adbanker ch 7 recap

Under ERISA, qualified plans:

Must benefit employees and beneficiaries May not discriminate in favor of highly compensated employees Must be approved by the IRS Have a vesting requirement

The Lucrative Lozenge Company provides a $5,000 monthly income to retirees who served as senior executives. This benefit is not available to other retirees of the company. This is an example of a:

Nonqualified plan

To be considered terminally ill, federal law defines a terminal illness as one which is expected to result in the person's death within how many months?

24

7-Pay Test

7-pay test is a limitation on the total amount that can be paid into a policy in the first 7 years. It compares premiums paid for the policy during the first 7 years with the net level premiums that would have been paid on a 7-year pay whole life policy providing the same death benefit. As long as the policy premium guidelines are met, the policy will avoid being deemed a modified endowment contract

Defined Benefit Plan

A defined benefit plan provides employees with a fixed and known benefit at retirement, the amount of which generally depends upon length of service and highest attained salary. The company assumes the responsibility for making sure money will be available to fund a pension for retiring workers.

Defined Contribution Plan

A defined contribution plan provides employees with a retirement benefit based on the value of the employee's account at retirement. The employer and employee or both can make contributions.

_________ consist(s) of the amount of premium that is returned to the policyowner if the insurer achieves lower mortality and expense costs than expected.

A dividend

A Tax-Sheltered Annuity may be established and funded by which of the following?

A not-for-profit community hospital association

Federal Tax Considerations for Retirement Plans- Qualified vs Nonqualified Plans

Nonqualified retirement plans do not meet requirements of federal law to be eligible for favorable tax treatment contributions to a nonqualified plan are not tax deductible Upon withdrawal, only the earnings are taxable Qualified Plans must meet the requirements of ERISA (Employee Retirement Income Security Act), which is a federal law that sets minimum standards for pension plans in private industry

If the annuitant, now deceased, was receiving income from a pure life or straight life annuity, how much goes into the annuitant's estate for valuation?

Nothing

CODA Plans (Cash or Deferred Arrangement Plans)

Permit employees to defer a portion of their salary to save for retirement Employees can choose to participate or not employer may match their contribution dollar for dollar or up to a certain percentage limit of the employee's salary to encourage employee participation ex. TSAs or (403(b))s

Income-tax Free

Policy loan from an in-force policy Qualified accelerated death benefit Policy dividend that is less than the premium paid Group life insurance death benefit proceeds (lump sum) Lump sum death benefit paid to a beneficiary

All of the following tax-free exchanges of life insurance and annuities are permitted, except:

Annuity to life insurance

Traditional IRAs

Anyone under the age of 72 who has earned income may open an IRA Contributions may be tax deductible in whole or part (or nondeductible if the owner is a participant in an employer-sponsored retirement plan and gross income exceeds certain thresholds) Contributions grow tax-deferred until they are withdrawn

Under what circumstance would a policy loan in a life insurance policy be taxable?

If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable

IRA Transfer

In many cases, IRA assets can be transferred directly into a new account. An IRA transfer is the movement of funds between the same type of plan, such as two IRA accounts. The money is transferred directly from one financial institution to another. Transfers are not taxable and can take place as often as desired.

ERISA requires which of the following?

Qualified plans must meet certain minimum standards

qualified plans

Qualified plans receive favorable tax treatment Employer contributions are immediately tax deductible to the employer at the time the contribution is made contributions are not taxable to the employee until withdrawn Distributions taken prior to 59 ½ are subject to taxation and a 10% penalty penalty may be waived for death, disability, qualified education costs, medical expenses, first-time home buyers and substantial equal payments over life expectancy retirees must begin taking taxable distributions at age 72. There is a tax penalty if these withdrawals are not made

Nonqualified Plans characteristics

Upon withdrawal, only the earnings are taxable Employee contributions paid with after-tax dollars (not tax-deductible) Usually not funded by the employer until the employee actually retires

Section 1035 Exchanges

allows for the exchange of existing insurance policies into another without incurring any tax liability on the interest and/or investment gains in the current contract can be useful if another insurance policy has features and benefits that are preferred or are superior to those found in an existing contract the new insurance contract may have higher fees and charges than the old one, which will inevitably reduce the returns or involve an increase in costs for such things as policy loans

Corporate-Owned Annuities

annuity contract owned by a non-natural person is not treated as an annuity for federal income tax purposes so the contract's gains are currently taxed as opposed to being tax deferred. In short, there are no tax benefits when an annuity is owned by a corporation

