NWM Federal Tax Considerations for LIfe Insurance and Annuities

An IRA uses immediate annuities to pay out benefits; the IRA owner is nearly 75 years old when he decides to collect distributions. What kind of penalty would the IRA owner pay? A. 50% tax on the amount not distributed as required B. No penalties, since the owner is older than 59 ½ C. 10% for early withdrawal D. 15% for early withdrawal

A. 50% tax on the amount not distributed as required When immediate annuities are used to pay IRA benefits, distributions must begin no later than age 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.

What type of annuity activity will cause immediate taxation of the interest earned? A. Failing to make a planned contribution B. Surrendering the annuity for cash C. Using the contract as collateral for a loan D. Changing a settlement option

B. Surrendering the annuity for cash One-sum cash surrenders give rise to immediate taxation of the interest earned.

Which concept is associated with "exclusion ratio"? A. How exclusion riders affect an insurance premium B. Policy provisions C. Annuities payments D. Dividend distribution

C. Annuities payments Some parts of an annuities payment are taxable, while others are not. The return of the principal paid in is nontaxable. The portion that is taxable is the actual amount of payment, less the expected return of the principal paid in. This relationship is called the "exclusion ratio".

Traditional IRA contributions are A. Deducted based on the income level. B. Never tax deductible. C. Partially tax deductible depending on the income level. D. Tax deductible.

D. Tax deductible. The following taxation rules apply to contributions made to traditional IRA plans: tax-deductible contributions for the year of the contribution (based on the person's income); contributions must be made in "cash" in order to be tax deductible; excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA; and tax-deferred earnings are not taxed until withdrawn.

A claimant, who is totally and permanently disabled, is eligible for Social Security Disability benefits after an elimination period of A. 24 months. B. 0 months. C. 5 months. D. 12 months.

C. 5 months Social Security applies a 5 month waiting period to claimants for disability benefits.

Social Security was created to provide all of the following benefits EXCEPT A. Disability income. B. Retirement income. C. Unemployment income. D. Survivor's benefits.

C. Unemployment income. Social Security is designed to provide protection against financial loss due to old age, disability, or death. It also provides income during retirement.

What is the number of credits required for fully insured status for Social Security disability benefits? A. 4 B. 10 C. 30 D. 40

D. 40 The term "fully insured" refers to someone who has earned 40 quarters of coverage (10 years of work times 4 maximum annual credits).

When contributions to an immediate annuity are made with before-tax dollars, which of the following is true of the distributions? A. Distributions are taxable. B. Distributions are nontaxable. C. Distributions cannot begin prior to age 70½. D. There are no distributions.

A. Distributions are taxable. If contributions are made with before-tax dollars, contributions to this fund are fully taxable. Distributions must begin no later than age 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.

Which of the following statements is TRUE concerning whole life insurance? A. Policy loans are tax deductible. B. Lump-sum death benefits are not taxable. C. Dividend interest is not taxable. D. Premiums are tax deductible.

B. Lump-sum death benefits are not taxable. Dividend interest is taxable; policy loans are not tax deductible, and premiums are not tax deductible.

An annuitant dies before the effective date of a purchased annuity. Assuming that the annuitant's wife is the beneficiary, what will occur? A. The premiums will decrease. B. The interest will continue to accumulate tax deferred. C. The interest will become immediately taxable. D. The premiums will increase.

B. The interest will continue to accumulate tax deferred. If the contract holder dies before the annuity starting date, the contract's interest becomes taxable. If the beneficiary of the annuity is a spouse, the tax can continue to be deferred.

Which of the following best describes taxation during the accumulation period of an annuity? A. The annuity is subject to state taxes only. B. The annuity is subject to both state and federal taxation. C. The growth is subject to immediate taxation. D. Taxes are deferred.

D. Taxes are deferred. The interest accumulated in an annuity is the tax base, but the taxes are deferred during the accumulation period. The cost base is the premium dollars that have already been taxed and will not be taxed again when withdrawn from the contract.

The minimum number of credits required for partially insured status for Social Security disability benefits is A. 4 credits. B. 6 credits. C. 10 credits. D. 40 credits.

B. 6 credits. To be considered partially insured, an individual must have earned 6 credits during the last 13-quarter period.

