ExamFx - Chapter Quiz - Federal Tax Considerations For Life Insurance And Annuities.
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.
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. A settlement option is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender.
If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an
Modified endowment contract. Any cash value life insurance policy that develops cash value faster than a seven-pay whole life contract is called a Modified Endowment Contract. It loses the benefits of a standard life contract.
Which of the following best describes taxation during the accumulation period of an annuity?
Taxes are deferred. The interest accumulated in an annuity is the tax base, but the taxes are deferred during the accumulation period. The cost base is the premium dollars that have already been taxed and will not be taxed again when withdrawn from the contract.
An employee quits her job where she has a balance of $10,000 in her qualified plan. If she decides to do a direct transfer from her plan to a Traditional IRA, how much will be transferred from one plan administrator to another and what is the tax consequence of a direct transfer?
$10,000, no tax consequence During an IRA direct transfer (or direct rollover), the full amount gets reinvested from one plan to the other.
If an annuitant dies during the accumulation period, what benefit (if any) will be included in the annuitant's estate?
Accumulated cash value If the annuitant died during the accumulation period, the insurer is obligated to return all or a portion of the annuity cash value (values accumulated in the annuity in accordance with contract terms), which will be included in the deceased annuitant's estate.
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.
An insured has a Modified Endowment Contract. He wants to withdraw some money in order to pay medical bills. Which of the following is true?
He will have to pay a penalty if he is younger than 59½. Any cash value life insurance policy that develops cash value faster than a seven-pay whole life contract is called a Modified Endowment Contract. It loses the benefits of a standard life contract. All withdrawals are subject to taxation on a LIFO basis, and if withdrawals are made earlier than the age of 59½, a 10% penalty is imposed.
What is the main purpose of the Seven-pay Test?
It determines if the insurance policy is a MEC. The Seven-pay Test determines whether an insurance policy is "over-funded" or if it's a Modified Endowment Contract. In other words, the cumulative premiums paid during the first seven years of a policy must not exceed the total amount of net level premiums that would be required to pay the policy up using guaranteed mortality costs and interest.
Death benefits payable to a beneficiary under a life insurance policy are generally
Not subject to income taxation by the Federal Government. When premiums are paid with after tax dollars, the death benefit is generally not subject to federal income taxation.
J transferred his life insurance policy to his son two years before his death. Which of the following is true?
The entire face value of the policy will be included in J's taxable estate. If a policyowner transfers or gives away a life insurance 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.
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. In accordance with Section 1035 of the Internal Revenue Code, certain exchanges of life insurance policies and annuities may occur as nontaxable exchanges. Review Content Next Question
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.
Which of the following is NOT true of Section 1035 Policy Exchanges?
Any exchange made under Section 1035 of the Internal Revenue Code must be completed within 30 days. Section 1035 of the Internal Revenue Code does not give a specific time limit to complete such an exchange.
Which of the following terms is used to name the nontaxed return of unused premiums?
Dividend The return of unused premiums is called a dividend. Dividends are not considered to be income for tax purposes, since they are the return of unused premiums.
What is the penalty for IRA distributions that are below the required minimum for the year?
50% 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.
An applicant buys a nonqualified annuity, but dies before the starting date. For which of the following beneficiaries would the interest accumulated in the annuity NOT be taxable?
Spouse If an annuities contract holder dies before the effective starting date, the contract's interest continues to be taxable, unless the beneficiary is a spouse. In that case, this tax can be deferred.
During the accumulation period in a nonqualified annuity, what are the tax consequences of a withdrawal?
Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 ½. When money is withdrawn from the annuity during the accumulation phase, the amounts are taxed on a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached.
Which of the following statements regarding the taxation of Modified Endowment Contracts is FALSE?
Withdrawals are not taxable. Any distributions from MECs are taxable, including withdrawals and policy loans. All of the other statements are true.
An IRA uses immediate annuities to pay out benefits; the IRA owner is nearly 75 years old when he decides to collect distributions. What kind of penalty would the IRA owner pay?
D50% tax on the amount not distributed as required When immediate annuities are used to pay IRA benefits, distributions must begin no later than age 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.
An annuitant dies before the effective date of a purchased annuity. Assuming that the annuitant's wife is the beneficiary, what will occur?
The interest will continue to accumulate tax deferred. If the contract holder dies before the annuity starting date, the contract's interest becomes taxable. If the beneficiary of the annuity is a spouse, the tax can continue to be deferred.
Which of the following is NOT an allowable 1035 exchange?
A whole life insurance policy is exchanged for a term insurance policy. The key is that the exchange may not be from a less tax-advantaged contract to a more tax-advantaged contract. "Same to same" is acceptable.
Traditional IRA contributions are tax deductible based on which of the following?
Owner's income Traditional IRA contributions are tax deductible, but may be limited if the owner's income exceeds a certain level.
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 As long as the funds are transferred intact and the form is filed, taxation is deferred.
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. If the beneficiary chooses to leave the money in the tax-deferred account until the calendar year in which the owner would have attained age 72, the distributions would be subject to income taxation at the rate at the time of withdrawal.
When would life insurance policy proceeds be included in the insured's taxable estate?
When there are any incidents of ownership at the time of death If the insured were the owner of the policy at the time of death or possessed any incidents of ownership at the time of death, the value of the policy will be included in the insured's taxable estate. If the insured, as policyowner, assigns or transfers ownership of the policy or makes a gift of the policy within 3 years prior to his or her death, the entire face amount of the policy will be included in his or her taxable estate.
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 If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for 10 years, $10,000 per year would be income tax free (as principal) and $3,000 per year would be income taxable (as interest).
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.
In a direct transfer, how is money transferred from one retirement plan to a traditional IRA?
From trustee to trustee In a direct transfer, the distribution is made directly from the trustee of the first plan to the trustee or administrator/custodian of the new IRA plan.
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. The cash value of a surrendered policy is only considered to be taxable as income if the cash value exceeds the amount of premiums paid for the policy.
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.
When contributions to an immediate annuity are made with before-tax dollars, which of the following is true of the distributions?
Distributions are taxable. If contributions are made with before-tax dollars, contributions to this fund are fully taxable. Distributions must begin no later than age 72 in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.
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. Distributions from 401(k) plans are taxable as ordinary income in the year of the distribution. However, if the distribution is rolled over to a Traditional IRA, taxes are deferred until the required minimum IRA distributions begin. Since this client actually took a distribution (instead of making a trustee-to-trustee roll over), the distribution is subject to 20% withholding tax.
Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase?
Withdrawn amounts are taxed on a last in, first out basis. When money is withdrawn from the annuity during the accumulation phase the amounts are taxed on a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached. After all of the interest is received and taxed the principal will be received with no additional tax consequences.
