Chapter 6 Selling Life Insurance Exam

Statements about the use of the Life Insurance Cost Index must include an explanation that indexes are useful only for comparing the relative costs of: A) two or more similar policies. B) nonrenewable term insurance. C) life insurance and annuities. D) term, whole life and endowment policies.

A

Key Employee life insurance Death proceeds from the policy are not taxable nor are premiums tax-deductible.

z

Under an executive bonus plan, if the employee takes loans from the insurance policy, the funds are: A) taxed but paid by the employer. B) taxed as ordinary income. C) taxed as capital gains. D) not taxed and treated as deferred income.

Taxed as Ordinary Income to the Employee

Regarding the Life Insurance Surrender Cost Index, a low index figure represents a relatively: A) high policy cost in the event of policy surrender value at the end of the designated period. B) low policy cost in the event of policy surrender at the end of a designated period. C) low cash surrender value at the end of the designated period. D) high cash surrender value at the end of the designated period.

B

An executive bonus plan is a nonqualified employee benefit arrangement in which an employer pays a bonus to an employee, who then: A) contributes it to a deferred compensation plan. B) uses it to pay his share of the premiums under an employer-owned life insurance policy. C) uses it to pay the premiums on a life insurance policy covering his life. D) contributes it to a 401(k) plan.

C An executive bonus plan is a nonqualified employee benefit arrangement in which an employer pays a bonus to a particular employee. The employee then uses the bonus to pay the premiums on a life insurance policy covering his life. The employee, not the employer, is the policyowner.

Herb and Felicia have been married for several years and are interested in increasing their life insurance protection as their family grows. Herb is a lawyer with a mid-sized firm. Felicia is a freelance writer of children's books. In planning for the future, when might they expect that their family will have its greatest need for income? A) If Felicia survives Herb and lives to an old age. B) When the children move away from the home. C) If Herb is diagnosed with a terminal illness and subsequently dies from it. D) While the children are in school.

D When a covered worker dies, a surviving spouse with small children will usually be eligible for Social Security benefits. However, Social Security cannot-and was not designed to-address a family's need for income when the breadwinner dies. Instead, life insurance addresses this need.

Which of the following statements pertaining to key-person life insurance is CORRECT? A) The policy is a company-owned asset. B) At the death of the key person, proceeds are paid to that person's beneficiary. C) The owner of a company cannot be considered a key person. D) The insured key person controls the policy.

A A key person is any person in an organization whose contributions are essential to its success. With key-person insurance, the business is the owner, premium payor, and beneficiary of the policy. The purpose of the insurance is to protect the business against the economic loss it would suffer if the key person were to die.

John names the United Way as the beneficiary of his $250,000 life insurance policy. At John's death, who is responsible for the income taxes payable on the lump sum proceeds received by the charity? A) There is no income tax payable on the death proceeds. B) John's estate. C) The United Way. D) The tax liability is split evenly between John's estate and the United Way.

A Lump-sum proceeds payable upon the death of the insured are not subject to income tax, regardless of the beneficiary.

The needs approach can be used to determine all of the following EXCEPT: A) amount needed to replace the breadwinner's projected increasing annual salary. B) amount of income needed if the breadwinner dies. C) amount needed to pay for a child's education. D) amount needed to provide income for the surviving spouse's retirement.

A The needs approach to determine how much life insurance is needed is not limited to fulfilling objectives in the event of death only, such as final expenses and immediate debts that need to be paid. It also considers a family's (or business's) living needs, such as maintenance income for the family, providing for a child's education, and planning for the surviving spouse's retirement income. Replacement of the breadwinner's projected increasing annual salary is a factor that is taken into account when using the human life value approach to determine how much life insurance is needed.

Which of the following statements regarding executive bonus plans is NOT correct? A) The employer becomes the policyowner of the insurance policy. B) The bonus is included in the employee's gross income. C) An executive bonus plan is a nonqualified employee benefit arrangement in which an employer pays a bonus to a particular employee. D) The employee uses the bonus to pay the premiums on a life insurance policy covering his life.

A An executive bonus plan, or Section 162 bonus plan, is a nonqualified employee benefit arrangement in which an employer pays a bonus to a particular employee. The bonus is tax deductible to the employer. The employee in turn uses the bonus to pay the premiums on a life insurance policy covering his/her life. The employee is the owner of the policy, and the bonus is included in the employee's gross income. When the employee dies, the beneficiary named in the policy receives the death proceeds free of tax.

Robert and his employer agree on the purchase of a split-dollar life insurance policy. If it is a traditional plan, each year the employer will contribute to the premium an amount equal to: A) the increase in the policy's cash value. B) one-half of the premium. C) two-thirds of the premium. D) the annual dividend.

