Quiz 9/1: Taxation of Personal Life Insurance

All of the following statements are true regarding the taxation of personal life insurance used for charity, EXCEPT:

A policy may be given to the charity, and the value of the policy is tax-deductible. If the individual chooses to make the premium payments for the charity, those are also tax-deductible. The charity must retain ownership and rights of the policy for the tax deductions to be valid. The individual may also make the charity a beneficiary of a policy without relinquishing ownership. Payments of premiums are not tax-deductible, and the proceeds will be deducted from the estate as a charitable contribution. In this case, the policyowner retains the right to change the beneficiary, if necessary. The correct answer is: When a charity is made a beneficiary of a personal life insurance policy, premiums are tax-deductible.

Which of the following statements best describes how accelerated benefits from a personal life insurance policy are taxed?

Accelerated benefits are received income tax-free as long as the distribution is qualified. This means that the insured is suffering a terminal illness which is expected to result in death within two years. The correct answer is: Accelerated benefits are received income tax-free as long as the distribution is qualified.

How is a life insurance policy affected when it becomes a MEC?

All withdrawals and surrenders from a MEC are taxable, but the interest accrued on the cash value is tax-deferred, and the death benefit is tax-free if received in a lump-sum. The correct answer is: Policy loans and withdrawals are taxed as ordinary income.

When a life insurance policy becomes a MEC, what are the tax consequences?

All withdrawals and surrenders from a MEC are taxable, but the interest accrued on the cash value is tax-deferred, and the death benefit is tax-free if received in a lump-sum. The correct answer is: Withdrawals and policy loans are taxed as ordinary income.

What is the general rule for taxation of personal life insurance?

As a general rule, premiums for life insurance policies are not tax-deductible and proceeds from life insurance policies are tax-free if received in a lump-sum. If proceeds are received in installments, a portion of the proceeds will contain interest, which is taxable. The correct answer is: Premiums are paid with after-tax dollars; proceeds received in a lump-sum are received tax-free; proceeds received in installments are taxable only to the extent of interest earned.

How are personal life insurance dividends taxed?

Dividends are considered a return of overcharged premium, and are not taxable because premiums are paid with after-tax dollars. Interest earned on dividends is taxable income. The correct answer is: All of the above

Which of the following best describes the tax consequences of life insurance dividends?

Dividends are not taxable because they are considered a return of overcharged premium, and personal life insurance premiums are paid with after-tax dollars. The correct answer is: Dividends are not taxable.

Life insurance dividends are:

Dividends are not taxable because they are considered a return of overcharged premium, and personal life insurance premiums are paid with after-tax dollars. The correct answer is: Not taxable

Tom and his employer split the cost of group life insurance premiums. What are the tax consequences?

For group life insurance, employer-paid premiums are tax-deductible as a business expense. Premiums paid by the employee are not tax-deductible. The correct answer is: Only the employer's portion of the premiums is tax-deductible.

Maria and her employer share in the cost of her group life insurance premiums. Which of the following is true?

For group life insurance, employer-paid premiums are tax-deductible as a business expense. Premiums paid by the employee are not tax-deductible. The correct answer is: Only the employer's premiums are tax-deductible.

What is the general rule for taxation of personal life insurance policy proceeds?

Generally, beneficiaries receive life insurance proceeds tax-free, if received in a lump-sum; however, proceeds from life insurance policies that result from a transfer of value, or were sold to another party, may be subject to taxation. The transfer of value rule does not apply when a life insurance policy is assigned as collateral on a loan. The correct answer is: All of the above

If Alex buys a life insurance policy as a gift for his wife, what are the tax consequences?

Gift tax is paid by Alex, the giver of the gift. The correct answer is: Alex pays the gift tax.

Edward purchases a life insurance policy as a gift for his aunt. Which of the following is true?

Gift tax is paid by Edward, the giver of the gift. The correct answer is: Edward pays the gift tax.

Which of the following is a material change in a life insurance policy?

If a life insurance policy's face amount is changed, then a new seven-pay test must be performed to make sure that the policy is not a MEC. The correct answer is: Increasing the policy face amount

Which of the following statements best describes how cash value in a life insurance policy is taxed?

In whole life insurance policies, premiums build cash value. The cash value increases as interest is earned on the premiums, which grows tax-deferred. The policyowner can borrow against the policy cash value. If the policy cash value is surrendered or endows, the interest is taxable as ordinary income. The correct answer is: If the policy cash value is surrendered, the interest earned on the cash value is taxable as ordinary income.