Nonqualified Deferred Compensation Plans

any employer provided retirement plan that does not comply with the ERISA requirements that apply to qualified plans are most commonly used when an employer wants to select certain key employees for which to provide a retirement plan. employer is not entitled to deduct contributions to the plan until the year in which a covered employee receives income from the plan employer's cost basis is equal to premiums paid Earnings in the plan are tax deferred to the employee until he/she receives income from the plan

Self-Employed Plans (HR-10 or KEOGH Plans)

are available to unincorporated sole proprietors (self-employed individuals) and their eligible employees Silent partners are not eligible These contributions are deductible

premiums

are considered a personal expense and are not deductible. They are paid with after-tax dollars. This establishes a cost basis in the policy for tax purposes.

Modified Endowment Contracts (MECs)

if a policy is funded too quickly it will be classified as a Modified Endowment Contract or an MEC. MEC rules impose stiff penalties to eliminate the use of life insurance as a short term savings vehicle

Roth IRA

is a nondeductible tax-free retirement plan for anyone with earned income contributions are not tax deductible as long as the account has been open for at least 5 years and the owner is at least 59 ½ proceeds may be received tax free Taxpayers can also take a tax-free and penalty-free distribution of earnings in cases of a death, disability, qualified first-time home purchase of $10,000 maximum and qualified tuition for higher education. This is presently without limitations when paying only the tuition charges on an annual basis

Savings Incentive Match Plan for Employees (S.I.M.P.L.E.)

may be established either as an IRA or a 401(k) plan. employer's contribution must be immediately vested at 100% means that the employee is entitled to all the employers' contributions immediately are only available to companies that have 100 employees or less and must be the only type of plan the company has available for the employees. An advantage of a SIMPLE plan is the elimination of high administrative costs Employer must match up to 3% of the employee elective contributions or contribute 2% of nonelective contributions in behalf of each group member

When withdrawing cash from a cash value life insurance policy, the amount of the withdrawal up to the policy's cost basis is tax-free. This tax accounting rule is referred to as:

First-In, First-Out (FIFO)

Example of Cost Basis

$21,000 Cash Value minus $18,000 Premiums (Cost Basis) = $3,000 Gain (Taxable)

An annuitant contributed $50,000 to her nonqualified annuity, and when she annuitized the policy, the insurance company determined that, based on her life expectancy, she will receive $100,000 in payments. If her initial monthly payment was $1,000, how much of that payment was taxable?

$500 The initial monthly payment will never be fully taxable. $50,000 (cost basis) divided by $100,000 (expected distribution) equals 50% (0.50). $1,000 x 0.50 = $500.

The exception to the rule concerning the non-deductibility of life insurance premiums is:

All employer paid group life insurance premiums

How are employer paid premiums on a group life insurance plan treated for tax purposes?

As an ordinary and necessary business expense

When may an employer deduct the premiums it pays for an employee's life insurance benefit?

As long as the business does not derive a direct benefit from the policy

If no __________ is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate.

Beneficiary

Estate Taxes and Benefits Included

Benefits may be included in the insured's estate, either intentionally or by default. The policy owner may name the estate as a beneficiary, or by default, if no beneficiary is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate. These values will be added to the amount in the estate and potentially be subject to federal estate taxes. If the policyowner is also the named insured, the proceeds will be added to the value of the insured's estate. It is usually recommended to name an owner other than the insured for this reason

A Roth IRA is unique for which of the following reasons?

Contributions are nondeductible and distributions are nontaxable

Death Benefit Proceeds

Death benefit proceeds from a group life insurance plan to an employee's named beneficiary are received income tax free.

An IRA account owner may take an early withdrawal from an individual retirement account without a penalty tax when certain qualified events occur, such as:

Death or permanent disability Up to $10,000 for the down payment on a home as a first time home buyer Medical expenses not covered or reimbursed by health insurance, or to pay health insurance premiums Qualified educational expenses

The federal law that governs the rights of plan participants and beneficiaries of most employer-sponsored benefit plans is ____________.

