Chapter 6- Qualified Plans and Federal Tax Considerations

Direct Rollover

20% withheld can be avoided if the distribution is made directly from the first plan to the trustee or administrator/ custodian of the new IRA Plan

LIFO (last in, first out)

Annuities follow a ______ format

the year they are received

Benefits that are withdrawn from any qualified retirement plan are taxable______ if the money is not moved properly Rollover/transfer

After-tax dollars (not tax deductible)

Contributions to a Roth IRA are with

Employees

For a retirement plan to be qualified, it must be designed for the benefit of

From trustee to trustee

In a direct transfer, how is money transferred from one retirement plan to a traditional IRA?

Grows tax deferred

In life insurance policies, cash value increases and

Premiums

Non tax deductible

One-Sum Cash Surrenders

Results in immediate taxation of the interest earned

Surrenders

Surrender value - past premium = amount taxable

contribution/ distribution

Taxes must be paid either upon ______ or upon _______, not both

earned income

Traditional IRAs and Roth IRAs are for individuals with____

Exclusion Ratio

Used to determine the annuity amounts to be excluded from taxes Annuitant is able to recover the cost basis nontaxable Cost basis is the principal amount, or the amount that was paid into the annuity, which is excluded from taxes The rest of each annuity payment is interest that has been earned and is taxable

Roth IRA

Which type of retirement account does not require the owner to start taking distributions at age 73?

Roth IRA

A form of an individual retirement account funded with after-tax contributions Can contribute 100% of earned income up to an IRS-specified max Contributions can continue regardless of the account owner's age and do not have to begin at a specified age Grow tax free as long as the account is open for at least 5 years

IRA (traditions Individual Retirement Account)

Allows individuals with earned income to make tax deductible contributions regardless of age Allowed to contribute a specified dollar limit each year, or 100% of their salary if less than the max allowed amount People 50 or older are entitled to make additional catch-up contributions Married couple double the individual amount Required to maintain separate account Withdrawals prior to age 59 ½ are considered early and subject to 10% additional tax At 73, owner must start receiving the minimum annual amount

Partial Surrenders

First In, First Out (FIFO)

Estate Tax

If the insured owns the policy, it will be included for the estate tax purposes If the policy is given away (possibly to a trust) and the insured dies within 3 years of the gift, the death benefit will be included in the estate

December 31 of the calendar year of the 5th anniversary

If the owner dies before distributions have begun, the entire interest must be distributed in full on or before _________ of the owner's death, unless the owner named a beneficiary

Accumulation

Period after an annuity has been purchased but before distribution begins

Living benefits

Permanent life insurance provides ______

Taxation of Personal Life Insurance

Premiums are not tax deductible

Settlement Options

Principal is tax free, but interest is taxable

Transfer for value

The life insurance policy is sold to another party prior to the insured's death

Settlement Options

ent Options Death benefit spread event over income period (averaged) Interest payments in excess of death benefit portion are taxable

Deductible contributions and tax-deferred growth

An employer-sponsored qualified retirement plan is approved by the IRS, which then gives both the employer and employee benefits such as

Roth IRA Tax

Contributions are not tax deductible Excess contributions are subject to a 6% tax penalty

Pre-tax dollars (tax deductible)

Contributions to a traditional IRA are with ______

Life Insurance Only

FIFO method applies to _____ Policyowner will receive their investment in the contract first before receiving any gains (or being taxed on those gains)

Tax advanatages

Qualified plans have ____

Death Benefit (Life Insurance)

Tax free if taken as a lump-sum distribution to a named beneficiary Principal is tax free; interest is taxable if paid in installments (other than lump sum)

Cash value exceeding premiums

Taxable at Surrender

The exclusion ratio

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

Surrendering the annuity for cash

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

Interest

When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income?

Individually Owned Annuity

A portion of each annuity benefit payment is taxable Anticipated return of the principal paid in is nontaxable

Policy loans can be repaid

By the owner while the policy is in force At policy surrender or maturity, subtracted from the cash value At the insured's death, subtracted from the death benefit

Traditional IRA

Contribute 100% of income up to an IRS Specified Limit Excess contribution penalty is 6% Grows tax deferred Contributions are tax deductible (Made with pre-tax dollars) 10% penalty for early nonqualified distributions prior to age 59 ½ Distributions are taxable Payouts begin by age 73

Nonqualified Plans

Contributions are not tax deductible No IRS approval Can discriminate Earnings grow tax deferred Excess over cost basis is taxed

Tax-Deferred Accumulation

Cost base represents the premium dollars that have already been taxed and will not be taxed again when withdrawn from the contract Interest accumulated in an annuity is the tax base, but the taxes are deferred during the accumulation period

Corporate Owned

Growth in the annuity is not tax deferred Interest income is taxed annually unless the corporation owns a group annuity for its employees, and each employee receives a certificate of participation

Distributions at Death

If the annuity contract holder dies before the annuitization date, the interest accumulated in the annuity becomes taxable If the beneficiary of the annuitant is a spouse, the tax can continue to be deferred

10

Individual beneficiaries other than a spouse must withdraw the entire amount from the account within ____ years of the account owner's death Not permitted to treat inherited IRA as their own Not owe tax on the assets in the IRA until they receive distributions from it

Accumulations

Interest taxable

Taxation of IRAs

When an annuity is used to fund a Traditional IRA distributions are fully taxable if contributions were made with pretax dollars 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

$3,000

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?

