Ch.7

G, being undecided on what to do with $100,000 just received on F's policy, decides to leave the proceeds on deposit with the insurer at interest. The rate being paid is 5%. In one year, what amount will be taxable to G?

$5,000 **While the lump sum death benefit is not income taxable, the interest paid on the amount left on deposit with the insurer is, whether taken in cash or left on deposit.

If a life insurance policy does not pass the ___ -pay test, it will be deemed a MEC.

7

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

As an ordinary and necessary business expense **Employer paid premiums on a group life insurance plan are treated as an ordinary and necessary business expense which is why it qualifies for tax deductibility.

Joe had $500,000 of life insurance at work. He has an additional $40,000 life insurance policy the company purchased on all employees. His wife is the primary beneficiary and their four children are contingent beneficiaries. Upon Joe's death, what are the tax consequences to his beneficiaries?

The $540,000 lump sum proceeds will be received income tax-free **The death benefit (face amount) of both individual and group policies received in a lump sum by a named beneficiary(s) is income tax-free.

If a life insurance policy does not pass the 7-pay test, it will be deemed a(n) _________.

When a life insurance policy does not pass the 7-pay test, it will be deemed a MEC.

All employer-paid premiums for amounts above $_________ of group life insurance are reported as taxable income to the employee.

$50,000

All employer-paid premiums for amounts of group life insurance over $__________ are reported as taxable income to the employee.

$50,000 **Premiums paid for death benefits exceeding $50,000 are taxable as income to the employee for the year in which the premium was paid.

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

Beneficiary **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.

Which of the following best defines the 'Cost Recovery Rule'?

Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender **The 'Cost Recovery Rule' stipulates that upon a partial withdrawal of cash or the surrender of a policy, the cash value in excess of premiums paid (cost basis) is subject to income tax.

If a(n) ________ does not pass the 7-pay test, it will be deemed a Modified Endowment Contract (MEC).

Life insurance policy

F has a $100,000 face amount term life policy for which F paid $10,000 in premium to date. F dies and the benefit is paid out to G, the beneficiary. What amount of the death benefit received is taxable as income to G?

Nothing **Lump sum death proceeds are not taxable as income to a named beneficiary.

If a taxable event occurs with a permanent life insurance policy in just about every case, the taxability is considered:

Ordinary income **In just about every case, if there is a taxable event associated with a permanent life insurance policy. The IRS considers it ordinary income.

To eliminate the use of life insurance as a short-term, tax-free savings vehicle, what tax law change took place?

The Modified Endowment Contract (MEC) rules were put into place **The rule states that if a policy is funded too quickly, it will be classified as a Modified Endowment Contract (MEC). MEC rules impose stiff penalties to eliminate the use of life insurance as a short-term, tax-free savings vehicle.

To be a qualified accelerated death benefit it must meet all of the following criteria, except:

The benefit amount cannot exceed the lesser of $50,000 or 7.5% of AGI **To be a qualified accelerated death benefit the benefit must meet the following conditions: a physician must give a prognosis of 24 months or less life expectancy for the named insured, 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, and the insurer provides a monthly report for the insured showing the amount paid and the amount of benefit remaining in the life insurance policy.

Under the Modified Endowment Contract rules the 7-Pay Test is defined as:

The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit **A MEC occurs at any time within the first seven years of a policy (or of a material change to a policy, such as a death benefit increase or decrease) that the sum of premiums paid is more than the number of years of payments times the annual premium required to endow the policy at age 95 or later.