tax treatment of life insurance and annuities
Roth IRAs
taxation rules contributions are not tax deductible excess contributions are subject to a 6% penalty tax traditional IRA distributions are taxable pre tax Roth IRA distributions are not taxable after tax no required minimum age for payouts
business insurance
premiums paid by businesses for life insurance policies used for business are generally not deductible as business expenses with exception of group insurance proceeds from the life insurance policies purchased for business purposes are received by the company income tax free if the business is subject to the alternative minimum tax AMT that tax may apply to death proceeds policy proceeds are not included in estate of an individual insured by a business unless the individual possesses some incident of ownership such as stockholder or owner
gifts of life insurance
transfer all incidents of ownership to gift receiver donor will not incur any gift tax liability unless gift value exceeds $10,000 recipient receives the gift tax free
federal estate tax federal income tax federal gift tax
transfer tax that is levied by the federal government on the right to transfer property at time of death as well as gift
spouses who are the sole designated beneficiary can do the following with IRA
treat an IRA as their own base the required minimum distribution on their own current age base the required minimum distribution on the decedents age at death reducing the distribution period by one each year withdraw the entire account balance by the end of the 5th year following the account owners death if the account owner died before the required beginning date surviving spouse can wait until the owner would have turned 72 to begin receiving RMDs
business beneficiary of a life insurance policy
or has a beneficial interest in the policy any premiums that the business pays for are not tax deductible
penalty tax exceptions where 10% early withdrawals do not apply
participant is age 59 and a half participant is totally disabled the money is used to make the down payment on a home not to exceed $10,000 and usually for first time homebuyers withdrawals are post secondary education expenses withdrawals are for catastrophic medical expenses or upon death
amounts available to Policyowner
permanent life insurance provides living benefits
taxation of annuities individual owned
potion of each annuity benefit payment is taxable and a potion is not potion that is nontaxable is the anticipated return of the principal paid in known as cost base portion that is taxable is the interest earned on the principal known as tax base
policy death benefits under business owned employer life insurance
received income tax free by beneficiary
transfer or direct transfer
refers to a tax free transfer of funds from one retirement program to a traditional IRA or a transfer of interest in a traditional IRA from one trustee directly to another
dividends
return of unused premium and are not considered income for tax purposes when dividends are left with the insurer to accumulate interest the interest earned on the dividend account is subject to taxation as ordinary income each year interest is earned whether or not the interest is paid out to the Policyowner
doctrine of economic benefit
stipulates that if an employee receives property or other benefits in the lieu of income, such property benefits would have been taxable income had they been received in cash economic benefit has been received and will be taxed accordingly Nonqualified deferred compensation funded with life insurance and aimed at certain key and highly compensated employees may be affected by this rule
individual retirement accounts distribution
subject to income taxation in the year the withdrawals are made in case of early distribution prior to age 59 and a half a 10% penalty will also apply
taxation rules that apply to MEC
tax deferred accumulations any distributions are taxable including withdraws and policy loans distributions are taxed on LIFO basis (last in first out) known as the interest first rule distributions before age 59 1/2 are subject to a 10% penalty
rollover
tax free distribution of cash from one retirement plan to another completed within 60 days money is taken out of first plan if the distribution from first plan is paid directly to the participant 20 % of the distribution must be withheld by payor this can be avoided if distribution is moved directly from one account to other insurer known as direct rollover
premature distributions and penalty tax
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 age 59 and 1/2
cash value group life
business owned life insurance policy or employer provided policy accumulates on a tax deferred basis and is taxed the same way as individual policy
cash value accumulations
can be burrowed against by the Policyowner or may be paid to the Policyowner upon surrender of the policy cash value grows tax deferred upon surrender or endowment any cash value in excess of cost basis is taxable as ordinary income upon death face amount is paid with no more cash value generally paid to the beneficiary income tax free
lump sum cash surrenders
cash surrender of an annuity results in immediate taxation of the interest earned
taxation of individual retirement accounts traditional IRAs
contributions deductible amounts and distributions following taxation rules apply to contributions made to traditional IRA plans tax deductible contributions for the year of the contribution based on persons income contributions must be made in cash in order to be tax deductible excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA tax deferred earnings the money that accumulates in the account are not taxed until withdrawn
corporate owned
corporate owned annuities have different tax implications than individual annuities: 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
general requirements for qualified plans met tax advantages apply
employer contributions are tax deductible to the employer and are not taxed as income to the employee the earnings in the plan accumulate tax deferred lump sum distributions to employees are eligible for favorable tax treatment
group life insurance premiums
employer pays for life insurance on employee policy is for employees benefit and tax deductible to the employer as a business expense if the group life policy coverage is $50,000 or less the employee does not have to report the premium paid by the employer as income and not taxable to the employee
modified endowment contracts
