Chapter 4 - Taxes, Retirement, and Other Insurance Concepts

How are income payments from a 403(b) plan taxed?

Funds contributed are excluded from the employee's current taxable income, but are taxable upon withdrawal

Survivor protection

Giving your beneficiaries a tax-free dollar amount in the case you pass away

What type of policy is typically issued without proof of insurability from the insured?

Group policy

In insurance policies, cash value increases:

Grow tax deferred

In life insurance policies, cash value increases

Grow tax deferred

Estate as beneficiary

If the insured's estate is the designated beneficiary at the time of the insured's death, the entire face amount of the policy will be included in his or her taxable estate. -Because they name the estate as the beneficiary

transfer of ownership

If the insured, as policyowner, assigns or transfers ownership of the policy or makes a gift of the policy within 3 years prior to his or her death, the entire face amount of the policy will be included in his or her taxable estate.

Traditional IRA Distributions

Income taxable for the year received (if you take money out of your IRA this year, you will pay income tax on it for this year - the growth you take out)

Who can contribute to a traditional IRA?

Individuals or married couples with earned income, regardless of age

Surrenders

-Amount that exceeds premiums paid taxable income (growth/additional money that is in the cash value over and above the premiums you have paid in) -In universal policies, partial surrenders reduce cash value and death benefit

What is taxable?

-Anything considered excess cash value (money you have paid in) -Interest on dividends (they are profits that are shared so it is coming into you like you earned income)

Third party ownership:

-Contracts that are owned by someone other than the insured are known as third-party ownership -· Most policies involving third-party ownership are written in business situations or for minors in which the parent owns the policy

what taxation rules apply to contributions and excess contributions on a Roth IRA?

-Contributions on a Roth IRA are not tax deductible -If contributions are greater than allowed maximum, they are subject to a 6% penalty

Accelerated Benefits

-Full benefits are tax free to terminally ill insured -Tax free up to chronically ill insured -Any amount received in excess of this dollar limit must be included in the insured's gross income (pay tax on it)

Policy loans characteristics

-Not taxable as income -Interest accumulates on outstanding policy loans -Unpaid loans subtracted from cash value upon surrender OR death benefit upon insured's death

Dividends

-Not taxable as income (return on unused premium) -Any interest earned is taxable as ordinary income

Traditional IRA Contributions

-Tax deductible -Must be made in cash -Tax deferred earnings (all of the growth that goes into this will be deferred until you take the money out)

Exceptions to 59.5 rule

-Total disability -Catastrophic medical expenses -Down payment on a first home (up to $10,000) -Post-secondary education

Cash Value increases

-grow tax deferred -amount in excess of cost basis is taxable as ordinary income

What percentage of a company's employees must take part in a noncontributory group life plan?

100% - If the employer pays all of the premium, all employees must be covered to avoid adverse selection

If IRA rollover is paid directly to the participant, what percentage must be withheld by the payor?

20

How many days does an employee have after terminating from group insurance in order to exercise the conversion option?

31 days

In order to qualify for conversion from a group life policy that has been terminated to an individual policy of the same coverage, a person must have been insured under the group plan for how many years?

5 years

The minimum number of credits required for partially insured status for Social Security disability benefits is:

6 credits during the last 13 quarter period

IRA rollovers must be completed within ____ days.

60

401(k)

A defined contribution plan that automatically takes out money from an employee's paycheck before income taxes and invests it in mutual funds for purposes of retirement savings - Eligibility: Any employer can offer these - Who contributes: Employer matches employee's contribution - Contribution limits: Established by IRS; adjusted annually

What is the name for an overfunded life insurance policy?

A modified Endowment Contract (MEC)

The president of a manufacturing company has offered one of the company's officers a special individual annuity plan that is unaavailble to lower echelon employees. this plan would be funded with before tax corporate dollars, and it does not meet government approval standards. This annuity plan is subject to:

A non qualified annuity plan

Group life insurance policies are written as what type of insurance?

