Chapter 6- Qualified Plans and Federal Tax Considerations
Direct Rollover
20% withheld can be avoided if the distribution is made directly from the first plan to the trustee or administrator/ custodian of the new IRA Plan
LIFO (last in, first out)
Annuities follow a ______ format
the year they are received
Benefits that are withdrawn from any qualified retirement plan are taxable______ if the money is not moved properly Rollover/transfer
After-tax dollars (not tax deductible)
Contributions to a Roth IRA are with
Employees
For a retirement plan to be qualified, it must be designed for the benefit of
From trustee to trustee
In a direct transfer, how is money transferred from one retirement plan to a traditional IRA?
Grows tax deferred
In life insurance policies, cash value increases and
Premiums
Non tax deductible
One-Sum Cash Surrenders
Results in immediate taxation of the interest earned
Surrenders
Surrender value - past premium = amount taxable
contribution/ distribution
Taxes must be paid either upon ______ or upon _______, not both
earned income
Traditional IRAs and Roth IRAs are for individuals with____
Exclusion Ratio
Used to determine the annuity amounts to be excluded from taxes Annuitant is able to recover the cost basis nontaxable Cost basis is the principal amount, or the amount that was paid into the annuity, which is excluded from taxes The rest of each annuity payment is interest that has been earned and is taxable
Roth IRA
Which type of retirement account does not require the owner to start taking distributions at age 73?
Roth IRA
A form of an individual retirement account funded with after-tax contributions Can contribute 100% of earned income up to an IRS-specified max Contributions can continue regardless of the account owner's age and do not have to begin at a specified age Grow tax free as long as the account is open for at least 5 years
IRA (traditions Individual Retirement Account)
Allows individuals with earned income to make tax deductible contributions regardless of age Allowed to contribute a specified dollar limit each year, or 100% of their salary if less than the max allowed amount People 50 or older are entitled to make additional catch-up contributions Married couple double the individual amount Required to maintain separate account Withdrawals prior to age 59 ½ are considered early and subject to 10% additional tax At 73, owner must start receiving the minimum annual amount
Partial Surrenders
First In, First Out (FIFO)
Estate Tax
If the insured owns the policy, it will be included for the estate tax purposes If the policy is given away (possibly to a trust) and the insured dies within 3 years of the gift, the death benefit will be included in the estate
December 31 of the calendar year of the 5th anniversary
If the owner dies before distributions have begun, the entire interest must be distributed in full on or before _________ of the owner's death, unless the owner named a beneficiary
Accumulation
Period after an annuity has been purchased but before distribution begins
Living benefits
Permanent life insurance provides ______
Taxation of Personal Life Insurance
Premiums are not tax deductible
Settlement Options
Principal is tax free, but interest is taxable
Transfer for value
The life insurance policy is sold to another party prior to the insured's death
Settlement Options
ent Options Death benefit spread event over income period (averaged) Interest payments in excess of death benefit portion are taxable
Deductible contributions and tax-deferred growth
An employer-sponsored qualified retirement plan is approved by the IRS, which then gives both the employer and employee benefits such as
Roth IRA Tax
Contributions are not tax deductible Excess contributions are subject to a 6% tax penalty
Pre-tax dollars (tax deductible)
Contributions to a traditional IRA are with ______
Life Insurance Only
FIFO method applies to _____ Policyowner will receive their investment in the contract first before receiving any gains (or being taxed on those gains)
Tax advanatages
Qualified plans have ____
Death Benefit (Life Insurance)
Tax free if taken as a lump-sum distribution to a named beneficiary Principal is tax free; interest is taxable if paid in installments (other than lump sum)
Cash value exceeding premiums
Taxable at Surrender
The exclusion ratio
What method is used to determine the taxable portion of each annuity payment?
Surrendering the annuity for cash
What type of annuity activity will cause immediate taxation of the interest earned?
Interest
When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income?
Individually Owned Annuity
A portion of each annuity benefit payment is taxable Anticipated return of the principal paid in is nontaxable
Policy loans can be repaid
By the owner while the policy is in force At policy surrender or maturity, subtracted from the cash value At the insured's death, subtracted from the death benefit
Traditional IRA
Contribute 100% of income up to an IRS Specified Limit Excess contribution penalty is 6% Grows tax deferred Contributions are tax deductible (Made with pre-tax dollars) 10% penalty for early nonqualified distributions prior to age 59 ½ Distributions are taxable Payouts begin by age 73
Nonqualified Plans
Contributions are not tax deductible No IRS approval Can discriminate Earnings grow tax deferred Excess over cost basis is taxed
Tax-Deferred Accumulation
Cost base represents the premium dollars that have already been taxed and will not be taxed again when withdrawn from the contract Interest accumulated in an annuity is the tax base, but the taxes are deferred during the accumulation period
Corporate Owned
Growth in the annuity is not tax deferred Interest income is taxed annually unless the corporation owns a group annuity for its employees, and each employee receives a certificate of participation
Distributions at Death
If the annuity contract holder dies before the annuitization date, the interest accumulated in the annuity becomes taxable If the beneficiary of the annuitant is a spouse, the tax can continue to be deferred
10
Individual beneficiaries other than a spouse must withdraw the entire amount from the account within ____ years of the account owner's death Not permitted to treat inherited IRA as their own Not owe tax on the assets in the IRA until they receive distributions from it
Accumulations
Interest taxable
Taxation of IRAs
When an annuity is used to fund a Traditional IRA distributions are fully taxable if contributions were made with pretax dollars If there are no distributions at the required age, or if the distributions are not large enough, the penalty is 25% of the shortfall from the required annual amount
$3,000
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 value would be income taxable?