In life insurance policies, cash value increases A. Are only taxed when the owner reaches age 65. B. Grow tax-deferred. C. Are income taxable immediately. D. Are taxed annually.

B. Grow tax-deferred. Generally life insurance cash values are only income taxed if the policy is surrendered (totally or partially) and the cash value exceeds the premiums paid.

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an A. Nonqualified annuity. B. Modified endowment contract. C. Accelerated benefit policy. D. Endowment.

B. Modified endowment contract. Any cash value life insurance policy that develops cash value faster than a seven-pay whole life contract is called a Modified Endowment Contract. It loses the benefits of a standard life contract.

Which of the following is true regarding taxation of dividends in participating policies? A. Dividends are taxable only after a certain amount is accumulated annually. B. Dividends are taxable in some life insurance policies and nontaxable in others. C. Dividends are considered income for tax purposes. D. Dividends are not taxable.

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

Life insurance death proceeds are A. Taxable to the extent that they exceed 7.5% of the beneficiary's adjusted gross income. B. Taxed as a capital gain. C. Taxed as ordinary income. D. Generally not taxed as income.

D. Generally not taxed as income. Life insurance death benefits are generally not taxed as income.

Which of the following is NOT true regarding policy loans? A. An insurer can charge interest on outstanding policy loans. B. A policy loan may be repaid after the policy is surrendered. C. Money borrowed from the cash value is taxable. D. Policy loans can be repaid at death.

C. Money borrowed from the cash value is taxable. Money borrowed from the cash value is not taxable. Policy loans can be repaid at any time, including surrender and death. An insurer can charge interest on outstanding policy loans.

What part of the Internal Revenue Code allows an owner of a life insurance policy or annuity to exchange or replace their current contract with another contract without creating adverse tax consequences? A. 401(k) Plan B. Section 457 Deferred Compensation Plan C. Section 1035 Policy Exchange D. Modified Endowment Exchange

C. Section 1035 Policy Exchange As long as the funds are transferred intact and the form is filed, taxation is deferred.

Death benefits payable to a beneficiary under a life insurance policy are generally A. Subject to income taxation by the Federal Government. B. Exempt from income taxation if under $10,000. C. Exempt from income taxation if over $10,000. D. Not subject to income taxation by the Federal Government.

D. Not subject to income taxation by the Federal Government. When premiums are paid with after tax dollars, the death benefit is generally not subject to federal income taxation.

An applicant buys a nonqualified annuity, but dies before the starting date. For which of the following beneficiaries would the interest accumulated in the annuity NOT be taxable? A. Charitable organization B. Dependents C. Annuitant D. Spouse

D. Spouse If an annuities contract holder dies before the effective starting date, the contract's interest continues to be taxable, unless the beneficiary is a spouse. In that case, this tax can be deferred.

All of the following benefits are available under Social Security EXCEPT A. Welfare benefits. B. Old-age and retirement benefits. C. Disability benefits. D. Death benefits.

A. Welfare benefits. Social Security is an entitlement program, not a welfare program

What is the penalty for IRA distributions that are below the required minimum for the year? A. 10% B. 25% C. 50% D. 60%

C. 50% If there are no distributions at the required age, or if the distributions are not large enough, the penalty is 50% of the shortfall from the required annual amount.

In a direct rollover, how is the money transferred from one plan to the new one? A. From the participant to the new plan B. From the original plan to the original custodian C. From trustee to trustee D. From trustee to the participant

C. From trustee to trustee In a direct rollover, the distribution is made directly from the trustee of the first plan to the trustee or administrator/custodian of the new IRA plan.

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase? A. Withdrawn amounts are taxed on a first in, last out basis. B. Taxes are deferred on withdrawn amounts, but a flat penalty is charged. C. Taxes are deferred on withdrawn amounts. D. Withdrawn amounts are taxed on a last in, first out basis.

D. Withdrawn amounts are taxed on a last in, first out basis. When money is withdrawn from the annuity during the accumulation phase the amounts are taxed on a last in first out basis (LIFO). Therefore, 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.

What is the main purpose of the Seven-pay Test? A. It ensures that the policy benefits are paid out in 7 years. B. It guarantees the minimum interest. C. It determines if the insurance policy is a MEC. D. It requires level premium payments for 7 years.