Annually renewable term

Modified Endowment Contract (MEC)

Any cash value policy that builds cash value faster than a Seven-Pay Whole Life Contract and therefore loses the tax advantages of life insurance.

Modified Endowment Contract (MEC)

Any cash value policy that builds cash value faster than a Seven-Pay Whole Life Contract and therefore loses the tax advantages of life insurance. - Withdrawals are taxable - Policy loans are taxable distributions - Accumulations are tax deferred - Distributions before age 59.5 incur a 10% penalty on policy gain

Employer contributions made to a qualified plan:

Are subject to vesting requirements.

Estate Creation

Beneficiary has a large amount of cash that is going to them from your death

How are accelerated benefits taxed to chronically ill

Benefits to chronically ill insured are tax free up to a certain limit

How are accelerated benefits taxed to terminally ill

Benefits to terminally ill insured are received tax free

According to the taxation rules of life insurance policies, how are cash value increases taxed?

Cash value growth is tax deferred

What does the insured receive in a group life contract?

Certificates of insurance (which are the employees)

Social security is an entitlement program in which includes the following benefits:

Death benefits Old-age and retirement benefits Disability benefits

Are dividends taxable?

Dividends are not considered to be income for tax purposes, since they are the return of unused premiums, therefore, dividends are not taxable. However, interest earned on dividends are subject to taxation as ordinary income

How are dividends taxed on participating policies?

Dividends are the return of unused premiums, so they are not considered income for tax purposes. However, if dividends are left with the insurer to accumulate interest, the interest earned on the dividend account is subject to taxation as ordinary income each year interest is earned.

Estate Conversion

Do something to save/conserve those assets (cash)

Who is the beneficiary on a key person life insurance policy?

Employer (the business)

Who is the owner on a key person life insurance policy?

Employer (the business)

In a direct rollover, how is the money transferred from one plan to the new one?

From trustee to trustee

How are life insurance death proceeds taxed?

If taken as a lump sum, proceeds are tax free. If other than lump sum, principal is tax free and interest is taxable.

Tax Deferred Accumulation on annuities

It grows but you are not paying tax on the growth as long as it stays within the contract

Estate conversion

Life insurance may be used to pay state inheritance taxed and federal estate taxes eliminating the need to sell assets from the estate

Are policy loans tax deductible?

No

Are premiums tax deductible?

No

Are death benefits taxable?

No, not taxable

Are policy dividends taxable?

No, not taxable

Upon surrender of a life insurance policy, what portion of the cash value will be taxed?

Only the portion in excess of the premium paid

Traditional IRA contributions are tax deductible based on what?

Owner's income

What are the group characteristics important for underwriting?

- Purpose - Size - Turnover - Financial strength of the group

SIMPLE

- Small employer (<100) - Contributes: Employer matches employee's contribution - Contribution limits: Established by IRS; adjusted annually - Taxation is deferred on both contributions and earnings until funds are withdrawn

What are common personal uses of life insurance?

- Survivor protection - Estate creation and conservation - Cash accumulation - Liquidity

What is the number of credits required for fully insured status for social security disability benefits?

"Fully insured" refers to someone who has earned 40 quarters of coverage (10 years of work times 4 maximum annual credits)

An employee quits her job where she has a balance of $10,000 in her qualified plan. If she decides to do a direct transfer from her plan to a Traditional IRA, how much will be transferred from one plan to another and what is the tax consequence of a direct transfer?

$10,000, no tax consequence

An insured decides to surrender his $100,000 Whole Life policy. The premiums paid into the policy added up to $15,000. At policy surrender, the cash surrender value was $18,000. What part of the surrender would be income taxable?

$3,000 - The difference between the premiums paid and the cash value would be taxable. In this example, the difference between the premiums paid ($15,000) and the cash value ($18,000) is $3,000.

Examples of third party ownership of a life insurance policy:

- A company purchases a life insurance policy on their manager, who is an important part of the operation - When an insured purchased a new home, the insured made an absolute assignment of a life insurance policy to the mortgage company - An insured couple purchases a life insurance policy insuring the life of their grandson

Some characteristics of policy loans

- An insurer can charge interest on outstanding policy loans - A policy loan may be repaid after the policy is surrendered - Money borrowed from the cash value is not taxable - Policy loans can be repaid at death

Who owns a group life contract?

