Chapter 10: Quiz

When the owner of a $250,000 life insurance policy died, the beneficiary decided to leave the proceeds of the policy with the insurance company and selected the Interest Settlement Option. If at the time of withdrawal the interest paid was $11,000, the beneficiary would be required to pay income tax on

$11,000 (The death benefit is not income taxable; any interest earned is income taxable.)

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?

$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.)

What is the penalty for IRA distributions that are below the required minimum for the year?

25% (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.)

An individual has been diagnosed with Alzheimer's disease. He is insured under a life insurance policy with the accelerated benefits rider. Which of the following is true regarding taxation of the accelerated benefits?

A portion of the benefit up to a limit is tax free; the rest is taxable income. (When accelerated benefits are paid to a chronically ill insured, they are tax free up to a certain limit. Any amount received in excess of this dollar limit must be included in the insured's gross income.)

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

A. Annuity payments (A portion of an annuity payment is taxable, while another portion is 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.")

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. There are no distributions. D. Distributions cannot begin prior to age 73.

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 73 in order for the annuitant to avoid penalties. The penalty is 25% of the shortfall from the required annual amount.)

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

A. 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.)

Which of the following is NOT true of Section 1035 Policy Exchanges?

Any exchange made under Section 1035 of the Internal Revenue Code must be completed within 30 days. (Section 1035 of the Internal Revenue Code does not give a specific time limit to complete such an exchange.)

All of the following are TRUE of the federal tax advantages of a qualified plan EXCEPT

At distribution, all amounts received by the employee are tax free. (Funds in a qualified plan accumulate on a tax-deferred basis; however, at distribution any amount received by the employee will be treated as ordinary income for tax purposes.)

Which of the following statements regarding deferred compensation funds is INCORRECT? A. They can be established by employers. B. They are usually qualified plans. C. They generally provide additional retirement benefits. D. They can be made with cash deposits to an annuity.

B. They are usually qualified plans (Deferred Compensation Funding refers to any employer retirement, savings, or other deferred compensation plan that is not a qualified retirement plan. Funding involves a contractual commitment between the employer and employee to pay compensation in future years. These plans are typically made with selected employees to provide additional retirement benefits.)

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. No penalties, since the owner is older than 59 ½ B. 15% for early withdrawal C. 25% tax on the amount not distributed at the required minimum age D. 10% for early withdrawal

C. 25% tax on the amount not distributed at the required minimum age (When immediate annuities are used to pay IRA benefits, distributions must begin no later than age 73 in order for the annuitant to avoid penalties. The penalty is 25% of the shortfall from the required annual amount.)

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. $7,000 B. $13,000 C. $10,000 D. $3,000

D. $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).)

If an insured surrenders his life insurance policy, which statement is true regarding the cash value of the policy? A. It is not considered to be taxable. B. It is automatically taxable. C. It is taxable only if it exceeds the amounts paid for premiums by 50%. D. It is only taxable if the cash value exceeds the amount paid for premiums.

D. It is only taxable if the cash value exceeds the amount paid for premiums. (The cash value of a surrendered policy is only considered to be taxable as income if the cash value exceeds the amount of premiums paid for the policy.)

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

D. Money borrowed from the cash value is taxable.

The advantage of qualified plans to employers is A. Taxable contributions. B. No lump-sum payments. C. Tax-free earnings. D. Tax-deductible contributions.

D. Tax-deductible contributions (Qualified plans have these tax advantages: employer contributions are tax deductible and are not taxed as income to the employee; the earnings in the plan accumulate tax deferred; lump-sum distributions to employees are eligible for favorable tax treatment.)

Which of the following statements regarding the taxation of Modified Endowment Contracts is FALSE? A. Accumulations are tax deferred. B. Distributions before age 59 1/2 incur a 10% penalty on policy gains. C. Policy loans are taxable distributions. D. Withdrawals are not taxable.

D. Withdrawals are not taxable (Any distributions from MECs are taxable, including withdrawals and policy loans. All of the other statements are true.)

Which of the following terms is used to name the nontaxed return of unused premiums?

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.)

Which of the following is true regarding taxation of dividends in participating policies?

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.)

Which of the following is used to determine the annuity amounts that are not taxable?

Exclusion ratio (The "exclusion ratio" is used to determine the annuity amounts that should be excluded from taxes. During the accumulation phase, the contributions to the annuity have already been taxed. Therefore, the contributions are not taxed during the income period.)

What method is used to determine the taxable portion of each annuity payment?

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.)

If taken as a lump sum, life insurance proceeds to beneficiaries are passed

Free of federal income taxation. (Life insurance proceeds to beneficiaries are passed free of federal income taxation if taken as a lump sum distribution. If the proceeds are taken as other than lump sum, part of the proceeds will be tax-free and part will be taxable. When paid in installments, part of the proceeds contains principal and some interest, so the interest portion is subject to federal income taxation.)

Life insurance death proceeds are

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

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?

He will have to pay a penalty if he is younger than 59 1/2 (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.)

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?

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

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?

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.)

What type of annuity activity will cause immediate taxation of the interest earned?

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

If an annuitant dies during the accumulation period, what benefit (if any) will be included in the annuitant's estate?

Accumulated cash value (If the annuitant died during the accumulation period, the insurer is obligated to return all or a portion of the annuity cash value (values accumulated in the annuity in accordance with contract terms), which will be included in the deceased annuitant's estate.)

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 become immediately taxable. C. The interest will continue to accumulate tax deferred. D. The premiums will increase.

C. 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 is true regarding taxation of accelerated benefits under a life insurance policy? A. They are always taxable to chronically ill insured. B. There is a 10% penalty for early distribution of the death benefit. C. They are always taxed. D. They are tax free to terminally ill insured.

D. They are tax free to terminally ill insured (When accelerated benefits are paid under a life insurance policy, they are received tax free by terminally ill insured, and tax free up to a limit for chronically ill insured.)

Which of the following statements is TRUE concerning whole life insurance?

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

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an

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.)

In which of the following instances would the premium be tax deductible?

Premiums paid by an employer on a $30,000 group term life insurance plan for employees (As a general rule, premiums paid for life insurance are not tax deductible. The exception to this rule is when an employer buys group term life insurance for his employees since it is considered a business expense.)

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.)

During the accumulation period in a nonqualified annuity, what are the tax consequences of a withdrawal?

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.)

Which of the following best describes taxation during the accumulation period of an annuity?

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.)

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase?

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.)