A Split-dollar insurance plans enable an employer and a select employee to share premium payments toward the purchase of insurance on the employee's life. Generally, the employer contributes to the premium each year an amount equal to the increase in the policy's cash value; the employee pays the balance. At death, the employer is entitled to receive from the proceeds an amount equal to its share of the premium payments (or the cash value, if greater); the employee's beneficiary receives the balance.

A company with 5 partners is considering a buy-sell plan. All of the following statements pertaining to buy-sell plans and this partnership are correct EXCEPT: A) if they use a cross-purchase plan, each partner would have to purchase 4 policies, or a total of 20 policies. B) if they decide on an insured entity buy-sell agreement, it would be funded with a total of 5 life insurance policies. C) if the company installed an entity buy-sell agreement, the business would be a party to the agreement. D) if the company installed a cross-purchase buy-sell agreement, the business would be a party to the agreement.

D In a partnership cross-purchase buy-sell plan, the partnership itself is not a part to the agreement. However, in an entity buy-sell plan, the partnership is a party to the buy-sell agreement.

Cybil is insured under a key-person life insurance policy owned by Delta Corporation and then quits her job. Which of the following statements is NOT correct? A) Delta can keep the policy in force. B) Cybil can convert the policy to an individual policy. C) Delta can surrender the policy for cash. D) Delta can assign the policy.

B If Cybil leaves Delta Corporation, the company can surrender the policy for cash, assign the policy, or keep it in force, because there is no need to maintain an insurable interest. Cybil has no conversion right with respect to the key-person policy because she does not own the policy.

A corporation has key-person life insurance on its president and vice president. The policies show a current total cash value of $15,000. Which of the following statements is CORRECT? A) The premiums the company pays for the policies are tax deductible. B) The company may use the policies' cash value for emergencies. C) The executives may access the policies' cash values during retirement. D) The policy proceeds will be taxable at the executives' deaths.

C With key-person life insurance, the owner, premium payor, and beneficiary of the policy is the business organization. Complete control of the policy rests with the business, which means key-person insurance can be considered a company-owned asset. The death proceeds and cash value can therefore be used for a variety of business purposes by the corporation. While premiums are not deductible, death proceeds received by the business are not taxable.

Hazel, Philip, and Anita are equal partners in a partnership worth $150,000. They decide to arrange an insured cross-purchase buy-sell agreement. Which of the following statements pertaining to this arrangement is CORRECT? A) If Hazel dies, Philip and Anita will each have a partnership interest of $50,000. B) The partnership will purchase and maintain a $50,000 policy on each of the partner's lives. C) Each individual partner must purchase and maintain a $50,000 policy on each of the other partner's lives. D) Hazel will purchase and maintain a $25,000 life insurance policy each on the lives of Philip and Anita.

D 150/6 Cross Purchase N (N-1) In a cross-purchase buy-sell agreement, the partners individually agree to purchase a proportional interest of the deceased partner. In turn, the executor of the deceased's estate is directed to sell the interest to the surviving partners. The partnership itself is not a party to the agreement. The number of life policies necessary to fund a cross-purchase buy-sell agreement can be determined by the following formula, where n equals the number of partners: n × (n - 1). Reference: 6.4.2.2 in the License Exam Manual

Brenda and Ted have an estate worth $10 million, the majority of which is invested in their family business. In order to pay the federal estate tax that will be due at the death of the survivor, they should consider purchasing a: A) family plan policy. B) joint life policy. C) second-to-die policy. D) multiple protection policy.

Second to die policy For Brenda and Ted, estate liquidity will be a major problem at their deaths since the majority of their assets are tied up in the family business. A solution is to purchase a second-to-die policy, which covers both parties but pays the death benefit only on the death of the survivor.

Which of the following statements regarding a deferred compensation plan is CORRECT? A) The employee uses part of his current income to purchase a whole life insurance policy, the cash value of which can be accessed only while employed by the current employer. B) The employer purchases a whole life insurance policy, the cash value of which the employee can access only while working for the employer. C) The employer purchases a whole life insurance policy on key employees and receives the death benefits if the employee dies before retirement. D) The employee agrees to forgo part of his current income until a specified future date, typically retirement, and may use life insurance as the funding vehicle for the plan.

D A deferred compensation plan is an arrangement whereby an employee (or owner) agrees to forgo some portion of his current income (such as annual raises or bonuses) until a specified future date, typically retirement. Life insurance is a popular funding vehicle for these plans in that the amounts deferred are used to pay premiums on cash value life insurance. At retirement, the cash values are available to the employee to supplement income. If the employee dies before retirement, his beneficiary receives the policy proceeds.

