from a pipe bursting is covered.

Margaret is a shareholder in a small corporation. She owns a life insurance policy with a face amount of $300,000 on her own life. The corporation adopts a cross-purchase buy-sell agreement and, as part of the agreement, one of the other shareholders buys Margaret's life insurance policy for $200,000 and names herself as beneficiary. The other shareholder pays $10,000 in premiums on the policy before Margaret dies. When Margaret dies, what amount of the $300,000 death benefit is subject to income tax? A)$100,000 B)$300,000 C)$0 D)$90,000

D // Although a transfer to a partner of the insured or to a corporation in which the insured is an officer or shareholder is exempt from the transfer-for-value rule, a transfer to a co-shareholder of the insured is not exempt. The co-shareholder's purchase of the policy from Margaret is subject to the transfer-for-value rule. Therefore, the death benefit is includible in the transferee's gross income to the extent that the death benefit ($300,000) exceeds the amount paid for the policy ($200,000) plus any subsequent premiums paid ($10,000). In addition, the $90,000 taxable gain may also be subject to the 3.8% Medicare contribution tax (also referred to as the Net Investment Income Tax) which applies to net investment income of taxpayers with MAGI exceeding a certain threshold.

Sarah has an HO-5 homeowners policy on her home. Her home is insured for $300,000. She has a detached garage for personal use with a replacement cost of $25,000. She also has a detached shed she rents to a local building contractor, who uses it for storage. The replacement cost of the shed is $10,000. How much of her $35,000 worth of detached buildings are covered have under Coverage B of her homeowners policy? A) $35,000 B) $20,000 C) $30,000 D) $25,000

D // Although the coverage under Coverage B of a homeowners policy is generally 10% of the coverage on the dwelling, the shed rented to the contractor is excluded from coverage. The garage used for personal use is insured for a replacement cost of $25,000.

Mark's corporate employer has provided him with a salary reduction nonqualified deferred compensation plan. The company decided to use a rabbi trust to hold the assets for the plan. The plan will provide Mark with 60% of his current salary at retirement. In addition, the plan provides for income to his spouse upon his death. Which of the following statements with regards to the company's plan are CORRECT? 1. Mark's benefits will be taxed as ordinary income upon distribution. 2. Mark's benefits will be tax-free upon distribution. 3. The funds his employer deposits into the rabbi trust are subject to the claims of the company's general creditors. 4. The risk of forfeiture is considered substantial, so there is no current taxation for Mark. A)2, 3, and 4 B)1 and 3 C)1 and 4 D)1, 3, and 4

D // Because Mark defers part of his salary, benefits from the plan are fully taxable as ordinary income upon distribution.

Stacy, a CFP® professional, has an appointment with Karen, one of her long-time clients, to coordinate life insurance planning. Karen is a single, 45 year old professional with no dependents. She wants to borrow $25,000 with a 5-year payback period and her goal is to ensure that it will be paid off if she dies prematurely. Stacy's next appointment is with Bob who is looking for permanent life insurance. Bob is currently making $45,000 per year and he expects a significant pay increase 5 years from today. Bob's brother and his wife will also be joining the meeting and they are looking for a life insurance policy that will pay their estate taxes. Which of the following statements regarding Stacy's clients is(are) CORRECT? 1) Karen, Bob, and Bob's brother and spouse are candidates for term life insurance. 2) Bob's brother and his wife may be able to benefit from a first-to-die life insurance policy to help cover their estate taxes. 3) Stacy should consider reviewing the terms of a modified whole life insurance policy with Bob and a term life insurance policy with Karen. 4) Karen, Bob, and Bob's brother and spouse are all candidates for a personal liability umbrella policy (PLUP). A) 2, 3, and 4 B) 1 only C) 1, 2, 3, and 4 D) 3 and 4

D // Bob needs permanent life insurance, therefore, he is not a candidate for term life insurance. Bob's brother and his wife would benefit from a second-to-die life insurance policy which is designed to cover estate taxes. Most clients are candidates for a personal liability umbrella policy (PLUP).

