A.D. Banker - Life Insurance Prep - Chapter 7

The exclusion ratio states that once the entire cost basis has been recovered from a non-qualified annuity income benefit payout then any further payments are ______. A. Taxed at the favorable annuity continuation income rates B. Taxed as capital gain but only 50% of the gain is applied C. Fully taxable since the excess payments must represent only earnings D. Still tax favored for annuitants over the age of 70

C. Fully taxable since the excess payments must represent only earnings Once the entire cost basis is recovered than any remaining payments are fully taxable as ordinary income

If a/(n) _____ does not pass the 7-pay test, it will be deemed a Modified Endowment Contract (MEC). A. Life insurance policy B. Annuity C. Endowment Contract D. Viatical settlement

A. Life insurance policy When a life insurance policy does not pass the 7-pay test, it will be deemed a MEC

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.

If funds are prematurely withdrawn from a Modified Endowment Contract (MEC) they are subject to a _____ % penalty on any gains. A. 6 B. 10 C. 20 D. 15

B. 10% For withdrawals of any gains from a MEC prior to age 59 1/2 there is a 10% tax penalty that applies/

Which of the following could initiate the Accelerated Benefits Provision or Rider of a life policy? A. A condition that is terminal B. Inability to perform some activities of daily living C. A total disability not reducing life expectancy D. A presumtive disability

A. A condition that is terminal The qualifying event in the Living Needs rider is the terminal status of the insured (i.e. projected to die within 1 or 2 years).

__________ consist(s) of the amount of premium that is returned to the policyowner if the insurer achieves lower mortality and expense costs than expected. A. A dividend B. The cash value C. The death benefit D. A policy loan

A. A dividend A participating insurer's dividend consists of the amount of premium returned to the policyowner if the insurer achieves lower mortality and expenses than expected.

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

A. 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

How are employer paid premiums on a group life insurance plan treated for tax purposes? A. A barter transaction B. As an ordinary and necessary business expense C. As a personal expense paid on behalf of the employee D. As compensation in lieu of cash

B. As an ordinary and necessary business expense Employer paid premiums on a group life insurance plan are treated as an ordinary and necessary business expense which is why it qualifies for tax deductibility.

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

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

Generally, the _____ is the amount of premiums paid into the policy less any dividends or withdrawals previously taken. A. Cash Value B. Cost Basis C. Net Premium D. Loan Amount

B. Cost basis Generally, the cost basis is the amount of premiums paid into the policy, less any dividends or withdrawals previously taken.

The Modified Endowment Contract (MEC) rules were put into place because: A. Too maybe consumers were being sold life insurance when they thought they were buying annuities B. Individuals were overfunding life insurance policies and using them as tax-free investment vehicles instead of a way to protect survivors against the financial cost of one's death C. Life insurance companies needed to become more competitive with other financial institutions D. The federal government needed a new source of tax revenue

B. Individuals were overfunding life insurance policies and using them as tax-free investment vehicles instead of a way to protect survivors against the financial cost of one's death Prior to 1988, individuals were using life insurance policies in place of investment vehicles to avoid paying taxes

When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit: A. Pays taxes based on the estate tax rate of the deceased B. Pays income tax on any gains at his or her own income tax rate C. Pays no income tax on any portion of the proceeds D. Pays income tax on any gains using the deceased's income tax bracket

B. Pays income tax on any gains at his or her own income tax rate When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at his or her own income tax rate.

If dividends are left on deposit with an insurer to earn interest: A. The dividend is taxable as well as the interest B. The dividend is tax-free, but the interest is taxable C. The interest is ta-free as well as the dividend D. The dividend is taxable, but the interest is tax-free

B. The dividend is tax-free, but the interest is taxable Interest paid by insurers on dividends left on deposit is taxable as income.

If a life insurance policy becomes a MEC, what was the cause? A. The policy was exchanged for an annuity B. The policy failed the 7-pay test C. The policy was rolled over into an IRA D. The policyowner stopped paying premiums after 7 years

B. The policy failed the 7-pay test A policy that does not pass the 7-Pay Test will be deemed a Modified Endowment Contract for the life of the contract.

Under what circumstance would a policy loan in a life insurance policy be taxable? A. Policy loans in life insurance are always tax-free B. If the policyowner dies, the policy loan becomes taxable C. If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable D. If the insured dies, the policy loan is taxable unless there is sufficient death benefit available to pay off the loan

C. If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable Policy loans and unpaid loan interest are subject to taxation if the loan amount exceeds the cost basis (the Cost Basis is the amount of premiums paid into the policy less any dividendTs or withdrawals previously taken) in the contract in the event the policy lapses or is surrendered for its cash value. Surrender charges, if any, may be applied as an offset to cost basis.

