Chapter 4: Taxes, Retirement, and Other Insurance Concepts
Qualified Plan Requirements
-Must be approved by the IRS -Exclusively for employees and their beneficiaries. -Formally written and communicated. -Plan cannot discriminate on ranking of employee - They are permanent - Must have a vesting (ownership) schedule. (applies to what the employer puts in)
All of the following are personal uses of life insurance EXCEPT A. Cash accumulation. B. Buy-sell agreement. C. Survivor protection. D. Estate creation.
B. Buy-sell agreement. Personal uses of life insurance include survivor protection, estate creation and conservation, cash accumulation, and liquidity. A buy-sell agreement is for business uses of life insurance.
The president of a manufacturing company has offered one of the company's officers a special individual annuity plan that is unavailable to lower-echelon employees. This plan would be funded with before-tax corporate dollars, and it does not meet government approval standards. This annuity plan is A. An executive annuity plan. B. Subject to government standards. C. Illegal. D. A nonqualified annuity plan.
D. A nonqualified annuity plan. Nonqualified plans are a perfectly legal way for selected employees to receive certain types of benefits. Before-tax corporate dollars can be used for these plans, and they are not subject to government standards. Because of this, however, nonqualified plans contributions are not tax-deductible, unlike with qualified plans.
Plans for Employers
Retirement plans 1. HR-10 Keogh (self-employed) -employer matches employee's contribution -established by IRS; adjusted annually 2. SEP (self employed/small business) -employee and employer contribute -established by IRS; adjusted annually 3. SIMPLE (small employer <100 employees) -employer matches employee contribution -established by IRS; adjusted annually 4. 401(k) (any employer) -employer matches employee contribution -established by IRS; adjusted annually 5. 403(b)-TSA (nonprofit) -employee plus employer contribution -established by IRS; adjusted annually TSA (tax sheltered annuity) can only be church, nonprofit, and educator of a city paid school (public education) Cost Basis (money you have already paid taxes on) TSA -contributions by employer through salary reduction -employee contributions up to an IRA set amount
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).
Rollover
withdrawal of the money from one qualified plan and placing it into another plan
What type of life insurance is most commonly used for group plans? A. Whole life B. Flexible premium whole life C. Decreasing term D. Annually renewable term
D. Annually renewable term Group insurance is usually written for employee-employer groups as annually renewable term insurance.
In group life policies, a certificate of insurance is given to A. The group sponsor. B. The insurance producer. C. The policyholder to keep on file. D. Each insured person.
D. Each insured person. In group life policies, individual certificates are given to each insured person.
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. $3,000 B. $13,000 C. $10,000 D. $7,000
A. $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).
Social Security was created to protect against all of the following EXCEPT A. Bad investment choices. B. Sickness in old age. C. Premature death. D. Disability.
A. Bad investment choices. Social Security is a Federal program enacted in 1935, that is designed to provide protection, for eligible workers and their dependents, against financial loss due to death, disability, superannuation (retirement income), and sickness in old age.
When an employer offers to give an employee a wage increase in the amount of the premium on a new life insurance policy, this is called a(n) A. Executive bonus. B. Key person policy. C. Fraternal association. D. Aleatory contract.
A. Executive bonus. When an employer offers to give an employee a wage increase in the amount of the premium on a new life insurance policy, this is called an executive bonus.
If a retirement plan or annuity is "qualified," this means A. It is approved by the IRS. B. It has a penalty for early withdrawal. C. It accepts after-tax contributions. D. It is noncancellable.
A. It is approved by the IRS. A qualified retirement plan is approved by the IRS, which then gives both the employer and employee benefits such as deductible contributions and tax-deferred growth.
What is the official name for the Social Security program? A. Old Age Survivors Disability Insurance B. Social Insurance Program C. Defined Benefit Retirement Insurance D. Qualified Pension Plan
A. Old Age Survivors Disability Insurance Social Security is formally called Old Age Survivors Disability Insurance - OASDI.
All of the following would be different between qualified and nonqualified retirement plans EXCEPT A. Taxation on accumulation B. Taxation of withdrawals C. Taxation of contributions D. IRS approval requirements
A. Taxation on accumulation Taxation on accumulation is deferred in both types of plans. The rest of the characteristics would differ.
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. The amount of the distribution is reduced by the amount of a 20% withholding tax. B. No taxes are due since the plan participant is over age 59 1/2. C. There is a 10% early withdrawal penalty. D. The amount distributed is subject to ordinary income tax.
A. 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.
Which of the following describes the tax advantage of a qualified retirement plan? A. The earnings in the plan accumulate tax deferred. B. Distributions prior to age 59½ are tax deductible. C. Employer contributions are deductible as a business expense when the employee receives benefits. D. Employer contributions are not taxed when paid out to the employee.