Which of the following statements describing insurance product recommendations and life cycle phases is(are) CORRECT? 1. There should be an emphasis on life and disability insurance during the asset accumulation phase, especially if there are dependents. 2. Disability insurance should be emphasized during the distribution phase. 3. Property and casualty insurance should be part of a client's risk management plan throughout the entire life cycle. 4. Health insurance should be emphasized to a greater degree once a client is approximately 60 years old. A)1, 2, 3, and 4 B)2, 3, and 4 C)1 only D)1, 3, and 4

D // Disability insurance should not be emphasized during the distribution phase. Generally, most clients are either retired or close to retiring in the distribution phase and their children are often financially independent at this time.

All of the following companies provide group health plans for their employees. Which of them is(are) subject to the COBRA continuation of coverage requirements? 1) Company A, with 15 full-time employees. 2) Company B, with 13 full-time employees and 16 part-time employees. 3) Company C, with 10 full-time employees and 30 part-time employees. A) 3 only B) 1 and 2 C) 1 only D) 2 and 3

D // Employers with group health plans and 20 or more employees are subject to the COBRA requirements. A part-time employee counts as half a full-time employee for purposes of this rule. Company B (13 + 8 = 21) and Company C (10 + 15 = 25) both satisfy the 20-employee rule.

Gerald, age 62, is covered by his employer's group health insurance plan. He resigns his position to retire and begins receiving Social Security retirement benefits. Gerald does not plan to return to work, but wants to ensure that he is never without health care coverage. Which of the following statements regarding Gerald's situation is CORRECT? A)Gerald has no need to purchase individual health coverage because he can purchase COBRA continuation coverage until he becomes eligible for Medicare at age 65. B)Gerald is not eligible for COBRA continuation coverage because he is on Social Security. C)Gerald is not eligible for COBRA continuation because he resigned voluntarily. D)Gerald should consider purchasing an individual health policy because his COBRA coverage will expire before he becomes eligible for Medicare at age 65.

D // Gerald is eligible for up to 18 months of COBRA continuation coverage as a result of his voluntary termination of employment. He should consider purchasing an individual health insurance policy because his COBRA coverage will expire before he becomes eligible for Medicare at age 65.

A client annuitized his fixed annuity and selected a life annuity with a 15-year period certain payout option. The income payments from the annuity were $2,000 per month. After 10 years of receiving income payments, the client died. Which of the following statements with respect to the client's income payments is(are) CORRECT? 1) Income payments of $2,000 per month will continue to the client's designated beneficiary for 5 years. 2) Income payments will stop. 3) If the client had chosen a straight life annuity payout option, payments would have ceased upon the client's death. 4) If the client had chosen a joint and survivor annuity, payments would have ceased upon the client's death. A) 1 and 4 B) 2, 3, and 4 C) 2 only D) 1 and 3

D // In a life annuity with period certain payout option, if the annuitant dies before the end of the specified period, payments continue to the annuitant's designee for the remaining term. In this case, payments continue for five years. The joint and survivor annuity payout option will continue to make payments until the death of the last of the two annuitants.

Mary and Robert are approaching retirement age and they are concerned about long-term care insurance. Which of the following could be considered as a funding source for their long-term care needs? 1) The balance in their flexible spending account (FSA) can be used to reimburse long-term care expenses tax-free. 2) Personal assets may be used to fund long-term care needs. 3) A life insurance accelerated death benefit may be used to pay qualified long-term care expenses. 4) A partnership long-term care insurance program may help fund long-term care needs while providing a specific dollar amount of asset protection if the beneficiary is eventually forced to apply for Medicaid benefits. A) 1, 2, 3, and 4 B) 1 and 4 C) 1, 2, and 3 D) 2, 3, and 4

D // Long-term care services or coverage cannot be reimbursed tax-free under the current provisions of a flexible spending account (FSA).

Meals are excludable from income if they are provided:By the employer.On the employer's premises.For the convenience of the employer. A)1 and 2 B)1 and 3 C)3 only D)1, 2, and 3

D // Meals must be provided on the premises of and for the convenience of the employer to be excludable from the income of the employee.