Cash Value Increases

Any cash value accumulations in the policy can be borrowed against by the policyowner, or may be paid to the policy owner upon surrender of the policy Grows tax deferred Upon surrender or endowment, any cash value in excess of cost basis (premium payments) is taxable as ordinary income Upon death, face amount is paid, no more cash value Death benefits paid to beneficiary income tax free

SECURE Act

January 1, 2023 Raised the required minimum distribution age from 72 to 73 Reduced penalty for failing to take an RMD from 50% to 25%

Policy Loans

May borrow against the policy's cash value Money borrowed is not income taxable Insurance company charges interest on outstanding policy loans

Death Benefit

Not income taxable

Lump-sum death benefit

Not income taxable

Policy Loans

Not income taxable

Policy dividends

Not taxable

Qualified Plans

Tax deductible contributions Plan approved by IRS Cannot discriminate Earnings grow tax deferred All withdrawals are taxed

Rollover

Tax free distribution of cash from one retirement plan to another Must be completed within 60 days from the time the money is taken out of the first plan If the distribution plan is paid directly to the participant, 20% of the distribution must be withheld by the payor

Withdrawal of Interest Principal

When money is withdrawn from the annuity during the accumulation phase, the amounts are taxed on a Last In, First Out basis (LIFO) 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

Qualified Plans

Designed for the exclusive benefit of the employees and their beneficiaries Are formally written and communicated to the employees Use a benefit or contribution formula that does not discriminate in favor of the prohibited group Are not geared exclusively toward the prohibited group Are permanent Are approved by the IRS Have a vesting requirement

Lump-sum/transfer for value

Life insurance proceeds paid to a named beneficiary are generally free of federal income taxation if taken as a _________ Exception to this rule would apply if the benefit payment results from a ______

Section 1035 Exchanges

Nontaxable exchange of cash value life insurance or annuity on the same life "Same to same" is acceptable

Cash Value Increases

Not taxable (as long as policy in force)

Prohibited Group

Officers, stockholders, or highly paid employees

Conditions where 10% penalty for early withdrawals would not apply

Participant is over 59 ½ Participant is totally disabled Money is used to make the downpayment on a home (not to exceed $10,000 and for first time home buyers) Withdrawals are for post-secondary education purposes Withdrawals are for catastrophic medical expenses, or upon death

Nonqualified Plans

Require no government approval and are used as a means for an employer to discriminate in favor of a valuable employee with regard to employee benefits Accept after-tax contributions

Traditional IRAs Tax

Tax-deductible contributions for the year of the contribution Contributions must be made in "cash" in order to be tax deductible (cash, check, money order) Excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA Tax-deferred earnings (money accumulated in the account) are not taxed until withdrawn

Dividend Interest

Taxable in the year earned

Cash Value Gains

Taxed at surrender

Premature Distributions and Penalty Tax

The IRS imposes a penalty for certain premature distributions under annuity contracts In addition to ordinary income tax that may be due, a 10% penalty is imposed on the annuity tax base for early withdrawals prior to ge 59 ½

Transfer

Refers to a tax free transfer of funds from one retirement program to a traditional IRA Transfer of interest in a traditional IRA from one trustee directly to another

Dividends

Return of unused premium Not considered income for tax purposes Not taxable (return of unused premium the interest is taxable) Interest earned on the dividend is subject to taxation

Spouses who are the sole designated beneficiary

Treat an IRA as their own Base the required minimum distribution (RMD) on their own current age Base the required minimum distribution on the decedent's age at death, reducing the distribution period by one year Withdraw the entire account balance by the the end of the 5th year following the account owner's death If the account owner died before the required beginning date, the surviving spouse can wait until the owner would have turned 73 to begging receiving RMDs

Surrenders

When a policy owner surrenders for cash value, some of the cash value received may be taxable as income if it exceeds the amount of the premiums paid for the policy

Roth IRA

Contribute 100% of income up to an IRS Specified Limit Excess contribution penalty is 6% Grows tax free (if account is open for at least 5 years) Contributions are not tax deductible (made with after tax dollars) Qualified distribution cannot occur until account is open for 5 years and owner is 59 ½ Distributions are not taxable No required minimum age for payouts

Partial Surrender

When an owner withdraws cash value from a universal life policy, both the cash value and the death benefit are reduced by the surrender