Chapter 7: Federal Tax Considerations for Life Insurance and Annuities

When the owner of a $250,000 life insurance policy died, the beneficiary decided to leave the proceeds of the policy with the insurance company and selected the Interest Settlement Option. If at the time of withdrawal the interest paid was $11,000, the beneficiary would be required to pay income tax on

$11,000. The death benefit is not income taxable; any interest earned is income taxable.

When must an IRA be completely distributed when a beneficiary is not named?

December 31 of the year that contains the fifth anniversary of the owner's death. If the owner dies before distributions have begun, the entire interest must be distributed in full on or before December 31 of the calendar year that contains the fifth anniversary of the owner's death, unless the owner named a beneficiary.

Death benefits payable to a beneficiary under a life insurance policy are generally

Not subject to income taxation by the Federal Government.

Traditional IRA contributions are

Tax deductible. The following taxation rules apply to contributions made to traditional IRA plans: tax-deductible contributions for the year of the contribution (based on the person's 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are taxed at 6% per year as long as the excess amounts remain in the IRA; and tax-deferred earnings are not taxed until withdrawn.

What is the tax consequence of amounts received from a Traditional IRA after the money was left in the tax-deferred account by the beneficiary?

income tax on distributions and no penalty

Which of the following is used to determine the annuity amounts that are not taxable?

Exclusion ratio The "exclusion ratio" is used to determine the annuity amounts that should be excluded from taxes. During the accumulation phase, the contributions to the annuity have already been taxed. Therefore, the contributions are not taxed during the income period.

If taken as a lump sum, life insurance proceeds to beneficiaries are passed

Free of federal income taxation.

If an insured surrenders his life insurance policy, which statement is true regarding the cash value of the policy?

It is only taxable if the cash value exceeds the amount paid for premiums

What method is used to determine the taxable portion of each annuity payment?

The exclusion ratio

In life insurance policies, cash value increases

Grow tax deferred. Generally, life insurance cash values are only income taxed if the policy is surrendered (totally or partially) and the cash value exceeds the premiums paid.

An insured decides to surrender his $100,000 Whole Life policy. The premiums paid into the policy added up to $15,000. At policy surrender, the cash surrender value was $18,000. What part of the surrender value would be income taxable?

$3,000 The difference between the premiums paid and the cash value would be taxable. In this example, the difference between the premiums paid ($15,000) and the cash value ($18,000) is $3,000.

Life insurance death proceeds are

Generally not taxed as income Life insurance death benefits are generally not taxed as income.

Who can make a fully deductible contribution to a traditional IRA?

An individual not covered by an employer-sponsored plan who has earned income Individuals who are not covered by an employer-sponsored plan may deduct the amount of their IRA contributions regardless of their income level.

A 60-year-old participant in a 401(k) plan takes a distribution and rolls it over to an IRA within 60 days. Which of the following is true?

The amount of the distribution is reduced by the amount of a 20% withholding tax.

If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for ten years, which of the following would be taxable annually?

$3,000

Which of the following terms is used to name the nontaxed return of unused premiums?

Dividend

In a direct rollover, how is the money transferred from one plan to the new one?

From trustee to trustee. In a direct rollover, the distribution is made directly from the trustee of the first plan to the trustee or administrator/custodian of the new IRA plan.

A policyowner cancels his life policy but instructs the insurance company to transfer the cash value of his policy to an annuity. This nontaxable transaction is called

1035 exchange

When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income?

Interest only If a beneficiary receives payments that contain both principal and interest portions, only the interest is taxable as income.

Which of the following statements is TRUE concerning whole life insurance?

Lump-sum death benefits are not taxable. Dividend interest is taxable; policy loans are not tax-deductible, and premiums are not tax-deductible.

What part of the Internal Revenue Code allows an owner of a life insurance policy or annuity to exchange or replace their current contract with another contract without creating adverse tax consequences?

Section 1035 Policy Exchange

Which of the following is NOT true regarding policy loans?

Money borrowed from the cash value is taxable.

If an immediate annuity is purchased with the face amount at death or with the cash value at surrender, this would be considered a

Settlement option

Which concept is associated with "exclusion ratio"?

annuity payments A portion of an annuity payment is taxable, while another portion is not. The return of the principal paid in is nontaxable. The portion that is taxable is the actual amount of payment, less the expected return of the principal paid in. This relationship is called the "exclusion ratio."