Chapter 7: Federal Tax Considerations & Retirement Plans

The IRS allows for 'catch-up' IRA contributions for those age _______ and older. A. 65 B. 50 C. 70 D. 62

B. 50 The age at which IRA 'catch-up' contributions can be made is 50 or older.

Sherman is the custodian at an elementary school and participates in its qualified retirement plan. This describes a: A. 403(b) Tax-Sheltered Annuity B. HR-10 Keogh Plan C. SIMPLE IRA D. Simplified Employee Pension

A. 403(b) Tax-Sheltered Annuity All four responses are qualified plans, but the one specifically designed for employees of nonprofit organizations and public schools is the 403(b) Tax-Sheltered Annuity.

When a life insurance policy does not pass the ______-pay test, it becomes classified as a MEC. A. 7 B. 10 C. 8 D. 9

A. 7 It is the 7-pay test that must be passed in order not to be classified as a MEC.

Which of the following statements regarding Roth IRAs is FALSE? A. As long as the account owner is under age 59 1/2 there is no maximum contribution limit B. There are no Required Minimum Distribution (RMD) age or amounts C. Contributions are not tax-deductible D. If the account owner is at least 59 1/2 and has held the account assets at least 5 years, there is no tax on earnings withdrawn

A. As long as the account owner is under age 59 1/2 there is no maximum contribution limit Roth IRAs are subject to the same maximum contribution limits as other IRAs.

Cash values within an ordinary straight whole life insurance policy _______ over time. A. Increase B. Vary C. Decrease D. Remain constant

A. Increase Cash values increase over time as premium is paid in and interest is reflected in the cash values shown in the policy's nonforfeiture table.

Which of the following is NOT a taxable event for a Modified Endowment Contract (MEC)? A. Lump sum death benefit paid to the beneficiary B. Withdrawal of cash value to pay for a daughter's wedding C. Taking out a policy loan D. Cash surrender of the policy

A. Lump sum death benefit paid to the beneficiary Withdrawal of any cash value to pay for a daughter's wedding, policy loans, and cash surrender of the policy are all taxable distributions. Lump-sum death benefits are considered to be tax-free life insurance proceeds.

How often may a person perform a rollover from one IRA to another? A. Once a year B. Every 6 months C. Once every 2 years D. Once each quarter

A. Once a year IRA rollovers may only be done once every 12 months.

All of the following are TRUE regarding qualified plans, except: A. Plans can discriminate in favor of highly compensated employees B. Employer contributions are immediately tax-deductible C. Distributions taken prior to age 59 1/2 are subject to tax and a tax penalty D. Employer contributions are not taxable to the employee until withdrawn

A. Plans can discriminate in favor of highly compensated employees In an ERISA-qualified plan, there can be no discrimination in favor of highly compensated employees.

By what means is a transfer for value made? A. Through an absolute assignment B. By requesting a change in the beneficiary designations C. By way of collateral assignment D. By a partial withdrawal

A. Through an absolute assignment To effect a transfer for value, an absolute assignment needs to take place.

What is the main purpose that IRC section 1035 was enacted? A. To allow for continued tax-deferral on any gains in an existing policy when a policyowner moves into a new one B. To allow policyowners to obtain features and benefits not available on their existing policies C. To allow consumers to get better performance from a new policy D. To allow consumers to obtain less expensive life insurance policies

A. To allow for continued tax-deferral on any gains in an existing policy when a policyowner moves into a new one The main purpose of section 1035 is to allow for the continuation of tax-deferral from an old policy into a new policy.

All employer-paid premiums for amounts of group life insurance over $__________ are reported as taxable income to the employee. A. $25,000 B. $50,000 C. $150,000 D. $100,000

B. $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.

What type of retirement plan is not required to have a vesting schedule, is not approved by the IRS, can discriminate in favor of highly compensated employees, and can benefit the employer? A. An ERISA plan B. A non-qualified plan C. A pension plan D. A qualified plan

B. A non-qualified plan A qualified plan is not allowed to have those features or requirements. Only a non-qualified plan can.

If an annuity is annuitized, then the _________ investment is recovered income tax-free over the income benefit payment period. A. Exclusion B. After-tax C. Non-guaranteed D. Pre-tax

B. After-tax Only the after-tax investment is recovered income tax-free from an annuity that is annuitized. It represents a return of the cost basis.

If a non-qualified variable annuity owned for 15 years is surrendered, what is the income tax consequence? A. Any amount that represents an excess over cost basis that has been held for over 1 year is treated as long-term capital gain with the balance considered short-term capital gain B. Any amount received in excess of its cost basis is taxable as ordinary income C. The amount received in excess of cost basis is taxed as a long-term capital gain D. The entire amount received is subject to ordinary income tax

B. Any amount received in excess of its cost basis is taxable as ordinary income The same tax rules apply to both fixed and variable annuities. The funds received in excess of the cost basis are taxable as ordinary income.

When withdrawing cash from a cash value life insurance policy, the amount of the withdrawal up to the policy's cost basis is tax-free. This tax accounting rule is referred to as: A. First-In, Still There (FIST) B. First-In, First-Out (FIFO) C. Last-In, First-Out (LIFO) D. Dollar Cost Averaging

B. First-In, First-Out (FIFO) FIFO accounting is first-in, first-out, which is why the recovery of amounts up to the cost basis are income tax-free.