endowment policy is an investment instrument endowment life insurance policies promise to pay face amount if the insured survives until the end of a specified period 20 years 30 years or when Policyowner reaches age 65 and if the insured dies within the same specified period require premiums far in excess of the amount to fund death benefit single premium life insurance financial products offering significant tax advantages purchased solely for purposes of setting aside large sums of money for tax deferred growth as well as tax free cash flow available via policy loans and partial surrenders to curtail this activity and determine if an insurance policy is overfunded the Internal Revenue Service established what is known as the 7 pay test any life insurance policy that fails a 7 pay test is classified as a modified endowment contract and loses standard tax benefits of a life insurance contract in MEC the cumulative premiums paid during the first 7 years of the policy exceed the total amount of the net level premiums that would be required to pay the policy up using guaranteed mortality costs and interest all insurance policies are subject to the 7 pay test and any time there is a material change to the policy such as an increase in the death benefit a new 7 pay test is required whether from a life insurance policy or a MEC the death benefit is tac free
values included in insureds estate incidents of ownership estate as beneficiary transfer of ownership
face amount of a life insurance policy may be included in the insureds taxable estate at death and subject to the federal estate tax 3 situation incident of ownership any one of the rights of policy ownership right to cash value the right to change the beneficiary the right to obtain policy loans right to assign policy if the insured Policyowner possessed any of these incidents of ownership at the time of death entire face amount of the policy will be included in the insureds taxable estate even tho actual price proceeds were paid to the beneficiary if the insureds estate is the designated beneficiary at the time of the insureds death the entire face amount will be included in his or her taxable estate if the insured as a Policyowner assigns or transfers ownership or makes a gift of the policy within 3 years prior to his her death the entire face amount of the policy will be included in his or her taxable estate taxes must be paid either upon contribution or upon distribution not both
values included in the annuitants estate
if annuitant dies during accumulation period the insurer is obligated to return all or a portion of the annuity cash value which will be included in the deceased annuitants estate if the annuity has been paid up and the annuitant dies during the annuity period the annuity benefits will be taxable and included in the deceased annuitants estate
distributions at death
if annuity contract holder dies before the annuitization date the interest accumulated in the annuity becomes taxable if the beneficiary of the annuity is a spouse the tax can continue to be deferred any unpaid annuity benefits following the death of annuitant are paid to the beneficiary and are taxable
amounts received by the beneficiary
if the owner dies before distributions have begun the entire interest must be distribute in full on or before December 31st of the calendar year of the 5th anniversary of the owners death unless the owner is named beneficiary
premiums not deductible group life insurance
key employee insurance stock redemption or entity purchase agreement split dollar insurance
amounts received by beneficiary general rule and exceptions
life insurance proceeds paid to a named beneficiary are generally free of federal income taxation if taken in a lumps sum exception would be if the benefit payments results from a transfer for value meaning the life insurance policy is sold to another party prior to the insureds death
charitable use
make an outright gift of a policy on the life of the donor full ownership donor retains full ownership with charity as beneficiary premium payments are not deductible on the donors federal income tax return
individual policy loans
may burrow against policy cash value money burrowed against the cash value is not income taxable however the insurance company charges interest on outstanding policy loans policy loans with interest can be repaid such as: by the owner while the policy is in force at policy surrender or maturity subtracted from the cash value at insureds death subtracted from the death benefit
rollovers and transfers
moving monies from one qualified retirement plan to another
individual beneficiaries IRA other than spouse
must withdraw entire amount from the account within 10 years of the account owners death cannot treat as their own cannot roll over amounts like the original owner the beneficiary generally will not owe tax on the assets in the IRA until they receive distributions
tax deferred accumulation
nontaxable cost base represents the premium dollars that have already been taxed and will not be taxed again when withdrawn interest accumulated in an annuity is the tax base but the taxes are deferred during the accumulation period
premium death benefit
not tax deductible tax free if taken as a lump some distribution to a named beneficiary principal is tax free interest is taxable if paid in installments other than lump sum
policy loans
not taxable to a business unlike individual taxpayer a corporation may deduct interest on a life insurance policy loan for loans up to $50,000
exclusion ratio
used to determine the annuity amounts to be excluded from taxes annuitant able to recover cost basis nontaxable the cost basis is the principal amount the amount that was paid into the annuity excluded from taxes the rest of each annuity payment is interest that has been earned and is taxable
surrender
when a policy owner surrenders a policy for cash value some of the cash received may be taxable if the income of cash surrender value exceeds the amount of premiums paid for the policy when the owner withdraws cash value from a universal life policy partial surrender both the cash value and the death benefit are reduced by the surrender
taxation of individual retirement annuities
when 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 50% of the shortfall from the required annual amount
settlement options
when beneficiary receives payments consisting of both the principal and interest the interest portion of payments received is taxable income
withdrawal of interest and principal
when money is withdrawn from the annuity during the accumulation phase the amounts are taxed on last in first out all withdrawals are taxable until the owners cost basis is reached after all the interest is received and taxed the principal will be received with no additional tax consequences
section 1035 policy exchanged the following are allowable exchanges
when policyowner exchanges a cash value life insurance policy for another must be on the same life and is considered no income tax deductible a life insurance policy for another life insurance policy an and endowment contract or an annuity contract endowment contract for another endowment or annuity contract annuity for another annuity key is that the exchange may not be from a less tax advantage contract same to same 1035 exchange is not taxable exchange of cash value life insurance or annuity of the same life