Cash Value Increases
Any cash value accumulations in the policy can be borrowed against by the policyowner, or may be paid to the policy owner upon surrender of the policy Grows tax deferred Upon surrender or endowment, any cash value in excess of cost basis (premium payments) is taxable as ordinary income Upon death, face amount is paid, no more cash value Death benefits paid to beneficiary income tax free
SECURE Act
January 1, 2023 Raised the required minimum distribution age from 72 to 73 Reduced penalty for failing to take an RMD from 50% to 25%
Policy Loans
May borrow against the policy's cash value Money borrowed is not income taxable Insurance company charges interest on outstanding policy loans
Death Benefit
Not income taxable
Lump-sum death benefit
Not income taxable
Policy Loans
Not income taxable
Policy dividends
Not taxable
Qualified Plans
Tax deductible contributions Plan approved by IRS Cannot discriminate Earnings grow tax deferred All withdrawals are taxed
Rollover
Tax free distribution of cash from one retirement plan to another Must be completed within 60 days from the time the money is taken out of the first plan If the distribution plan is paid directly to the participant, 20% of the distribution must be withheld by the payor
Withdrawal of Interest Principal
When money is withdrawn from the annuity during the accumulation phase, the amounts are taxed on a Last In, First Out basis (LIFO) All withdrawals will be taxable until the owner's cost basis is reached After all of the interest is received and taxed, the principal will be received with no additional tax consequences
Qualified Plans
Designed for the exclusive benefit of the employees and their beneficiaries Are formally written and communicated to the employees Use a benefit or contribution formula that does not discriminate in favor of the prohibited group Are not geared exclusively toward the prohibited group Are permanent Are approved by the IRS Have a vesting requirement
Lump-sum/transfer for value
Life insurance proceeds paid to a named beneficiary are generally free of federal income taxation if taken as a _________ Exception to this rule would apply if the benefit payment results from a ______
Section 1035 Exchanges
Nontaxable exchange of cash value life insurance or annuity on the same life "Same to same" is acceptable
Cash Value Increases
Not taxable (as long as policy in force)
Prohibited Group
Officers, stockholders, or highly paid employees
Conditions where 10% penalty for early withdrawals would not apply
Participant is over 59 ½ Participant is totally disabled Money is used to make the downpayment on a home (not to exceed $10,000 and for first time home buyers) Withdrawals are for post-secondary education purposes Withdrawals are for catastrophic medical expenses, or upon death
Nonqualified Plans
Require no government approval and are used as a means for an employer to discriminate in favor of a valuable employee with regard to employee benefits Accept after-tax contributions
Traditional IRAs Tax
Tax-deductible contributions for the year of the contribution Contributions must be made in "cash" in order to be tax deductible (cash, check, money order) Excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA Tax-deferred earnings (money accumulated in the account) are not taxed until withdrawn
Dividend Interest
Taxable in the year earned
Cash Value Gains
Taxed at surrender
Premature Distributions and Penalty Tax
The IRS imposes a penalty for certain premature distributions under annuity contracts In addition to ordinary income tax that may be due, a 10% penalty is imposed on the annuity tax base for early withdrawals prior to ge 59 ½
Transfer
Refers to a tax free transfer of funds from one retirement program to a traditional IRA Transfer of interest in a traditional IRA from one trustee directly to another
Dividends
Return of unused premium Not considered income for tax purposes Not taxable (return of unused premium the interest is taxable) Interest earned on the dividend is subject to taxation
Spouses who are the sole designated beneficiary
Treat an IRA as their own Base the required minimum distribution (RMD) on their own current age Base the required minimum distribution on the decedent's age at death, reducing the distribution period by one year Withdraw the entire account balance by the the end of the 5th year following the account owner's death If the account owner died before the required beginning date, the surviving spouse can wait until the owner would have turned 73 to begging receiving RMDs
Surrenders
When a policy owner surrenders for cash value, some of the cash value received may be taxable as income if it exceeds the amount of the premiums paid for the policy
Roth IRA
Contribute 100% of income up to an IRS Specified Limit Excess contribution penalty is 6% Grows tax free (if account is open for at least 5 years) Contributions are not tax deductible (made with after tax dollars) Qualified distribution cannot occur until account is open for 5 years and owner is 59 ½ Distributions are not taxable No required minimum age for payouts
Partial Surrender
When an owner withdraws cash value from a universal life policy, both the cash value and the death benefit are reduced by the surrender