An Individual Retirement Account (IRA) may be funded with all of the following, except: A. Mutual Funds B. Life Insurance C. Certificates of Deposit (CDs) D. Annuities

B. Life Insurance Life insurance does not meet the IRS qualifications for funding an IRA.

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? A.All premiums paid may be deducted from the face value before taxation B. The $540,000 lump sum proceeds will be received income tax-free C. The $40,000 will be taxed since the premium was tax-deductible by the employer D. $460,000 is income taxable to the recipient

B. 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.

Clayton is asking his life insurance producer about any potential taxation issues related to his $100,000 personal Whole Life policy. All of the following are TRUE, except: A. Since his policy is a personal policy, he cannot deduct the premiums he pays for the policy B. The interest that he pays on policy loans is tax-deductible C. Annual increases in the policy's cash value are not taxable at the time they are credited to the policy D. Upon surrender of the policy, he will be taxed on any amount by which the cash value exceeds the cost basis (premiums paid) of the contract

B. The interest that he pays on policy loans is tax-deductible The interest on policy loans is not tax-deductible

When establishing a SIMPLE, what two different types of qualified plans must employers choose between? A. Keogh or corporate B. SEP or TSA C. 401(k) or IRA D. Defined benefit or defined contribution

C. 401(k) or IRA A SIMPLE may take the form of either a 401(k) or an IRA.

Life insurance policy premiums establish a _________ in the policy for tax purposes. A. Dividend B. Loan C. Cost basis D. Cash value

C. Cost basis Cost basis is primarily established by accounting for the premiums paid into the policy.

When an employee receives a fixed and known benefit at retirement, it comes from a(n) __________ plan. A. Profit-Sharing B. SEP-IRA C. Defined Benefit D. Defined Contribution

C. Defined Benefit Defined benefit plans pay out a fixed and known benefit to retirees based on a formula considering years of employment and highest earnings.

Which of the following best defines the 'Cost Recovery Rule'? A. The earnings on the policy's cash values are taxed every year and build up a cost basis which is recovered income tax-free upon surrender B. When a policy is surrendered, the earnings within the policy are accounted for first C. Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender D. The amount of the policy's internal expenses plus the life producer's commission make up the total cost of the policy

C. 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.

Which of the following statements about a Modified Endowment Contract (MEC) is FALSE? A. Taxable distributions include cash value surrenders and policy loans B. Funds distributed before age 59 1/2 are subject to a 10% penalty on any gains C. If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment D. The 7-Pay Test compares the premiums paid for the policy during its first 7 years with the annual net level premiums of a 7-Pay Policy

C. If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment Any funds distributed are subject to a last-in, first-out (LIFO) tax treatment, meaning gains will be taxed before principal.

Any employee-paid group life insurance premiums are __________. A. Tax-deferred B. Tax-exempt C. Not tax-deductible D. Tax-deductible

C. Not tax-deductible Any employee-paid group life insurance premiums are not tax-deductible.

Which of the following would always be considered a Modified Endowment Contract? A. Limited Pay Whole Life B. Straight or Continuous Pay Whole Life C. Single Premium Whole Life D. Variable Whole Life

C. Single Premium Whole Life Single Premium Whole Life would always be a MEC as it would always fail the 7-Pay Test.

All of the following are times in which life insurance policy cash values can become taxable, except: A. When the policy is sold B. If the policy fails to meet the IRS definition of life insurance C. When a policy loan is taken out D. At policy surrender

C. When a policy loan is taken out Policy loans do not trigger a taxable event.

Employer-paid premiums for employee group term life do not constitute taxable income to the employee for coverage up to ___________. A. $25,000 B. $40,000 C. $30,000 D. $50,000

D. $50,000 Employer-paid group life insurance premiums for coverage up to $50,000 are not taxable as income to the employee.

Which of the following statements about Section 1035 transactions is TRUE? A. All surrender charges are waived on any existing policy B. A 1035 allows an annuity to be exchanged for life insurance C. Any surrender charges satisfied on the old policy carry over into the new policy D. A new application is required when moving into a new life insurance policy

D. A new application is required when moving into a new life insurance policy If an existing policy has a surrender charge, it is still applied. The new policy requires evidence of insurability, and new surrender charges will apply to the new policy if it has them.

An annuity held within a traditional IRA ____________. A. Makes the tax-deferral aspect of the annuity tax-free B. Generates tax credits upon withdrawal C. Allows for withdrawals prior to age 59 1/2 without any tax penalty D. Does not provide any additional tax-deferral benefit

D. Does not provide any additional tax-deferral An annuity already has a tax-deferred element to it. An annuity inside a traditional IRA does not provide any additional tax-deferral benefit; however, the annuity may provide other benefits that other investments cannot.

Anyone under the age of 70 1/2 who has _________ can open up a Traditional IRA. A. Investment Income B. Investable Assets C. Annuity Income Benefit Payments D. Earned Income

D. Earned Income The requirement is earned income.

All of the following are true regarding ERISA qualified plans, except: A. The plan must be IRS approved B. The plan must benefit employees and beneficiaries C. A vesting schedule must be established D. Employers must establish a pension plan

D. Employers must establish a pension plan Establishing a corporate pension plan is optional; however, if one is established it must meet the ERISA requirements in order to qualify for favorable tax treatment.

An employer's contribution to a SIMPLE plan is vested _________. A. Over 7 years in equal amounts B. In the fifth year at 100% C. In equal amounts over 3 years D. Immediately at 100%

D. Immediately at 100% Employer contributions to a SIMPLE plan are vested immediately at 100%.

Janelle is the beneficiary of a life insurance policy in which the insured has died. What is the only way she can receive the claim amount totally free from income taxes? A. Choose the interest income only settlement option B. Select the 10-year period certain settlement option C. Elect the life only settlement option D. Receive the claim amount in a lump sum

D. Receive the claim amount in a lump sum Any settlement option will generate taxable income to the beneficiary. The only way to be exempt from any income taxation is to receive the death benefit in a lump sum.