ERISA

All of the following are characteristics of a 403(b) plan, EXCEPT:

Employees of corporations participate

Keogh Plans are NOT available to:

Employees of large companies presently participating in a qualified retirement plan which are not self employed

Qualified Plans characteristics

Entire amount of withdrawal is taxable to the employee upon distribution Must meet ERISA minimum standards Contributions made by employee are tax-deductible or pre-tax

Accelerated Death Benefits

Generally, the payment of an accelerated death benefit is tax free to a recipient if the benefit payment is qualified. To be a qualified benefit the benefit must meet the following conditions: A physician must give a prognosis to the named insured of a life expectancy of 24 months or less The amount of the benefit must at least be equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit The insurer provides a monthly report for the insured showing the amount paid and the amount of benefit remaining in the life insurance policy

Premiums Paid by the Employer and the Employee

Group term life premiums paid by an employer are tax deductible to the business as an ordinary and necessary business expense. Any employee paid premiums are not eligible for a tax deduction. Employer paid premiums in connection with group life insurance does not constitute taxable income to the employee unless the death benefit paid for by the employer exceeds $50,000. All employer paid premiums for amounts above $50,000 are reported as taxable income to the employee.

Taxation

If a contract is deemed to be a MEC, then any funds that are distributed are subject to a "last-in, first-out" (LIFO) tax treatment, rather than the normal "first-in, first out" tax treatment. Taxable distributions include partial withdrawals, cash value surrenders and policy loans (including automatic premium loans).

All of the following statements regarding a Modified Endowment Contract are correct, EXCEPT:

If a policy is deemed a MEC, the owner has 7 years to receive a refund of excess premiums and remove the MEC status

Penalties

If the contract is a MEC, all cash value transactions are SUBJECT TO TAXATION and penalty. Funds are subject to a 10% penalty on gains withdrawn prior to age 59 ½. This is considered a premature distribution. Distributions made on or after 59 ½ and distributions paid out due to death or disability are not subject to the penalty

Exclusion Ratio

Investments are taxed on a last-in, first-out basis (LIFO). for income tax purposes the first money out of the annuity will be considered as earnings, not principal, and will be taxed as ordinary income when withdrawn from the contract withdrawals made prior to the annuitant's age 59 ½ are generally subject to a 10% early withdrawal penalty.

Types of exchanges the IRS will allow on a tax-free basis are from:

Life insurance to life insurance Life insurance to an annuity Annuity to an annuity Life insurance or annuity to long-term care But NEVER an annuity to life insurance

Concerning eligibility for a 403(b) retirement plan, which of the following would not qualify?

Student athlete receiving a scholarship and a stipend

If an annuitant withdraws funds from their annuity prior to age 59 1/2 what is the tax consequence?

Tax and 10% penalty tax on the withdrawal that represents earnings

Which of the following plans is designed for employees of non-profit organizations, which includes schools and other 501(c)(3) entities?

Tax-Sheltered Annuity (TSA)

Taxation of Annuities- individual annuities

Tax-qualified annuities are generally funded with pre-tax dollars Non-qualified annuities are generally funded with after-tax dollars. the cost basis equals the total amount paid for a deferred annuity. The basis is the starting point for establishing gain or loss. Any interest or other gains during the accumulation phase of the annuity are tax-deferred. the cost basis equals the total amount paid for a deferred annuity. The basis is the starting point for establishing gain or loss. Any interest or other gains during the accumulation phase of the annuity are tax-deferred.

Death benefits are paid to the estate of the policyowner/insured in which of the following situations?

The beneficiary is the estate

roth ira- There are many owners' benefits with the following being the most distinct.

The contribution period may exceed age 72 The IRS code pertaining to the minimum distribution of IRAs does not apply Qualifying annuitants receive distributions tax free

Rollover

The payment is made directly to the IRA owner. The owner will have 60 days to deposit the check into a new IRA to avoid taxes and penalties. This type of transaction is reported to the IRS and is only allowed once per year. A 20% withholding of funds is required unless a direct rollover occurs. A direct rollover applies when the funds are transferred from one qualified plan to the trustee of an IRA or another plan. There is no 60 day requirement

What is "defined" in a defined contribution plan?