A. The earnings in the plan accumulate tax deferred. Contributions are tax deferred, and earnings on the money in the plan accrue on a tax-deferred basis.
All of the following are true of key person insurance EXCEPT A. The plan is funded by permanent insurance only. B. There is no limitation on the number of key employee plans in force at any one time. C. The employer is the owner, payor and beneficiary of the policy. D. The key employee is the insured.
A. The plan is funded by permanent insurance only.
All of the following are true of key person insurance EXCEPT A. The plan is funded by permanent insurance only. B. There is no limitation on the number of key employee plans in force at any one time. C. The employer is the owner, payor and beneficiary of the policy. D. The key employee is the insured.
A. The plan is funded by permanent insurance only. Key Person coverage may be funded by any type of life insurance.
All of the following are characteristics of a group life insurance plan EXCEPT A. There is a requirement to prove insurability on the part of the participants. B. The participants receive a Certificate of Insurance as their proof of insurance. C. A minimum number of participants is required in order to underwrite the plan. D. The cost of the plan is determined by the average age of the group.
A. There is a requirement to prove insurability on the part of the participants. There is no individual underwriting for group life insurance.
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.
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.
Who is a third-party owner? A. An irrevocable beneficiary B. A policyowner who is not the insured C. An insurer who issues a policy for two people D. An employee in a group policy
B. A policyowner who is not the insured Third-party owner is a legal term used to identify an individual or entity that is not an insured under the contract, but that has a legally enforceable right under it.
All of the following are TRUE of the federal tax advantages of a qualified plan EXCEPT A. Employee and employer contributions are not counted as income to the employee for income tax purposes. B. At distribution, all amounts received by the employee are tax free. C. Employer contributions are tax deductible as ordinary business expense. D. Funds accumulate on a tax-deferred basis.
B. 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.
What does "liquidity" refer to in a life insurance policy? A. The insured receives payments each month in retirement. B. Cash values can be borrowed at any time. C. The death benefit replaces the assets that would have accumulated if the insured had not died. D. The policyowner receives dividend checks each year.
B. Cash values can be borrowed at any time. Liquidity in life insurance refers to availability of cash to the insured through cash values.
A partnership buy-sell agreement in which each partner purchases insurance on the life of each of the other partners is called a A. Stock redemption plan. B. Cross-purchase plan. C. Key person plan. D. Split-dollar plan.
B. Cross-purchase plan.
Which of the following terms is used to name the nontaxed return of unused premiums? A. Surrender B. Dividend C. Premium return D. Interest
B. 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.
All of the following are business uses of life insurance EXCEPT A. Funding business continuation agreements. B. Funding against general company financial loss. C. Compensating executives. D. Funding against financial loss caused by the death of a key employee.
B. Funding against general company financial loss. Both life and health insurance can be used for a variety of purposes in a business setting, including the funding of business continuation agreements, compensating executives, and protecting the firm against financial loss resulting from the death or disability of key employees.
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.
Which of the following is an eligibility requirement for all Social Security Disability Income benefits? A. Be at least age 50 B. Have attained fully insured status C. Be disabled for at least 1 year D. Have permanent kidney failure
B. 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.
Which of the following statements concerning a Simplified Employee Pension plan (SEP) is INCORRECT? A. Employer contributions are not included in the employee's gross income. B. SEPs are suitable for large companies. C. SEPs allow the employer to make annual tax deductible contributions up to 25% of an employee's earned income. D. SEPs have a higher tax deductible contribution limit than an IRA.
B. SEPs are suitable for large companies. An SEP is a benefit plan that is designed to be provided by a small employer for the benefit of the employees.
A producer is helping a married couple determine the financial needs of their children in the event one or both should die prematurely. This is a personal use of life insurance known as A. Juvenile protection provision B. Survivor protection C. Life planning D. Survivorship insurance
B. Survivor protection Life insurance can provide the funds necessary for the survivors of the insured to be able to maintain their lifestyle in the event of the insured's death. This is known as survivor protection.
Which of the following describes the tax advantage of a qualified retirement plan? A. Employer contributions are not taxed when paid out to the employee. B. The earnings in the plan accumulate tax deferred. C. Distributions prior to age 59½ are tax deductible. D. Employer contributions are deductible as a business expense when the employee receives benefits.
B. The earnings in the plan accumulate tax deferred. Contributions are tax deferred, and earnings on the money in the plan accrue on a tax-deferred basis.
An employee quits his job on May 15 and doesn't convert his Group Life policy to an individual policy for 2 weeks. He dies in a freak accident on June 1. Which of the following statements best describes what will happen? A. The insurer will pay nothing because the employee has terminated his group insurance and hasn't started the individual one. B. The insurer will pay the full death benefit from the group policy to the beneficiary. C. The insurer will pay a reduced death benefit to the beneficiary. D. The insurer will pay the death benefit minus one month's premium.