Burt, age 63, purchased a commercial real estate property. An office building located on the property is rented by a tenant who makes monthly rent payments to Burt's real estate investment firm. Burt has a wife and 2 children and personally owns 3 cars and his business has 9 employees. Which of the following statements is(are) CORRECT? 1) When Burt purchased his property insurance, he needed to have a financial interest in the property for the policy to be approved by underwriting. 2) Burt should raise his liability coverage on his personal automobiles and purchase a personal liability umbrella policy in the event one of his employees has an accident. 3) Burt should purchase at least 90% of the property's replacement cost in the form of commercial property insurance policy. A)1, 2, and 3 B)1 and 2 C)3 only D)1 and 3

D // Only statement 2 is incorrect. Burt personally owns the vehicles. In order to have employees covered for liability, he would need to have the vehicles placed in the name of the business and purchase a commercial insurance policy.

Which of the following statements describing the advantages and disadvantages of variable life insurance are CORRECT? 1) Variable life insurance has the potential to generate greater investment returns than whole life insurance. 2) The owner may choose from a variety of investment subaccounts. 3) The actual cash value in a variable life insurance policy may differ greatly from the anticipated cash value. 4) The owner is guaranteed that the cash value can never decline to zero. A) 2 and 3 B) 1, 3, and 4 C) 1 and 2 D) 1, 2, and 3

D // Only statement 4 is incorrect. One of the disadvantages of variable life insurance is that the buyer must be willing to give up the guarantee of a stated cash value in exchange for the possibility of an enhanced cash value and death benefit.

Bob, one of your younger clients, just finished having coffee with his golf acquaintances and they were discussing the benefits of their current life insurance policies. When asked about his life insurance policy, Bob was uncertain of its key characteristics and benefits. He had long forgotten your presentation outlining his life insurance needs, choices, and the reasoning behind your recommendation of his current universal life insurance policy. Which of the following statements to remind Bob about the features of his life insurance policy are CORRECT? 1) Universal life insurance may be considered an unbundled life insurance contract because of its flexible premium and adjustable death benefit. 2) The Option A death benefit includes both the cash value and the face amount. 3) The cash accumulation value is determined by current interest rates or the specified minimum guaranteed interest rate, whichever is highest. 4) The cash accumulation value is determined by the rate offered on the start date of the contract. A) 1, 2, and 4 B) 1, 2, and 3 C) 2 and 4 D) 1 and 3

D // The Option A death benefit only includes the face amount of the policy. An Option B death benefit includes both the face amount and the cash value. The cash value accumulation is determined by the greater of the guaranteed minimum interest rate, as specified at inception, or the current market interest rate.

Derrick is involved in an automobile accident. The other driver is seriously injured and incurs medical expenses of $200,000. Following the accident, the other driver's employer-provided health insurance covers $180,000 of these expenses. At the ensuing trial, the judge finds that Derrick's negligence caused the accident and that he is responsible for the other driver's injuries. Which of the following statements regarding the application of the collateral source rule to this situation is CORRECT? A) Derrick is not required to pay any damages because the other driver recovered from his own insurance company. B) Derrick must pay $10,000 in damages, representing 50% of the amount not paid by the other driver's health insurance. C) Derrick must pay only $20,000 in damages because the other driver recovered $180,000 from a collateral source. D) Derrick must pay the entire $200,000 in damages even though the other driver's insurance covered $180,000 of his medical expenses.

D // The collateral source rule provides that damages assessed against a negligent party will not be reduced simply because the injured party has other sources of recovery available. Derrick must pay the entire $200,000 in damages.

Jane's employer has 200 employees, 160 non-key employees and 40 key employees. The employer's group term life insurance plan covers 150 employees including 120 of the non-key employees. Along with the other non-key employees, Jane is provided with $50,000 in group term life insurance coverage under the plan. The cost of $1,000 of protection per month for someone in Jane's age bracket is $0.66. What amount is included in Jane's annual gross income as a result of her group term life insurance coverage? A)$33 B)$330 C)$396 D)$0

D // The employer's plan is discriminatory because it does not cover at least 85% of the 160 non-key employees (160 × 85% = 136). As a result, all of the key-employees would not be eligible for the $50,000 exclusion for group term life insurance coverage; however, since Jane is a non-key employee, she would retain her $50,000 exclusion.

Bill is covered by a homeowners HO-4 policy for tenants, which has a $500 deductible. While he is at work, burglars steal his television, stereo, $150 cash, and $1,000 designer watch. Which of the following statements is CORRECT? A) Only the television and stereo are covered. B) None of the losses will be covered. C) The cash is not covered. D) All of the items are subject to the deductible, but the watch is subject to a specific coverage limit.