When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at_____ tax rates.

C. Ordinary income When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at ordinary income tax rates.

Why are dividends not taxable as income when paid out to a participating policyholder? A. They represent a return of a portion of the premium paid B. To create parity with nonparticipating policies under the tax code C. Because they are often the sole source of a policyholders' income D. They are paid from a non-profit organization

A. They represent a return for a portion of the premium paid A participating insurance company's dividend consists of the amount of premium that is returned to the policyowner if the insurance company achieves lower mortality and expense costs than expected.

Generally, life insurance will be considered 'incidental' to a qualified plan if no more than what percentage of the contributions are used to pay insurance premiums? A. 80% B. 70% C. 60% D. 50%

D. 50% Generally, life insurance will be considered 'incidental' to a qualified plan if no more than 50% of the contributions are use to pay insurance premiums, and the insurance amount is not more than 100 times the expected monthly benefit amount

______ are not taxable because they are considered a return of excess premium. A. Policy loans B. Death Benefits C. Cash Values D. Dividends

D. Dividends Dividends are considered a return of unearned premium which is why they are paid out income tax free

H has an annuity funded with pre-tax dollars. So far H has placed $10,000 into the policy and it is now worth $25,000. If H cashes out the annuity, how much is taxable? A. $25,000 B. $10,000 C. $15,000 D. Zero

A. $25,000 Since the contributions are pre-tax and the earnings are tax-deferred, the entire amount is taxable upon withdrawal.

Regarding an accelerated death benefit, a physician must give prognosis of ____ months or less life expectancy for the named insured. A. 24 months B. 6 months C. 12 months D. 18 months

A. 24 months The prognosis of a physician must be a life expectancy of 24 months or less

If no _____ is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate. A. Beneficiary B. Insured C. Spouse D. Relative

A. Beneficiary The policyowner may name the estate as a beneficiary, or by default, if no beneficiary is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate.

The exclusion ratio states that once the entire cost basis has been recovered from a non-qualified annuity income benefit payout then any further payments are ______;. A. Fully taxable since the excess payments must represent only earnings B. Still tax favored for annuitants over the age of 70 C. Taxed as capital gain but only 50% of the gain is applied D. Taxed at the favorable annuity continuation income rates

A. Fully taxable since the excess payments must represent only earnings Once the entire cost basis is recovered than any remaining payments are fully taxable as ordinary income

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

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

Death benefits are paid to the estate of the policyowner/insured in which of the following situations? A. The beneficiary is the estate B. The primary beneficiary is a minor C. The contingent beneficiary has outlived the primary beneficiary D. The primary beneficiary is the deceased's spouse

A. The beneficiary is the estate If the beneficiary is listed as the estate, then upon death of the insured that is where the funds will end up.

To qualify for a tax-free accelerated death benefit, the insured must be given a prognosis of how many months or less life expectancy? A. 36 B. 6 C. 24 D. 12

C. 24 Federal law establishes 24 months as a person's maximum life expectancy to be defined as terminally ill. for the activation of an accelerated death benefit rider, and for the purpose of limiting such claims, insurance companies often define terminal illness as one which would result in death within 12 months.

All of the following are transaction that qualify as a 1035 exchange, except: A. A variable annuity into a fixed annuity B. An equity indexed annuity into a variable annuity C. An equity indexed annuity into a variable universal life insurance policy D. A traditional whole life policy into a universal policy

C. An equity indexed annuity into a variable universal life insurance policy Annuities cannot be 1035 exchanged into a life insurance policy.

If a policyowner unintentionally pays premiums in excess of the MEC guidelines, the excess premium can be refunded by the insurer within 60 days after the ____. A. End of the calendar year B. End of the tax year C. End of the contract year D. Latest premium payment was received

C. End of the contract year If a policyowner unintentionally pays premiums in excess of the MEC guidelines, the excess premium can be refunded by the insurer within 60 days after the end of the contract year.

When an annuitant annuitizes their annuity that as a cost basis in it, the amount of the income benefit payment subject to tax is determined by using the: A. Annuity rule B. Exception rule C. Superannuation ratio D. Exclusion ratio

D. Exclusion ratio The exclusion ratio allows the annuitant to account for the cost basis overtime so that the initial payments are not 1005 taxable until all cost basis has been fully accounted for.

Why would someone 1035 exchange their existing policy? A. The existing producer has retired B. To eliminate the MEC label by going into a new life insurance policy C. To help a producer qualify for a sales incentive contest D. To seek higher returns, lower costs, and / or increased benefits

D. To seek higher returns, lower costs, and / or increased benefits To potentially receive a better deal over the long-run is the reason for more 1035 exchanges.

