Chapter 7- Federal Tax Considerations and Retirement Plans- A.D Banker

A Section 1035 Exchange is permitted in each of the following transactions, except: A A Variable Universal Life Policy is exchanged for an Equity-Indexed Annuity B An annuity contract is exchanged for another annuity contract C An annuity is exchanged for a Whole Life Policy D A Whole Life Policy is exchanged for a Universal Life Policy

C An annuity is exchanged for a Whole Life Policy IRC section 1035 does not authorize the exchange of an annuity policy for any kind of life insurance policy.

All of the following statements about Group Life Insurance are true, except: A Employees are taxed on any premiums paid on insurance in excess of $50,000 B Employer paid premiums are tax deductible C Employees receive a tax deduction for employer paid premiums D Employee paid premiums are not tax deductible

C Employees receive a tax deduction for employer paid premiums Employer, NOT employee, paid premiums are tax deductible. Only when the insurance benefit exceeds $50,000 does the employee have to report it as taxable income.

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 50% B 80% C 70% D 60%

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

_______________ 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 A policy loan C The cash value D The death benefit

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.

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

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

Which of the following statements about a Modified Endowment Contract (MEC) is FALSE? A If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment B Taxable distributions include cash value surrenders and policy loans C 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 D Funds distributed before age 59 1/2 are subject to a 10% penalty on any gains

A If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment Any funds distributed are subject to a last-in, first-out (LIFO) tax treatment, meaning gains will be taxed before principal.

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.

To eliminate the use of life insurance as a short-term, tax-free savings vehicle, what tax law change took place? A The Modified Endowment Contract (MEC) rules were put into place B Death benefits became income-taxable C Loan interest became tax-deductible D Employer-paid premiums were made non-tax-deductible

A The Modified Endowment Contract (MEC) rules were put into place

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

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

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

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

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 $15,000 B $25,000 C $10,000 D Zero

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

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

B Exclusion ratio The exclusion ratio allows the annuitant to account for the cost basis overtime so that the initial payments are not 100% taxable until all cost basis has been fully accounted for.

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 as capital gain but only 50% of the gain is applied B Fully taxable since the excess payments must represent only earnings C Taxed at the favorable annuity continuation income rates D Still tax favored for annuitants over the age of 70

B 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.

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

The Modified Endowment Contract (MEC) rules were put into place because: A Life insurance companies needed to become more competitive with other financial institutions 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 Too many consumers were being sold life insurance when they thought they were buying annuities 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

The Modified Endowment Contract (MEC) rules were put into place because: A Too many 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 The federal government needed a new source of tax revenue D Life insurance companies needed to become more competitive with other financial institutions

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.

Any employee-paid group life insurance premiums are __________. A Tax-exempt B Not tax-deductible C Tax-deductible D Tax-deferred

B Not tax-deductible

Janelle is the beneficiary of a life insurance policy in which the insured has died. What is the only way she can receive the claim amount totally free from income taxes? A Choose the interest income only settlement option B Receive the claim amount in a lump sum C Elect the life only settlement option D Select the 10-year period certain settlement option

B Receive the claim amount in a lump sum

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 face income tax consequences and tax penalties C She will have to pay income taxes D She will pay surrender charges for failing to annuitize

B She will face income tax consequences and tax penalties

Joe had $500,000 of life insurance at work. He has an additional $40,000 life insurance policy the company purchased on all employees. His wife is the primary beneficiary and their four children are contingent beneficiaries. Upon Joe's death, what are the tax consequences to his beneficiaries? A $460,000 is income taxable to the recipient B The $540,000 lump sum proceeds will be received income tax-free C All premiums paid may be deducted from the face value before taxation D The $40,000 will be taxed since the premium was tax-deductible by the employer

B The $540,000 lump sum proceeds will be received income tax-free The death benefit (face amount) of both individual and group policies received in a lump sum by a named beneficiary(s) is income tax-free.

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 The Modified Endowment Contract (MEC) rules were put into place C Loan interest became tax-deductible D Death benefits became income-taxable

B The Modified Endowment Contract (MEC) rules were put into place 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.

In which of the following circumstances is an annuity's tax-deferral benefit lost? A The annuity has a long-term care rider B The annuity is owned by a corporation C The annuity is held beyond age 70 1/2 D The annuity is owned by someone other than the annuitant

B The annuity is owned by a corporation If a corporation owns an annuity, the tax-deferral benefit is lost. Tax-deferral of annuity earnings is only for natural persons.

The life insurance policy cost basis consists of: A The net amount at risk B The premiums paid in C The cash value of the policy D The dividends received

B The premiums paid in The premiums paid establish a cost basis in the policy.

13 / 15 By what means is a transfer for value made? A By a partial withdrawal B Through an absolute assignment C By requesting a change in the beneficiary designations D By way of collateral assignment

B Through an absolute assignment To effect a transfer for value, an absolute assignment needs to take place.

All of the following are times in which life insurance policy cash values can become taxable, except: A If the policy fails to meet the IRS definition of life insurance B When a policy loan is taken out C At policy surrender D When the policy is sold

B When a policy loan is taken out Policy loans do not trigger a taxable event.

Which of the following best defines the 'Cost Recovery Rule'? A 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 B When a policy is surrendered, the earnings within the policy are accounted for first C Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender D The amount of the policy's internal expenses plus the life producer's commission make up the total cost of the policy

C 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 best defines the 'Cost Recovery Rule'? A When a policy is surrendered, the earnings within the policy are accounted for first B The amount of the policy's internal expenses plus the life producer's commission make up the total cost of the policy C Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender D 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

C 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.

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

C 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 held, referred to as the 'incidental benefits' limitation, which the IRS developed standards, or rules, to determine the allowable limits.

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

C 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 held, referred to as the 'incidental benefits' limitation, which the IRS developed standards, or rules, to determine the allowable limits.

Which of the following is NOT a taxable event for a Modified Endowment Contract (MEC)? A Cash surrender of the policy B Withdrawal of cash value to pay for a daughter's wedding C Lump sum death benefit paid to the beneficiary D Taking out a policy loan

C Lump sum death benefit paid to the beneficiary 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.

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

C 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.

All of the following regarding policy loans are true, except: A The interest on a policy loan is not deductible B The policy loan is not taxable so long as the policy remains in force C Policy loans are taxable if the policy remains in effect and the amount borrowed exceeds the premiums paid D Policy loans cannot exceed the amount in the cash value

C Policy loans are taxable if the policy remains in effect and the amount borrowed exceeds the premiums paid

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 pay surrender charges for failing to annuitize B She will have to pay tax penalties C She will face income tax consequences and tax penalties D She will have to pay income taxes

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

Which of the following policies would be deemed a MEC? A Variable Universal Life B Universal Life C Single Premium Whole Life D 10-pay Whole Life

C Single Premium Whole Life Since a single premium life insurance policy clearly does not pass the 7-pay test, it will automatically be deemed a MEC.

To eliminate the use of life insurance as a short-term, tax-free savings vehicle, what tax law change took place? A Death benefits became income-taxable B Employer-paid premiums were made non-tax-deductible C The Modified Endowment Contract (MEC) rules were put into place D Loan interest became tax-deductible

C The Modified Endowment Contract (MEC) rules were put into place

What are the tax ramifications when an annuity contract is owned by a corporation? A The premiums are tax deductible as a business expense B Withdrawals are taxed, but at the favorable corporate rate C There is no tax benefit D There is no tax penalty for early withdrawal

C There is no tax benefit Because a corporation is a non-natural person, a corporate-owned annuity is not treated as an annuity for tax purposes . There is no tax benefit or deferral--earnings are taxed every year.

All of the following are times in which life insurance policy cash values can become taxable, except: A When the policy is sold B At policy surrender C When a policy loan is taken out D If the policy fails to meet the IRS definition of life insurance

C When a policy loan is taken out Policy loans do not trigger a taxable event.

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

D 24

Distributions from a Modified Endowment Contract (MEC) made on or after age _____ are not subject to any tax penalties. A 65 B 62 C 70 1/2 D 59 1/2

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

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

D An equity indexed annuity into a variable universal life insurance policy

If no beneficiary is living at the time of the insured's death, the benefit will automatically be paid __________. A To next of kin B The funeral home C The deceased's spouse D Into the insured's estate

D Into the insured's estate 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.

All of the following transactions qualify for IRC Section 1035 exchange tax treatment, except: A Life insurance may be exchanged for an annuity B A life insurance policy may be exchanged for another life insurance policy C A life insurance policy can be exchange for a long-term care policy D Nonqualified tax deferred annuities may be exchanged for life insurance policies

D Nonqualified tax deferred annuities may be exchanged for life insurance policies IRS Section 1035 covers like kind exchanges of insurance contracts. Permitted exchanges include Life > Life, Life > Annuity, Annuity > Annuity. Life insurance or annuity contracts may also be exchanged for certain long-term care contracts.

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. A Long-term capital gain B Short-term capital gain C Alternative Minimum Tax (AMT) D Ordinary income

D Ordinary income

H owns a nonqualified variable annuity that has a separate account invested in the stock market. If H withdraws funds from the annuity, the earnings on the withdrawal will be taxed as: A Long-term capital gains B Dividend income C Short-term capital gains D Ordinary income

D Ordinary income Regardless of the source of the gains inside an annuity, all taxable withdrawals are subject to ordinary income tax rates.

If an annuitant withdraws funds from their annuity prior to age 59 1/2 what is the tax consequence? A Tax on the tax deferred portion of the withdrawal along with a 15% tax penalty B Tax on the entire withdrawal plus a 10% tax penalty C Tax on cost basis and 10% tax penalty on the tax deferred portion of the withdrawal D Tax and 10% penalty tax on the withdrawal that represents earnings

D Tax and 10% penalty tax on the withdrawal that represents earnings The withdrawal that represents earnings will be taxed along with a 10% tax penalty.

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. If the business does not receive more than 50% of the death benefit c. An employer cannot ever deduct premiums it pays for an employee's life insurance benefit d. Employers can always 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

To be considered terminally ill, federal law defines a terminal illness as one which is expected to result in the person's death within how many months? a. 36 b. 24 c. 12 d. 6

b. 24

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

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

c. The policy failed the 7-pay test