NJ Life Producer Exam Lesson 42

The death benefit of any life insurance policy owned by the insured at death is included in that person's ___

estate.

Cal bought a $100,000 universal life policy ten years ago. He has paid $8,000 in premiums into the policy. He now decides to surrender the policy for its full $15,000 cash value. What amount is taxable?

$7,000 Only the gain, which is the difference between what Cal paid into the policy and the cash value he receives, is taxable income.

the 7-pay test is used to see if the policy is counted as a MEC

If, at any point during the first seven policy years, the sum of premiums paid at that point exceeds the sum of premiums that would have been required at that point to pay up the policy in seven years, the policy becomes a MEC.

Transfer-for-Value Rule exceptions:

a policy is sold by the current owner to the insured person a policy is sold to a business partner (or the partnership) of the current owner a policy is sold to a corporation in which the current owner is an officer or shareholder

Cash value withdrawals from a non-MEC life insurance policy are generally treated on a first-in/first-out (FIFO) basis for tax purposes, which means the first funds withdrawn are recognized as:

a return of premiums

To qualify for accelerated benefits from a life insurance policy on a tax-free basis, an insured must meet all of the following qualifications, EXCEPT:

approved by the insurance company as meeting its definition of terminally ill

policy loans (taxation of personal life insurance)

generally not taxable income

Modified Endowment Contract (MEC)

if the policy is heavily funded in the first seven years its deemed a MEC it is not: a specific type of life insurance

A MEC is not a unique type of life insurance but a classification assigned to any permanent life insurance policy that violates excessive funding rules of the Tax Code. Once a policy becomes a MEC it can never revert to a non-MEC status.

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Accelerated benefits paid to the insured are not taxable if certain qualifications are met.

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Except in certain transfer-for-value cases, life insurance death benefits are income tax free.

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Life insurance policy dividends are a return by the insurer of excess premiums (called "divisible surplus") and therefore are not taxable, but interest accrued on dividends left with the insurer is taxable.

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Non-MEC policy cash value distributions are taxed under favorable FIFO rules, meaning withdrawals are treated first as a tax-free return of premiums.

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Partial withdrawals from a non-MEC universal life insurance policy are taxable:

when withdrawals exceed the sum of the premiums paid into the policy

Under the "bring-back rule," the death benefit of a life insurance policy that was transferred to a third party by the insured is included in the insured's estate if made within

3 years prior to the insured's death

Which of the following statements correctly describes the tax treatment of life insurance death benefit settlement options other than a lump-sum payment?

The death benefit principal of every settlement option payment is income tax free, but the interest earnings are taxable income to the beneficiary in the year earned. In general, life insurance death benefits paid to a beneficiary in a lump sum are not taxed, but if the payout option is other than a lump sum, interest earnings are taxable income to the beneficiary in the year earned.

premiums (taxation of personal life insurance)

are not tax deductible

transfer-for-value-rule formula

death benefit - sum of new owner's purchase price and premiums paid = policy gain (taxable)

Policy cash values accumulate tax deferred and are tax free if distributed as part of the ____

death benefit.

MECS (taxation of personal life insurance)

insurance contracts that fail to meet the statutory definition of LI lose their tax advantages and are considered modified endowment contracts. if funds are withdrawn before the owner 59 1/2 years old, they must pay 10% tax as a penalty

Settlement options that involve leaving death benefit proceeds with the insurer will result in taxation on the ____ portion of future distributions.

interest

The premiums that a company pays for corporate-owned life insurance (COLI) on the lives of its employees are generally:

not tax deductible

cash value (taxation of personal life insurance)

not taxable as long as they remain in the policy. Once withdrawn, the earnings from interest will be taxed.

accelerated benefits (taxation of personal life insurance)

not taxed as long as the insured is terminally or chronically ill

dividends (taxation of personal life insurance)

received as a lump sum are not taxable, however, interest earned is taxable

death benefit (taxation of personal life insurance)

deaths benefits paid out in a lump sum are not considered taxable income. however, if the death benefit is received through a settlement option, the interest earned will be taxed

Transfer-for-Value Rule

if a life insurance policy is "transferred for value" (i.e., sold) to another party, a portion of the death benefit proceeds is taxable to the beneficiary.

Cash distributions from a MEC while the insured is alive are subject to unfavorable LIFO tax rules and therefore subject to income taxation. If the policyowner is under age 59½, a 10 percent penalty may also be assessed.

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