Which statement most accurately describes the tax consequences on premiums for individual life insurance and annuities?

Individual life insurance and annuities are purchased with after-tax dollars. Premiums generally cannot be deducted from taxes. The correct answer is: Premiums are not tax-deductible.

Which of the following is generally true regarding premiums for individually-purchased life insurance and annuities?

Individual life insurance and annuities are purchased with after-tax dollars. Premiums generally cannot be deducted from taxes. The correct answer is: They are not tax-deductible.

What are the tax implications when personal life insurance is given as a gift and the recipient owns the policy, but the gift-giver pays the premiums?

Individuals may also make a gift of a life insurance policy by paying premiums. The policy is owned by the donee, but premiums are paid by the donor. The premium payments are taxable only up to those amounts exceeding the federal gift limits. The correct answer is: The gift-giver pays tax, but only up to the amount exceeding the federal gift limit.

What are the tax consequences of interest growth on the cash value in a whole life policy?

Interest accrued on the cash value in a whole life policy is tax-deferred. The correct answer is: Interest is tax-deferred.

Cash value in a whole life policy accrues interest:

Interest accrued on the cash value in a whole life policy is tax-deferred. The correct answer is: Tax-deferred

Susan has a $500,000 permanent life insurance policy. She has paid $200,000 in premiums, and the policy has a cash value of $216,000. If Susan dies, her beneficiary will pay taxes on:

Life insurance death benefits are tax-free. The cash value is included in the death benefit, so it is not taxed. The correct answer is: $0

Who pays tax on personal life insurance given as a gift?

Life insurance given as a gift may be subject to a federal gift tax, which is paid by the giver of the gift. The correct answer is: The gift-giver

Which type of life insurance policy allows an employer to deduct premium payments as an ordinary business expense for tax purposes?

Life insurance policy premium payments are not tax-deductible as a business expense if the company is using the policy for business purposes; however, the proceeds are tax-free. The exception to this is when a business purchases group insurance for the benefit of its employees. The correct answer is: Group life insurance

All of the following are true regarding business life insurance, EXCEPT:

Life insurance policy premium payments are not tax-deductible as a business expense if the company is using the policy for business purposes; however, the proceeds are tax-free. The exception to this is when a business purchases group insurance for the benefit of its employees. The correct answer is: If a business purchases group insurance for the benefit of its employees, employer-paid premiums are not tax-deductible.

Life insurance proceeds are subject to taxation if they result from a ____________, or sale of the policy to a third party.

Life insurance proceeds are subject to taxation if they result from a transfer for value, or sale of the policy to a third party. The correct answer is: Transfer for value

All of the following are true regarding the transfer for value rule, EXCEPT:

Life insurance proceeds are subject to taxation if they result from a transfer for value, or sale of the policy to a third party. A transfer of value constitutes any exchange of the policy benefits for something of value, whether it be money, an exchange of policies, or consideration for another contract. The transfer of value rule prevents a tax-free transfer of wealth. Taxation of proceeds from life insurance policies resulting from a transfer of value does not apply to assignment of benefits for collateral on a loan or transfer between the policyholder and the insured. The correct answer is: The transfer of value rule permits a tax-free transfer of wealth.

Which of the following best explains why personal life insurance policy proceeds received in installments are subject to tax?

Life insurance proceeds received in installments are subject to tax because the death benefit is reinvested into an annuity which grows interest. Each payment contains principal (the death benefit) and interest. The interest-portion of each payment is taxable. The correct answer is: Personal life insurance proceeds received in installments are reinvested in an annuity, which grows interest.

Which of the following is true regarding the taxation of universal life insurance policies?

Partial surrenders from a universal life policy are not taxable up to the amount of premium that makes up the cash value. Once all premiums have been withdrawn, then all withdrawals consisting of the interest portion of the cash value are subject to taxation. The correct answer is: Cash value grows tax-deferred, but may be subject to taxation upon withdrawal.

A policy loan on a whole life policy is:

Policy loans are not taxable. The correct answer is: Not taxable

What are the tax consequences of a policy loan on a whole life insurance policy?

Policy loans are not taxable. The correct answer is: Policy loans are not taxable.

All of the following statements regarding policy loans from personal life insurance policies are true, EXCEPT:

Policyowners may take out a loan against their life insurance policy cash value. The borrowed money is not taxable. The insurer will charge interest on loans that have not been repaid. Loans are repaid or recovered upon policy surrender or maturity. The correct answer is: When a personal life insurance policy endows, the amount of any unpaid loan plus interest is not deducted from the policy proceeds.