The actual policy (master/policy) is issued to the sponsor of the group, often an employer

Keogh (HR-10)

- Only for self-employed - Contributes: Employer matches employee's contribution - Contribution Limits: Established by IRS; adjusted annually - Tax deductible and it accumulates tax deferred until withdrawal

SEP (Simplified Employee Pension)

- Self-employed/Small employer - Contributes: Employee + Employer - Contribution limits: Established by IRS; adjusted annually

403(b) / TSA (tax sheltered annuity)

- Eligibility: nonprofit (red cross), church affiliations (pastor), educators that work for state funded school/university

General requirements for qualified plans

- Exclusive benefit of the employees and their beneficiaries - Formally written and communicated - Cannot discriminate - permanent - Approved by the IRS - Vesting requirement

early withdrawal penalty

Penalize you 10% before 59.5

Cash Accumulation

Policies like a whole life, variable life, or universal life have a cash value -Policies grow the cash value

Social security benefits

Retirement, disability and survivors

If an immediate annuity is purchased with the face amount at death or with the cash value at surrender, this would be considered a:

Settlement Option - A settlement option is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender

Which of the following would be considered a nonqualified retirement plan? Split-dollar plan 401(k) Keogh Plan Roth IRA

Split-dollar plan

Liquidity

Surrender the policy, they can fairly quickly turn that cash into cold hard cash

A producer is helping a married couple determine the financial needs of their children in the event one or both should die prematurely. This is a personal use of life insurance known as

Survivor Protection

What type of annuity has zero cost basis?

TSA

The premiums paid by the employer in a business life insurance policy are:

Tax deductible by the employer -The premiums that an employer pays for life insurance on an employee, whereby the policy is for the employee's benefit, are tax deductible to the employer as a business expense

What is a policy feature you lose under an MEC?

Tax free loans

All of the following would be different between qualified and nonqualified retirement plans except:

Taxation on accumulation

When planning for survivor protection in life insurance, what needs to be considered?

The insureds: - Current assets - Liabilities - Survivor's needs

What is the best reason to purchase life insurance rather than annuities?

To create an estate

What is the purpose of key person insurance?

To minimize the risk of financial loss caused by the death of a key employee

An insured under a life insurance policy has been diagnosed with a terminal illness and has 6 months to live. The insured knows that his financial state will worsen even more with the upcoming medical expenses. What option could the insured utilize?

Viatical settlement

What is the name of the insured who enters into a vatical settlement?

Viator - Viator means the owner of a life insurance policy who enters into or seeks to enter into a viatical settlement contract

Executive bonus

When an employer offers to give an employee, a wage increases in the amount of the premium on a new life insurance policy

Is interest on dividends taxable?

Yes

Are traditional IRA contributions tax deductible?

Yes - the contributions are tax deductible based on the owner's income

Is excess cash value taxable?

Yes, because it has been deferred into the life insurance policy

Who is a third-party owner?

a Policyowner who is not the insured

IRA rollover

a tax-free distribution of cash or other property from one retirement plan, which is deposited into another retirement plan

Life settlement

a transaction in which the owner of a life insurance policy sells a life insurance policy to a third party for some form of compensation, usually cash

Vatical statement allows

an insured with a life-threatening condition to sell the existing policy in order to receive benefits when they are most needed - Viators typically receive a percentage of the policy's face value from the person who purchases the policy

If an insured surrenders his life insurance policy, which statement is true regarding the cash value of the policy?

o It is only taxable if the cash value exceeds the amount paid for premiums (THIS ONE) o It is not considered to be taxable o It is taxable only if it exceeds the amounts paid for premiums by 50% o It is automatically taxable

SIMPLE Plan

small employer (no more than 100 employees) - Both contributions and earnings are tax deferred until withdrawal