All of the following statements about executive bonus plans are correct EXCEPT: A) the bonus paid to the employee is includable in his gross income. B) the employee is the policyowner. C) they are considered nonqualified plans. D) at the employee's death, the company receives the death proceeds free of tax.

D An executive bonus plan is a nonqualified plan in which life insurance is purchased by one or more employer-selected employees. The employee purchases, owns, and names the beneficiary, so the employer retains no policy rights. At the employee's death, the beneficiary receives the death proceeds free of tax. The premiums paid to the employee as a bonus are deductible by the employer, and the amount paid to the employee is reportable as income.

A company with three partners is considering a buy-sell plan. All of the following statements pertaining to buy-sell plans and this partnership are correct EXCEPT: A) no benefits will accrue to the partnership from the buy-sell agreement until one of the partners dies. B) an insured entity buy-sell agreement designates the partnership as the beneficiary. C) if they choose a cross-purchase plan, each partner would have to purchase two policies for a total of six plans. D) if they choose an entity buy-sell agreement, the business would be party to the agreement.

B A partnership would want an individual, not the partnership to be a beneficiary, so in the death of one of the partners, the other person or people can buy out that person's interest in the business.

Three equal partners in a business worth $600,000 decide to set up an insured cross-purchase buy-sell agreement. How large a policy would each partner buy to insure the lives of the other partners? A) $200,000.00 B) $100,000.00 C) $50,000.00 D) $150,000.00

100,000 Each partner's share of the $600,000 business equals $200,000. Thus, if each partner were to purchase a $100,000 policy covering the lives of the other two, the benefits payable at the death of a partner--a total of $200,000--would enable the two survivors to purchase the deceased's interest in full and retain an equal partnership basis.

With three partners in a business, how many life insurance policies would be required to insure an entity buy-sell plan? A) Six policies. B) Eight policies. C) Three policies. D) Nine policies.

3 policies In an entity buy-sell plan, the partnership buys and pays the premiums for a life insurance policy on the life of each partner. The partnership in the above example would own three policies, one insuring each partner. In contrast, in a cross-purchase plan, the partners individually agree to purchase the interest of a deceased partner. The number of life policies necessary to fund a cross-purchase plan can be determined by using the following formula, where n equals the number of partners: n × (n − 1).

Which of the following statements pertaining to partnership buy-sell plans is CORRECT? A) By law, a partnership ceases to exist when a partner dies. B) In a cross-purchase plan, the partnership is a party to the buy-sell agreement. C) A partnership buy-sell agreement can work if only 2 partners are involved. D) Homer and Wilbur are partners. Each buys an insurance policy to insure the life of the other. Therefore, their buy-sell agreement is an entity plan.

A

All of the following are advantages of life insurance as property EXCEPT: A) the death proceeds create an instant estate. B) the policy's value is guaranteed. C) the death proceeds payable to a beneficiary are protected against the insured's creditors. D) the death proceeds are exempt from federal estate tax.

D Life insurance proceeds can be subject to the federal estate tax if the proceeds are paid to the insured-owner's estate or if the insured-owner held any incidents of ownership in the policy.

In a close corporation, a buy-sell plan provides multiple advantages for all concerned. It usually takes 1 of 2 forms: a cross-purchase plan, in which the stockholders purchase the interest of the deceased stockholder as individuals, and a stock redemption plan, in which the corporation purchases the deceased stockholder's shares. In the case of multiple stockholders, a stock redemption plan requires fewer policies than a cross-purchase plan. A corporation does not cease to exist because an owner dies, and it is necessary to arrange for the disposition of the deceased owner's interests.

z

Which of the following statements pertaining to deferred compensation plans is CORRECT? A) A deferred compensation arrangement is a non-qualified plan funded by the employee. B) A deferred compensation arrangement is a non-qualified plan funded by the employer. C) A deferred compensation arrangement is a qualified plan funded by the employer. D) A deferred compensation arrangement is a qualified plan funded by the employee.

A Deferred compensation plans are agreements between employers and employees whereby the employee reduces current income by deferring the receipt of currently due salary, bonus, commission, or salary increase until a specified future date - typically at retirement. Funded by the employee, deferred compensation arrangements are non-qualified plans that typically favor highly paid executives. Basically a "promise" to pay future benefits to the employee, contributions to the plan are not deductible to the employer until the employee actually begins taking distributions, at which time the employee would begin paying taxes on those distributions.