Federal Tax considerations for Life and Annuities

What part of group life insurance-if any-is tax exempt for employees?

the cost of the first $50,000 of coverage

Annuity taxation is best understood in the context of the two phases of an annuity:

1. accumulation stage 2. payout (annuitization) stage

In accordance with Section 1035 of the Tax Code, which of the following exchanges is permitted on a tax-free basis?

A deferred market-value adjusted annuity for an immediate variable annuity.

immediate annuity

bought to regularly distribute income. A person who buys an immediate annuity exchanges a lump sum amount of money for a series of monthly income payments

master policy

in a group life policy, it indicates the sponsor as policy owner and premium payor

The exclusion ratio is expressed as a formula:

investment in the contract divided by = amount excluded from income expected return

gain

the portion of the benefit includible in the beneficiary's income for tax purposes

Under Section 1035, the following tax-free exchanges are allowed:

-an annuity for an annuity -a life insurance policy for an annuity -a life insurance policy for another life insurance policy -a life insurance policy for an endowment policy -an endowment policy for another endowment policy (as long as the maturity date of the new policy is no later than the maturity date of the original policy)

There are three situations in which a withdrawal from an annuity before age 59½ will not be penalized with the 10 percent tax:

1. The contract owner dies. 2. The contract owner becomes disabled. 3. The withdrawal is taken in substantially equal payments over the owner's life.

In accordance with Section 1035 of the Tax Code, all the following exchanges are permitted on a tax-free basis EXCEPT A universal life insurance policy exchanged for a whole life insurance policy. A deferred variable annuity for an immediate fixed annuity. A fixed deferred annuity for a universal life insurance policy. A variable life insurance policy exchanged for a deferred fixed annuity.

A fixed deferred annuity for a universal life insurance policy.

Which of the following best explains why Section 1035 of the Tax Code does not permit a tax-free exchange of an annuity for a life insurance policy?

Allowing a tax-free exchange of an annuity for life insurance would enable taxable annuity gain to escape taxation via the life insurance death benefit.

Which statement about group insurance is NOT true? The employer owns the policy, holds the master policy, and often pays the entire premium. The employees are the individual insureds. Employee contributions are disallowed. The amount of insurance coverage provided for each employee is typically some percentage of his or her salary.

Employee contributions are disallowed.

When owned by non-natural entities like a corporation, the accumulating values in a deferred annuity contract are taxed in which one of the following ways?

Income tax is payable on the annual increase in the contract's value.

For estate tax purposes, what is the value of any life insurance policy a person owns at his or her death?

It is generally includible in the valuation of his or her estate.

Which of the following sections of the Tax Code deals with the exchange of life insurance policies and annuities?

Section 1035

To avoid being recognized as a modified endowment contract (MEC), a life insurance policy must meet the 7-pay test. Which one of the following most correctly describes the 7-pay test?

The 7-pay test applies specifically to the premiums paid into a contract during its first seven years. If this amount exceeds the net level premiums that would have been required to produce a paid-up policy after seven level annual payments, then the policy is a MEC.

Sally is a 25-year-old clerk employed by Acme, Inc. Under Acme's employer-pay-all group life plan, Sally's coverage is $60,000. The premiums for what portion of that coverage are taxable to Sally?

The cost of the first $50,000 of coverage is tax exempt for employees. Because Sally has $60,000 of coverage, $10,000 ($60,000 - $50,000) is taxable to her.

Interest that accumulates on funds paid into deferred annuities is taxed in which of the following ways?

The funds are not taxed while they remain in the annuity.

The IRS has identified three situations in which pre-59 ½ annuity withdrawals are not penalized. The IRS does not impose the 10 percent penalty if the withdrawal is made for any of the following reasons, EXCEPT:

The owner can establish financial hardship.

Which statement about death benefits paid to a beneficiary under a group life insurance plan is NOT correct? Taxation of death benefits paid under a group plan is the same as that of individually owned policies. They are fully tax exempt. They are tax exempt if paid in a lump sum. If paid under a settlement option, interest on the payout is taxable to the beneficiary.

They are fully tax exempt.

Which one of the following most accurately describes the income tax treatment of life insurance death benefits received by a terminally ill insured under the accelerated benefits rider?

They are generally income tax free.

Which one of the following most accurately describes how annuities owned by non-natural entities (corporations, for instance) are taxed?

They are taxed differently than personally owned annuities are taxed.

Corporate owned life insurance

a business life insurance plan that typically covers lower level employees who are insured for the benefit of the corporation. Such a plan is usually reserved for very large corporate employers or organizations. Under a COLI plan, the corporation takes out and owns individual policies on individual employees. It names itself as the beneficiary and at the death of the individual employee, the company receives the benefit.

annuity

a cash contract between a person (the annuity owner) and a life insurance company (the annuity insurer). Set up to accumulate or distribute a sum of money

modified endowment contract

a category of life insurance policy that fails to meet the 7 pay test imposed the federal government.

qualified retirement plan

a formal retirement plan set up by an employer to provide its employees with future benefits. It does so in a way that meets certain IRS- imposed requirements. By meeting these qualifying standards, the plan is granted advantageous tax treatment. Such tax treatment favors both the employer and the employees

group life insurance

a life insurance policy that covers multiple non-related people and may not discriminate against rank and file employees. To ensure this does not occur: The plan must benefit at least 70 percent of all employees or At least 85 percent of the employees who participate in the plan must not be key employees

Tax sheltered annuity (TSA)

a retirement plan reserved for non-profit organizations and their employees. Both employer and or employee contribute funds into the plan. The funds are directed into individual accounts set up for each participating employee.

universal life insurance policy

an extremely flexible life insurance policy in which the policy owner can, within certain limits increase premiums, reduce premiums or pay no premiums. Similarly the policy owner can increase the benefit paid at death (subject to insurability) or can decrease it. The three factors central to the policy (mortality, expenses, and interest) are separate elements.

natural persons

an individual- a parent, spouse, or partner in a business relationship

nonqualified annuities

annuities that are not used to fund a qualified plan such as an IRA or 403b plan

qualified annuity

annuities used to fund a qualified plan; they are tax recorded.

transfer for value rule

applies when life insurance policies are sold or transferred to another party for valuable consideration. In such cases the beneficiary may be subject to income tax when the death benefits are paid.

partial surrender

in a permanent (non-universal) life policy, a partial surrender is the actual surrendering of a portion of the policy. The death benefit under a partial surrender is reduced proportionately by the amount of the surrender.

What are policies that do not meet IRC Section 7702's definition of life insurance generally called?

modified endowment contracts (MECs)

accelerated benefits rider

pays out part or all of the policy's face value while the insured is still living. In this way the benefit is "accelerated". Most of these riders pay less than the full face value as an accelerated benefit.

long term care rider

provides financial support for the costs of medical care, nursing home care, and assisted living care care for extended durations

7 pay test

to be considered a life insurance policy, the policy must meet the terms of this test. Applies specifically to the premiums paid into a contract during its first seven years. If this amount exceeds the net level premiums that would have been required to produce paid up future benefits after 7 level annual payments are made, then the policy is MEC

surrendered

when a policy owner actively cancels the policy.