When may an employer deduct the premiums it pays for an employee's life insurance benefit? A. As long as the business does not derive a direct benefit from the policy B. Employers can always deduct the premiums it pays for an employee's life insurance benefit C. An employer cannot ever deduct premiums it pays for an employee's life insurance benefit D. If the business does not receive more than 50% of the death benefit

A. As long as the business does not derive a direct benefit from the policy As long as the insurance death benefit is not payable to the employer when an employee dies, the premiums paid for the life insurance are deductible to the business.

Under the Modified Endowment Contract rules the 7-Pay Test is defined as: A. Any life insurance policy that endows in 7 years B. The cash value at the end fo year 7 exceeds the total premiums paid C. The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit D. The least amount of premium required to be paid in the first 7 years to maintain the policy to age 70

C. The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit A MEC occurs at any time within the first seven years of a policy (or of a material change to a policy, such as a death benefit increase or decrease) if the sum of premiums paid exceeds the amount of premiums that would be paid in a 7-pay contract.

If Charlotte wishes to cash out her annuity at age 58 after having it for over 20 years, what should she know about prior to doing it? A. She will have to pay tax penalties B. She will have to pay income taxes C. She will face income tax consequences and tax penalties D. She will pay surrender charges for failing to annuitize

C. She will face income tax consequences and tax penalties Due to her age, she will face both income taxes and tax penalties

Generally, life insurance death proceeds are income tax free to the policy beneficiary, except: A. If the employer deducts the premiums on a group life insurance plan covering the employees B. When the death benefit option B is selected on a Variable Universal Life policy C. When a transfer of ownership has taken place D. When the policy is classified as a MEC

C. When a transfer of ownership has taken place Life insurance proceeds are generally income tax free except when a transfer of ownership has taken place

The cost recovery rule states: A. That the excess cash value over premiums paid is considered taxable income when withdrawn B. The first dollar out of a permanent life insurance policy is considered taxable income C. The insurer can hold back funds associated with any costs of underwriting, issuing, and maintaining the policy D. Premiums paid in can be refunded at the policyowner's request

A. That the excess cash value over premiums paid is considered taxable income when withdrawn If the policyowner does surrender or withdraw funds from the policy, the difference between what is received and what had been paid in is generally taxed as ordinary income. This is the Cost Recovery Rule.

Which of the following is the reason why premiums paid on personal life insurance are not deductible? A. They are considered to produce a guaranteed source of income B. They rarely exceed 10% of a taxpayer's AGI C. They are considered a personal expense D. It makes the deductibility of employer paid premiums more attractive

C. They are considered a personal expense For individuals, premiums are considered a personal expense and are not deductible. They are paid with after-tax dollars. This establishes a cost basis in the policy for tax purposes.

If money is paid when a change of ownership in a life insurance policy takes place, this is generally known as a _________. A. Viatical settlement B. Life settlement C. Transfer of value D. 1035 Exchange

C. Transfer of value A transfer of value takes place when money is paid for a change in ownership

All of the following tax-free exchanges of life insurance and annuities are permitted, EXCEPT ______. A. Life insurance to an annuity B. Annuity to long term care insurance C. Life insurance to long term care insurance D. Annuity to life insurance

D. Annuity to life insurance Annuities may not be exchanged for life insurance.

If the annuitant dies during the annuity or payout phase, the remaining value int he account will be: A. Added to the deceased annuitant's estate for valuation B Added to the original owner's estate for valuation, if the owner is different from the annuitant C. Added to the beneficiary's estate for immediate estate taxation D. 100% taxable as income to the recipent

A. Added to the deceased annuitant's estate for valuation If the annuitant dies during the annuity or payout phase, the remaining value in the account will be added to the deceased annuitant's estate for valuation.

Which of the following establishes a cost basis in an annuity? A. After-tax contributions B. Tax deferred interest C. Pre-tax contributions D. Tax deferred gains

A. After-tax contributions Cost basis is established with any after-tax premiums deposited into the annuity

A qualified pension plan must meet ____ requirements A. SEC B. COBRA C. OSHA D. ERISA

D. ERISA A qualified plan must meet the requirements of the Employee Retirement Income Security Act (ERISA)

The restrictions on the amount of life insurance that can be held in a qualified plan are known as: A. Undue concentration B. Overinsurance C. Unsuitability D. Incidental benefits limitation

D. Incidental benefits limitation There are limitations on the types of benefits that may be included in a qualified plan, such as a restriction on the amount of life insurance that can be help, referred to as the 'incidental benefits' limitation, which the IRS developed standards, or rules, to determine the allowable limits.

ERISA sets minimum standards for pension plans primarily in the ____ industry. A. Public and Private B. Public C. Quasi-government D. Private

D. Private ERISA focuses in on the private industry pension plans