B. The insurer will pay the full death benefit from the group policy to the beneficiary. The employee usually has a period of 31 days after terminating from the group in order to exercise the conversion option. During this time, the employee is still covered under the original group policy.
Which of the following best defines the "owner" as it pertains to life settlement contracts? A. The insurance provider B. The policyowner of the life insurance policy C. A financial entity that sponsors the transaction D. A fiduciary for the contract
B. The policyowner of the life insurance policy The term owner refers to the owner of the policy who may seek to enter into a life settlement contract. The term does not include an insurance provider, a qualified institutional buyer, a financing entity, a special purpose entity, or a related provider trust
All of the following would be eligible to establish a Keogh retirement plan EXCEPT A. A hair dresser who operates her business at her house. B. The president and employee of a family corporation. C. A sole proprietor of a service station who employs four employees . D. A sole proprietor of film development store with no employees.
B. The president and employee of a family corporation. Keogh plans are for self-employed individuals and their employees.
Which of the following employees insured under a group life plan would be allowed to convert to individual insurance of the same coverage once the plan is terminated? A. Those who have no history of claims B. Those who have been insured under the plan for at least 5 years C. Those who have worked in the company for at least 3 years D. Those who have dependents
B. Those who have been insured under the plan for at least 5 years If the master contract is terminated, every individual who has been on the plan for at least 5 years will be allowed to convert to individual insurance of the same coverage.
What is the name of the insured who enters into a viatical settlement? A. Viatical broker B. Viator C. Third party D. Contingent
B. Viator Viator means the owner of a life insurance policy who enters into or seeks to enter into a viatical settlement contract.
In order to qualify for conversion from a group life policy that has been terminated to an individual policy of the same coverage, a person must have been insured under the group plan for how many years? A. 1 B. 3 C. 5 D. 10
C. 5 If the master contract is terminated, every individual who has been on the plan for at least 5 years will be allowed to convert to individual insurance of the same coverage.
All of the following are examples of third-party ownership of a life insurance policy EXCEPT A. A company purchases a life insurance policy on their manager, who is an important part of the operation. B. When an insured purchased a new home, the insured made an absolute assignment of a life insurance policy to the mortgage company. C. An insured borrows money from the bank and makes a collateral assignment of a part of the death benefit to secure the loan.
C. An insured borrows money from the bank and makes a collateral assignment of a part of the death benefit to secure the loan. A collateral assignment is the transfer of some or all of the death benefits of the policy to a creditor as security for a loan, but does not give the creditor the rights of ownership. In the event of the insured's death, the creditor would only be able to recover that portion of the policy's proceeds equal to the creditor's remaining interest in the loan.
A key person insurance policy can pay for which of the following? A. Workers compensation B. Hospital bills of the key employee C. Costs of training a replacement D. Loss of personal income
C. Costs of training a replacement A key person insurance policy will pay for costs of running the business and replacing the employee.
Two attorneys operate their practice as a partnership. They want to start a program through their practice that will provide retirement benefits for themselves and three employees. They would likely choose A. 403(b) plan. B. 401(k) plan. C. HR-10 (Keogh Plan). D. Section 457 Deferred Compensation Plan.
C. HR-10 (Keogh Plan). HR-10 (Keogh Plans) are plans specifically for self-employed and their employees.
If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an A. Endowment. B. Nonqualified annuity. C. Modified endowment contract. D. Accelerated benefit policy.
C. 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.
The advantage of qualified plans to employers is A. No lump-sum payments. B. Taxable contributions. C. Tax-deductible contributions. D. Tax-free earnings.
C. 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.
A corporation is the owner and beneficiary of the key person life policy. If the corporation collects the policy benefit, then A. IRS has no jurisdiction. B. The benefit is received as taxable income. C. The benefit is received tax free. D. The benefit is subject to the exclusionary rule.
C. The benefit is received tax free. Should a key person die, the benefit is treated as a reimbursement to the business for loss of services from that key person.
Which of the following is an example of liquidity in a life insurance contract? A. The flexible premium B. The money in a savings account C. The cash value available to the policyowner D. The death benefit paid to the beneficiary
C. The cash value available to the policyowner Liquidity in life insurance refers to availability of cash to the insured. Some life insurance policies offer cash values that can be borrowed at any time and used for immediate needs.
Which of the following is the best reason to purchase life insurance rather than annuities? A. To create regular income payments B. To liquidate a sum of money over a lifetime C. To create an estate D. To liquidate a sum of money over a period of years
C. To create an estate With insurance, the death benefit creates an immediate estate should the insured die.
Which of the following statements regarding the taxation of Modified Endowment Contracts is FALSE? A. Policy loans are taxable distributions. B. Accumulations are tax deferred. C. Withdrawals are not taxable. D. Distributions before age 59 1/2 incur a 10% penalty on policy gains.