C. It determines if the insurance policy is a MEC. The Seven-pay Test determines whether an insurance policy is "over-funded" or if it's a Modified Endowment Contract. In other words, the cumulative premiums paid during the first seven years of a policy must not exceed the total amount of net level premiums that would be required to pay the policy up using guaranteed mortality costs and interest.

Which of the following is an eligibility requirement for all Social Security Disability Income benefits? A. Have permanent kidney failure B. Be at least age 50 C. Have attained fully insured status D. Be disabled for at least 1 year

C. Have attained fully insured status Although Social Security offers many benefits, such as retirement, survivors and Medicare, only those who have attained fully insured status are eligible for Disability Income benefits. Contributing to Social Security for 40 quarters (10 years) attains fully insured status.

If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for ten years, which of the following would be taxable annually? A. $10,000 B. $7,000 C. $3,000 D. $13,000

C. $3,000 If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for 10 years, $10,000 per year would be income tax free (as principal) and $3,000 per year would be income taxable (as interest).

All of the following are considered Social Security benefits EXCEPT A. Survivors. B. Retirement. C. Group. D. Disability.

C. Group. Social Security provides three types of benefits: Retirement, Disability and Survivors.

When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income? A. Neither principal nor interest B. Principal only C. Interest only D. Both principal and interest

C. Interest only If a beneficiary receives payments that contain both principal and interest portions, only the interest is taxable as income.

What method is used to determine the taxable portion of each annuity payment? A. The exclusion ratio B. The excise ratio C. The annuity to age ratio D. The marginal tax formula

A. The exclusion ratio The ratio of the total investment in that contract to the expected return is developed to determine the portion of the annuity payment that will be taxable and nontaxable.

An insured has a Modified Endowment Contract. He wants to withdraw some money in order to pay medical bills. Which of the following is true? A. He cannot withdraw money from his MEC before age 59½. B. He will have to pay a penalty if he is younger than 59½. C. He will have to pay a penalty regardless of his age. D. He will not have to pay a penalty, regardless of his age.

B. He will have to pay a penalty if he is younger than 59½. Any cash value life insurance policy that develops cash value faster than a seven-pay whole life contract is called a Modified Endowment Contract. It loses the benefits of a standard life contract. All withdrawals are subject to taxation on a LIFO basis, and if withdrawals are made earlier than the age of 59½, a 10% penalty is imposed.

Which of the following terms is used to name the nontaxed return of unused premiums? A. Interest B. Surrender C. Dividend D. Premium return

C. Dividend The return of unused premiums is called a dividend. Dividends are not considered to be income for tax purposes, since they are the return of unused premiums.

A 60-year-old participant in a 401(k) plan takes a distribution and rolls it over to an IRA within 60 days. Which of the following is true? A. No taxes are due since the plan participant is over age 59 1/2. B. There is a 10% early withdrawal penalty. C. The amount distributed is subject to ordinary income tax. D. The amount of the distribution is reduced by the amount of a 20% withholding tax.

D. The amount of the distribution is reduced by the amount of a 20% withholding tax. Distributions from 401(k) plans are taxable as ordinary income in the year of the distribution. However, if the distribution is rolled over to a Traditional IRA, taxes are deferred until the required minimum IRA distributions begin (which is generally no later than age 70 1/2). Since this client actually took a distribution (instead of making a trustee-to-trustee roll over), the distribution is subject to 20% withholding tax.

All of the following are requirements of eligibility for Social Security disability income benefits EXCEPT A. Fully insured status. B. Waiting period of 5 months. C. Being age 65. D. Inability to perform any gainful work.

C. Being age 65. The term fully insured refers to someone who has earned 40 quarters of coverage (the equivalent of 10 years of work), and is therefore entitled to receive Social Security retirement, Medicare, and survivor benefits. The waiting, or elimination period for Social Security disability benefits is 5 months.

During the accumulation period in a nonqualified annuity, what are the tax consequences of withdrawal? A. Neither interest nor principle is taxed, but penalties may be imposed. B. Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 ½. C. Nontaxable principal may be withdrawn first, but the 10% penalty will be imposed if under age 59 ½. D. Both interest and principal are taxed; no other penalties are imposed.

B. Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 ½. When money is withdrawn from the annuity during the accumulation phase, the amounts are taxed on a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached.