CHAPTER 7:
Regarding an accelerated death benefit, a physician must give a prognosis of ___ months or less life expectancy for the named insured. A: 24 B: 12 C: 18 D: 6
A: The prognosis of a physician must be a life expectancy of 24 months or less.
All of the following are true regarding ERISA qualified plans, except: A Employers must establish a pension plan B The plan may not discriminate C The plan must be IRS approved D A vesting schedule must be established
A: 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 insured has contributed $12,000 in premiums toward a universal life policy. She decides to cancel the policy and take the cash value of $15,000. What are the tax consequences of this distribution? A $12,000 is a return of after tax dollars (i.e. cost basis), $3,000 is taxable as ordinary income B The full $15,000 is tax deferred C The distribution at surrender is tax free D $12,000 is a return of after tax dollars (i.e. cost basis), $3,000 is taxable as long-term capital gain
A: Upon surrender of a permanent life insurance contract, cash value received is taxable to the extent it exceeds total premium paid (i.e. CSV - cost basis = equity). The equity is taxed as ordinary income.
The Modified Endowment Contract (MEC) rules were put into place because: A 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 C Life insurance companies needed to become more competitive with other financial institutions D Too many consumers were being sold life insurance when they thought they were buying annuities
B: Prior to 1988, individuals were using life insurance policies in place of investment vehicles to avoid paying taxes.
To eliminate the use of life insurance as a short-term, tax-free savings vehicle, what tax law change took place? A Employer-paid premiums were made non-tax-deductible B Loan interest became tax-deductible C The Modified Endowment Contract (MEC) rules were put into place D Death benefits became income-taxable
C: The Modified Endowment Contract (MEC) rules were put into pace The rule states that if a policy is funded too quickly, it will be classified as a Modified Endowment Contract (MEC). MEC rules impose stiff penalties to eliminate the use of life insurance as a short-term, tax-free savings vehicle.
Generally, the payment of an accelerated death benefit is _______ to a recipient if the benefit payment is qualified. A Tax free B Tax free up to $50,000 C Taxable D Taxable to the extent it exceeds 7.5% of AGI
Generally, the payment of an accelerated death benefit is tax free to a recipient if the benefit payment is qualified.
All of the following are times in which life insurance policy cash values can become taxable, except: A At policy surrender B When a policy loan is taken out C If the policy fails to meet the IRS definition of life insurance D When the policy is sold
Policy loans do not trigger a taxable event.
Which of the following best defines the 'Cost Recovery Rule'? A The amount of the policy's internal expenses plus the life producer's commission make up the total cost of the policy B When a policy is surrendered, the earnings within the policy are accounted for first C 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 D 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 is NOT a taxable event for a Modified Endowment Contract (MEC)? A Cash surrender of the policy B Taking out a policy loan C Withdrawal of cash value to pay for a daughter's wedding D Lump sum death benefit paid to the beneficiary
D: 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.
Employer-paid premiums for employee group term life do not constitute taxable income to the employee for coverage up to ___________. A $40,000 B $30,000 C $25,000 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.
If no __________ is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate. A Spouse B Insured C Relative D Beneficiary
D: 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.
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).
If a(n) ________ does not pass the 7-pay test, it will be deemed a Modified Endowment Contract (MEC). A Viatical settlement B Endowment contract C Annuity D Life insurance policy
D: Life Insurance Policy When a life insurance policy does not pass the 7-pay test, it will be deemed a MEC.
Which is true regarding the taxation of the cash value in a Universal Life Policy prior to withdrawal? A Tax interpolated B Tax deductible C Tax free D Tax deferred
D: Tax-deferred All life insurance cash value accumulations are tax deferred. The primary benefit of Universal Life is the potential of a higher interest crediting rate than the fixed rate in whole life policies.
For an individually purchased life insurance policy, the premiums are considered a __________. A Deductible business expense B Deductible personal expense C Nondeductible business expense D Nondeductible personal expense
D: The premiums paid for an individual life insurance policy are a personal expense and are not deductible.
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 tax year B End of the contract year C End of the calendar year D Latest premium payment was received
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.
All of the following regarding policy loans are true, except: A The interest on a policy loan is not deductible B Policy loans cannot exceed the amount in the cash value C The policy loan is not taxable so long as the policy remains in force D Policy loans are taxable if the policy remains in effect and the amount borrowed exceeds the premiums paid
If the policy lapses with a loan outstanding, the excess borrowed over the premium paid becomes taxable as ordinary income.
All of the following regarding employer group life insurance are true, except: A Employer-paid premiums do not constitute taxable income to the employee unless the death benefit exceeds $50,000 B Employee-paid premiums are tax-deductible to the employee C Premiums paid by an employer are tax-deductible to the business as an ordinary and necessary business expense D Death benefit proceeds paid to an employee's named beneficiary are received income tax-free
Premiums paid by an employee are not eligible for a tax deduction.
An insured has paid $1,000 in annual premiums for her permanent life insurance policy for 12 years. Now upon surrendering the policy she is due to receive $15,000 of cash value. How much of this cash value is taxable? A $3,000 B $12,000 C Zero D
The Cost Recovery Rule states that at surrender, cash values will be recovered tax-free to the extent of the cost basis of the policy. The cost basis is $12,000 (i.e. 12 years x $1,000 annual premium). The $3,000 excess over cost basis ($15,000 of CSV less $12,000 cost basis) is taxed as ordinary income.
Life insurance policy premiums establish a _________ in the policy for tax purposes. A Cash value B Loan C Cost basis D Dividend
C: Cost Basis Cost basis is primarily established by accounting for the premiums paid into the policy.