The percentage or amount of an employee's deposits to the plan

IRS Requirements of Qualified Plans

There must be a minimum level of participation and vesting stated in the contract All benefits remain equal or improve upon any merger of 2 or more plans When a participant may begin receiving distribution from the plan must be stated in the contract Limitations of benefits both minimums and maximums must be stated at the beginning of a contract Benefits may not be reduced by any Social Security retirement benefit Must provide either a joint and survivor or survivor benefit for the participant and his/her beneficiary Procedures for a claims review must be available both to the participant and his/her beneficiary Under a qualified plan, the employer's contributions are tax-deductible in the year they were made and are not taxable to the employee until benefits are received

Defined Contribution Plan-

This is a type of retirement plan in which a certain amount or percentage of money is set aside each year by a company for the benefit of the employee. Qualified = Tax Advantages Nonqualified = No Tax Advantages Defined Benefit Plan = Defines Money Coming Out Defined Contribution Plan = Defines Money Going In

All of the following are times in which life insurance policy cash values can become taxable, except:

When a policy loan is taken out

Life Insurance Transfer for Value Rule

When a transfer of ownership takes place through an absolute assignment which is a change of ownership, the so-called IRC Transfer for Value Rule comes into play along with what it takes to qualify for one of the exceptions. Life insurance death proceeds are income tax free to the policy beneficiary EXCEPT when a transfer of ownership has taken place In order for the life insurance policy's death benefit to remain income tax free to the beneficiary the transfer of policy ownership must qualify for one of the exceptions, otherwise the death proceeds will be taxable income to the beneficiary to the extent the death benefit exceeds the value of the consideration given for the policy plus any future premiums paid.

cash values

When the policy matures, it can be paid in a lump sum or using one the settlement options offered by the insurer. As with other distributions made while insured is alive, the sum in excess of the cost basis is taxable as ordinary income.

Premature Distributions

Withdrawals before age 59½ are generally are subject to a 10% penalty tax

Taxable

Withdrawals, cash surrenders, and policy loans distributed from a MEC up to an amount equal to the earnings Interest earned on policy dividends Interest received from a life insurance death benefit settlement option Life insurance cash withdrawals or surrenders that exceed the cost basis Death benefits included in an insured's estate

Distributions

Withdrawals, known as Required Minimum Distributions (RMDs), from the account must start by April 1 of the year following the year the owner turns age 72. Failure to take all or part of an annual RMD incurs a 50% penalty tax on the amount not distributed.

Estate Taxation

accumulation phase, if the contract owner dies, the value of the annuity is included in the owner's estate for valuation If the annuitant dies during the annuity or payout phase, the remaining value in the account will be added to the deceased annuitant's estate for valuation if the annuitant was receiving income from a pure life or straight life annuity, the company keeps the balance and nothing goes into the annuitant's estate for valuation

Tax-Sheltered Annuities (TSAs)

are qualified annuity plans benefitting employees of public schools under IRC Sec 403(b), as well as other nonprofit organizations qualified by the internal revenue code 501(c)(3) These accounts are owned by the employee and are nonforfeitable and will be paid upon death, retirement, or termination of the employee

Death Benefit Proceeds (Claims)

death benefit, or face amount, of the policy is generally not considered taxable income when paid as a lump sum death benefit to a named beneficiary. If a settlement option is used instead of a lump sum payment, any interest or earnings component of each payment would be considered taxable as ordinary income.

Individual Retirement Accounts (IRAs)

established by individuals, they are not considered "qualified plans" IRAs are described in Section 408 of the Tax Code and have their own set of rules. This means an individual can set up a traditional or Roth IRA, whether or not the employer has established a qualified plan at work.

Dividends

participating insurance company's dividend consists of the amount of premium that is returned to the policyowner if the insurance company achieves lower mortality and expense costs than expected dividends themselves are not taxable since dividends are considered a return of unearned premium.

Cash Values

policy will generally experience increases in the cash value annually interest or gains are not taxable at the time they are credited to the policy policyowner does sell, surrender, or withdraw funds from the policy, the difference between what is received and what had been paid in is generally is taxed as ordinary income. When the policy matures, it can be paid in a lump sum or using one the settlement options offered by the insurer

Policy Loans

policyowner takes out a loan against the cash value of a life insurance policy, the amount of the loan is not taxable loan is not taxed as long as the policy is in force policy lapses with a loan outstanding the excess over cost basis becomes taxable as ordinary income

Simplified Employee Pensions (SEPs)

set up by any private sector company that does not offer another type of qualified plan plan is very popular with self-employed individuals. The SEP plan uses employer funded IRAs. The employer makes contributions and deducts as a business expense. All distributions are taxable upon receipt

Distributions at Death

the annuitant dies during the accumulation phase of the annuity the beneficiary receiving the death benefit must pay income tax on any gain embedded in the policy at ordinary income tax rates