How are premiums for group life insurance taxed?

Premiums for group life insurance paid by the employee are not tax-deductible, but the employer can deduct premiums it pays as a business expense. The correct answer is: Employer-paid premiums are tax-deductible as a business expense, but employee-paid premiums cannot be deducted from taxes.

All of the following statements about key person life insurance are true, EXCEPT:

Premiums for key person life insurance are not tax-deductible. The correct answer is: Premiums are tax-deductible as a business expense.

How are group life insurance benefits taxed?

Proceeds from a group life policy are tax-free if taken in a lump-sum. Proceeds taken in installments will be subject to taxes on the interest portion of the installments. The correct answer is: Proceeds are tax-free if taken in a lump-sum, but subject to tax on the interest portion if taken in installments.

If life insurance death benefits are received in one lump-sum, what are the tax consequences?

The death benefit from a life insurance policy is tax-free if received in a lump-sum. The correct answer is: Death benefits received in a lump-sum are not taxable.

Life insurance death benefits received in a lump-sum are:

The death benefit from a life insurance policy is tax-free if received in a lump-sum. The correct answer is: Not taxable

Erin bought a $100,000 whole life insurance policy. When she is 65 she decides to surrender the policy for its cash value of $60,000. Of the cash value, $50,000 is premiums. How much of Erin's cash surrender is taxable?

The difference between the cash value and the premiums paid is taxable upon policy surrender ($60,000 - $50,000 = $10,000). The correct answer is: $10,000

Jacob has a $150,000 whole life policy. He decides to surrender his policy at the age of 63 when his cash value totals $90,000 of which $83,000 Jacob has paid in premiums. What portion of Jacob's cash surrender is taxable?

The difference between the cash value and the premiums paid is taxable upon policy surrender ($90,000 - $83,000 = $7,000). The correct answer is: $7,000

Based on the 1980 C.S.O. tables, at what age may a life insurance policy endow at the earliest?

The earliest age at which a life insurance policy may endow is age 95. The new 2001 C.S.O. tables increase that age to 120. The correct answer is: 95

All of the following are reasons the face amount of a life insurance policy may be subject to tax, EXCEPT:

The face amount of a life insurance policy may be included in the taxable estate of the deceased and subject to federal estate tax in one or more of following situations: 1.) the deceased was the owner of the policy or an incident of ownership occurred at the time of death. An incident of ownership is one or more rights of owning a policy, including the rights to surrender the policy for cash value, change the beneficiaries, borrow or take loans against the policy, or assign or transfer the policy; 2.) the deceased's estate is the policy's designated beneficiary; and 3.) the deceased gifted, assigned or transferred ownership of the policy within three years prior to the date of death. The correct answer is: The policy proceeds are paid out in a lump-sum.

The seven-pay test is best described as:

The seven-pay test assures that life insurance policies meet the legal definition of life insurance and do not become MECs. The correct answer is: Premiums paid in a seven-year period cannot be more than the total annual premiums in a seven-year paid-up policy.

Which of the following best describes the seven-pay test?

The seven-pay test assures that life insurance policies meet the legal definition of life insurance and do not become MECs. The correct answer is: Premiums paid over a seven-year period cannot exceed the total level annual premiums for a paid-up policy in seven years.

Which of the following examples correctly demonstrates how personal life insurance policy surrenders are subject to tax?

The taxable portion of a cash-building life insurance policy upon surrender is the difference between the cash value and the amount of premiums paid. David's policy has $100,000 cash value, but he only paid $80,000 in premiums, so $20,000 (the growth on the premiums) is subject to tax. The correct answer is: David surrenders his joint life insurance policy. It has a total cash value of $100,000, but he only paid $80,000 in premiums. Therefore, $20,000 is taxable.

June is receiving life insurance policy proceeds in fixed-amount installments. What are the tax consequences of her benefits?

When the insurer reinvests policy proceeds from a life insurance policy, interest accrues. The principal (policy proceeds) is not taxable, but the interest portion of each installment benefit is taxable. The correct answer is: Interest is taxed.

Fred is receiving life insurance death benefits in fixed-amount installments. How will his income benefits be taxed?

When the insurer reinvests policy proceeds from a life insurance policy, interest accrues. The principal (policy proceeds) is not taxable, but the interest portion of each installment benefit is taxable. The correct answer is: Only the interest is taxed.