A permanent policy is surrendered for its cash value, and that sum is greater than the amount of premiums paid in. How is the excess taxed? A Taxed as ordinary income B No tax is due C Taxed as long term capital gain D Taxed as a short term capital gain
A: Upon surrender, any equity (i.e., amount above total premiums paid) is taxed as ordinary income. The premiums paid are also referred to as 'cost basis.'
___________ are not taxable because they are considered a return of excess premium. A Death Benefits B Dividends C Cash Values D Policy loans
B: Dividends Dividends are considered a return of unearned premium which is why are they are paid out income tax free.
If a policyowner of a life insurance policy accidently pays in premiums in excess of the MEC guidelines, the insurer can refund the excess within ______ days of the end of the contract year. A: 30 B: 60 C: 45 D: 10
B: 60 Any excess premium can be refunded by the insurer within 60 days after the end of the contract year.
Contributions to a nonqualified retirement plan are: A Tax-deductible up to $50,000 B Not tax-deductible C Fully tax-deductible D Partially tax-deductible
B: Not tax-deductible Contributions to a nonqualified retirement plan are not tax-deductible.
Under the Modified Endowment Contract rules the 7-Pay Test is defined as: A The least amount of premium required to be paid in the first 7 years to maintain the policy to age 70 B 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 C The cash value at the end of year 7 exceeds the total premiums paid D Any life insurance policy that endows in 7 years
B: 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.
Participating policy dividends become taxable as income when: A The policyowner receives them in cash B They are distributed by the insurer C The total amount of dividends received by a policyowner exceeds the total amount of premium he/she has paid D They are declared by the board of directors
C: When the total amount of dividends received exceeds the total amount of premium paid, the excess is taxable as income to the policyowner.
The exception to the rule concerning the non-deductibility of life insurance premiums is: A Third-Party Ownership Policies B Key Employee Insurance C All employer paid group life insurance premiums D Life insurance to fund a Buy-Sell Agreement
An employer may deduct 100% of the total group life premium it pays as a business expense, but the value of premiums for any employee's coverage in excess of $50,000 must be 'imputed' to the employee and income tax paid on that amount.
To be a qualified accelerated death benefit it must meet all of the following criteria, except: A The insurer provides a monthly report to the insured showing the amount paid and the amount of benefit remaining in the life insurance policy B The benefit amount cannot exceed the lesser of $50,000 or 7.5% of AGI C A physician must give a prognosis of 24 months or less life expectancy for the named insured D The amount of the benefit must at least be equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit
B: The benefit amount cannot exceed the lesser of 50,000$ or 7.5% of AGI To be a qualified accelerated death benefit the benefit must meet the following conditions: a physician must give a prognosis of 24 months or less life expectancy for the named insured, the amount of the benefit must at least be equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit, and the insurer provides a monthly report for the insured showing the amount paid and the amount of benefit remaining in the life insurance policy.
An insured has paid $1,000 in annual premiums for her permanent life insurance policy for 12 years. Now upon surrendering the policy she is due to receive $15,000 of cash value. How much of this cash value is taxable? A $15,000 B Zero C $3,000 D $12,000
C: $3,000 The Cost Recovery Rule states that at surrender, cash values will be recovered tax-free to the extent of the cost basis of the policy. The cost basis is $12,000 (i.e. 12 years x $1,000 annual premium). The $3,000 excess over cost basis ($15,000 of CSV less $12,000 cost basis) is taxed as ordinary income.
All employer-paid premiums for amounts above $_________ of group life insurance are reported as taxable income to the employee. A $25,000 B $75,000 C $50,000 D $100,000
C: $50,000 All employer-paid premiums for amounts above $50,000 are reported as taxable income to the employee.
When a life insurance policy does not pass the ______-pay test, it becomes classified as a MEC. A: 8 B: 10 C: 7 D: 9
C: 7 It is the 7-pay test that must be passed in order not to be classified as a MEC.
_________ 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 The death benefit B The cash value C A dividend D A policy loan
C: 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.
When would a life insurance policy loan be subject to income taxation? A If the policy lapses when there is a policy loan outstanding which is in excess of the policy's cost basis B When the outstanding loan is in excess of $10,000 C When any part of the policy loan is used to pay for the policy's premium D When the policy loan is greater than the premiums paid into the policy
A: if the policy lapses when there are is a policy loan outstanding which is in excess of the policy's cost basis Only the portion of an outstanding policy loan in excess of the policy's cost basis will be subject to income taxation if the policy lapses.
If life insurance proceeds are paid to the deceased's estate they may be subject to ________ taxes. A State Income B Federal Income C Federal Estate D Probate
C: Federal Estate While the death benefit is income tax free, the amount in the deceased's estate may be subject to Federal Estate taxes
If a life insurance policy does not pass the 7-pay test, it will be deemed a(n) _________. A Annuity B Savings account C MEC D Commodity
C: MEC When a life insurance policy does not pass the 7-pay test, it will be deemed a MEC.
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 Annual increases in the policy's cash value are not taxable at the time they are credited to the policy C The interest that he pays on policy loans is tax-deductible 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
C: The interest on policy loans is not tax-deductible.
Which of the following statements about a Modified Endowment Contract (MEC) is FALSE? A 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 B Taxable distributions include cash value surrenders and policy loans C Funds distributed before age 59 1/2 are subject to a 10% penalty on any gains D If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment
D: Any funds distributed are subject to a last-in, first-out (LIFO) tax treatment, meaning gains will be taxed before principal.