D // The watch is considered jewelry and is limited to $1,500. In this instance, it is covered entirely (less the deductible). All of the items are subject to the deductible. The cash is fully covered because the amount is within the $200 limit.

Four years ago, Janet was granted a nonqualified stock option (NQSO) to purchase 500 shares of employer stock at $30 per share. Janet would like to receive as many shares of stock as she can from the option, but she does not have any cash to pay for the exercise cost of the option. She exercised the option when the fair market value of the stock was $40. Assume Janet's marginal income tax rate is 24%. If Janet opts for a cashless exercise, how many shares of employer stock can she receive (ignoring FICA)? A) 405 B) 500 C) 0 D) 95

D // This is an example of the cashless exercise of an NQSO. Janet will receive 95 shares of the employer stock, calculated as follows: The exercise cost of the option is $15,000; (500 shares × $30 per share). In addition, because the option is a NQSO, Janet will have to pay ordinary income tax of $1,200 on the bargain element: [($40 FMV − $30 exercise price) × 500 shares × 24% tax rate]. Therefore, the total cost of the option is $16,200. To cover the total cost of the option, 405 shares of the stock must be sold; ($16,200 total cost ÷ $40 fair market value (FMV) per share). Thus, 500 − 405 = 95.

Which of the following eligibility requirements must be met for a disabled worker to receive workers' compensation benefits? A)The disabled person need only work in a covered occupation. B)The disabled person must either work in a covered occupation or must have a job-related accident or disease. C)The disabled person need only have a job-related accident or disease. D)The disabled person must work in a covered occupation and must have a job-related accident or disease.

D // To receive workers' compensation benefits, two eligibility requirements must be met: the disabled person must work in a covered occupation and the worker must have a job-related accident or disease. Most occupations are covered by workers' compensation, but many states exclude coverage for farm workers, domestic servants, and casual employees.

Keith has an HO-5 homeowners policy on his house. The dwelling is insured for $200,000. His house is partially destroyed by a tornado and is uninhabitable for 6 months. Keith moves into his brother's house, where he lives rent free until his house is repaired. He incurs expenses of $3,000 for meals while his house is under repair. Which of the following statements regarding Keith's coverage under Coverage D of his HO-5 policy is CORRECT? A)Benefits under Coverage D are limited to $1,500 for the first 50% of Keith's meals. B)Benefits under Coverage D are limited to $3,000 for Keith's meals. C)Coverage D pays no benefits because Keith lived rent free during the repairs. D)Coverage D covers Keith's meals plus the fair rental value of Keith's house during the repairs.

D // Under Coverage D, if the insured does not incur additional living expenses when the dwelling is uninhabitable, the insured receives a benefit equal to the fair rental value of the property. The additional cost of meals is also covered.

Phillip is involved in a serious automobile accident and incurs medical expenses and other damages totaling $300,000. Philip sues the other driver for negligence. At the ensuing trial, the court finds both drivers were negligent and rules that the other driver was 90% responsible for the accident while Phillip was 10% responsible. Assuming that the contributory negligence rule applies, which of the following statements regarding the outcome of this case is CORRECT? A) Phillip can recover $150,000 from the other driver. B) Phillip can recover $300,000 from the other driver. C) Phillip can recover $30,000 from the other driver. D) Phillip can recover nothing from the other driver.

D // Under the contributory negligence rule the injured party cannot recover damages if his own negligence contributed to his injuries, even if his own negligence was slight. Note: pure contributory negligence is more theory than practice. Most states have some sort of comparitive negligence laws on the books.

Your client, Claudia, has come to you seeking advice on selecting the appropriate life insurance product. During your conversation, she asks you about the difference between a universal life insurance policy with an Option A death benefit and a universal life insurance policy with an Option B death benefit. Which of the following statements CORRECTLY describe the differences between these two policy types? 1) A universal life insurance policy with an Option A death benefit is more expensive than a universal life insurance policy with an Option B death benefit. 2) A universal life insurance policy with an Option B death benefit has a level death benefit. 3) The net amount at risk to the insurance company remains constant over time with a universal life insurance policy with an Option B death benefit. 4) In a universal life insurance policy with an Option A death benefit, the death benefit is only the face amount. A) 1 and 2 B) 2 and 3 C) 1 and 4 D) 3 and 4

D // Universal life insurance with an Option B death benefit is more expensive than universal life insurance with an Option A death benefit because the death benefit is equal to a specified amount of insurance plus the cash value. Universal life insurance with an Option A death benefit provides a death benefit equal to only the face amount of the policy. Over time, the net amount at risk to the insurance company decreases under universal life insurance with an Option A death benefit while it remains constant under universal life insurance with an Option B death benefit.