C. Withdrawals are not taxable. Any distributions from MECs are taxable, including withdrawals and policy loans. All of the other statement are true.
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? A. $50,000 B. $18,000 C. $15,000 D. $3,000
D. $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 percentage of a company's employees must take part in a noncontributory group life plan? A. 0% B. 25% C. 75% D. 100%
D. 100% If the employer pays all of the premium, all employees must be covered to avoid adverse selection.
An employee quits his job and converts his group policy to an individual policy; the premium for the individual policy will be based on his A. Experience Rating. B. Group rate. C. Insurer's scheduled rate. D. Attained age.
D. Attained age. If an employee terminates membership in the insured group, the employee has the right to convert to an individual whole life policy without proving insurability. The insurer will determine what type(s) of policy an employee may convert to, but it must be issued at a standard rate, based on the individual's attained age.
For a retirement plan to be qualified, it must be designed for the benefit of A. Key employee. B. Employer. C. IRS. D. Employees.
D. Employees. Qualified plans are designed for the exclusive benefit of the employees and their beneficiaries.
Which of the following is correct concerning the taxation of premiums in a key-person life insurance policy? A. Premiums are tax deductible by the key employee. B. Premiums are tax deductible as a business expense. C. Premiums are taxable to the employee. D. Premiums are not tax deductible as a business expense.
D. Premiums are not tax deductible as a business expense. The business cannot take a tax deduction for the expense of the premium. However, if the key employee dies, the benefits paid to the business are usually received tax free.
Which of the following would be considered a nonqualified retirement plan? A. 401(k) B. Keogh plan C. Roth IRA D. Split-dollar plan
D. Split-dollar plan Examples of nonqualified plans are individual annuities and deferred compensation plans for highly paid executives, split-dollar insurance arrangements, and Section 162 executive bonus plans.
Which of the following is NOT true of life settlements? A. They could be used for a key person coverage B. They could be sold for an amount greater than the current cash value. C. They involve insurance policies with large face amounts. D. The seller must be terminally ill.
D. The seller must be terminally ill. With Life Settlements, unlike with viatical settlements, the seller does not need to be terminally ill. They usually involve life insurance policies with a face amount of $250,000 or more, "key-person" coverage, corporate owned policies, or policies representing excess coverage that is no longer needed, and could be sold for an amount greater than the current cash value.
IRAs and Roth IRAs
IRA is traditional Traditional IRAs -proof of earned income -Contributions are always pretax up to age 70 and a half. There are up to limits. The contribution is deductible to your income for the year. -Withdrawals: (you dont want to withdrawal before age 59 1/2- 70 1/2) (10% penalty for early withdrawal) (must take money out at 70 1/2) Roth IRAs -proof of earned income -contributions are made with after tax money, you can continue to contribute after age 70 1/2, they have up to limits, Roth IRA is never deductible Withdrawals -You can take money out of a Roth IRA at anytime with no tax or penalty since you put in with after taxed dollars. Qualified Distribution -Have the Roth at least 5 years -you don't take anything out until 59 1/2 or older. -will never pay tax on growth if you make qualified distributions
Business Uses of Life Insurance
Key Person Insurance (top seller or something in a business) This life insurance policy is a security for the business. Death benefit would pay to the business. Buy-sell agreement -is a legal contract that determines what will be done with a business in the event that an owner dies or becomes disabled. This is also referred to as a business continuation agreement. -cross purchase: when each partner buys a policy on the other -entity purchase: when a partnership buys the policy on the partners. -Both the business partners and their spouses have to sign this legal document.
Qualified vs Non-qualified
Qualified has to follow IRS rules Non-qualified does not follow any IRS requirements. Only offered to highly paid employees. Employer gets a tax deduction.
Personal Uses for Life Insurance
Reasons people purchase insurance: 1. Survivor protection 2. Estate Creation 3. Estate Conservation 4. Cash accumulation 5. Liquidity
Gross Income
a person's income before taxes or other deductions
nonprofit organization
an organization that uses its surplus to fulfill its purpose instead of distributing the surplus to its owners or members
Pretax contribution
contribution made before federal and/or state taxes are deducted from earnings
surrender
early termination of a policy by the policyowner
Policy endowment
maturity date
LIFO (last in, first out)
principle applied to asset management in life insurance products, under which it is assumed that the funds paid into the policy last will be paid out first
FIFO (first in, first out)
principle under which it is assumed that the funds paid into the policy first will be paid out first
Earned Income
salary, wages, or commissions; but not income from investments, unemployment benefits, and similar sources of income.
Vesting
the right of a participant in a retirement plan to retain part or all of the benefits