Which of the following statements concerning homeowners insurance is(are) CORRECT? 1. War, earth movement, power failure, and volcanic eruptions are all general exclusions. 2. An HO-6 policy is designed for condominium owners. 3. Coverage on the dwelling is on an actual cash value basis provided that the amount of insurance coverage is at least 80% of the replacement cost of the building. 4. Section D provides coverage for loss of use. A)3 only B)1, 2, 3, and 4 C)1, 2, and 4 D)2 and 4

D // Volcanic eruptions are one of the 12 basic perils. Coverage on the dwelling is on a replacement cost basis provided that the amount of insurance coverage is at least 80% of the replacement cost of the building.

Dennis participates in a qualified retirement plan maintained by his employer. The retirement plan includes a life insurance policy with a $100,000 death benefit payable to Dennis's son, Bob. The cash value of the policy is $60,000. During his participation in the plan, Dennis included $25,000 in his gross income, representing the cost of insurance. If Dennis dies today and the $100,000 death benefit is paid to Bob, what amount must Bob include in his gross income? A)$60,000 B)$100,000 C)$0 D)$35,000

D // When a beneficiary receives the death benefit from a life insurance policy funded within a qualified plan, the taxable portion equals the cash surrender value of the policy ($60,000) minus any costs included in the participant's income during the participant's life ($25,000).

Julian is a partner in the XYZ Partnership. He owns a life insurance policy with a face amount of $300,000 on his own life. The XYZ partners adopt a cross-purchase buy-sell agreement, and as part of that agreement William, another partner, buys Julian's life insurance policy for $50,000 and names himself as beneficiary. William pays $10,000 in premiums on the policy before Julian dies. Upon Julian's death, what amount of the $300,000 death benefit must William include in his gross income? A)$300,000 B)$240,000 C)$60,000 D)$0

D // William's purchase of the policy from Julian is not subject to the transfer-for-value rule because the transferee (William) is a partner of the insured. Therefore, the entire death benefit is excluded from William's gross income.

Kevin signs a contract to act as an agent for a local businessman, Gary. While acting as Gary's agent, Kevin enters into several contracts with prospective clients. However, Kevin is a minor and lacks legal capacity to enter into contracts. Which of the following statements regarding this situation is(are) CORRECT? 1) Kevin may void the contract he entered into with Gary. 2) The prospective clients are not bound by the contracts they entered into with Kevin as Gary's agent. 3) Gary may void the contract he entered into with Kevin. A) 1, 2, and 3 B) 3 only C) 1 and 2 D) 1 only

D /// Statement 1 is correct. Because Kevin lacked contractual capacity, he may void the agency contract. Statement 2 is incorrect. An agent does not have to have the contractual capacity to enter into binding contracts for the principal because the contracts are treated as contracts of the principal, not the agent. Statement 3 is incorrect. When an agent lacks capacity to act as an agent, the agency contract may be voided by the agent but not by the principal.

Disability insurance needs analysis is used to design an insurance program that will provide protection against a loss of income resulting from a disability. Which of the following statements regarding disability insurance needs analysis are CORRECT? 1) Disability insurance needs analysis should assume that the individual will receive Social Security disability benefits. 2) The elimination period selected should always be the shortest. 3) If the benefits are taxable, the after-tax cash flows should be sufficient to replace the lost income. 4) The term of the benefits should match the term of work-life expectancy. A)1, 3, and 4 B)1 and 2 C)1, 2, 3, and 4 D)3 and 4

D /// Statements 3 and 4 are correct. Statement 1 is incorrect because the Social Security definition of disability is stringent and qualifying for benefits is difficult. Statement 2 is incorrect because the appropriate elimination period is not always the shortest. The elimination period should be tailored to match the client's ability to cover his expenses from emergency funds.