Federal Tax Considerations for Life Insurance and Annuities

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.

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.

Which of the following is NOT true regarding policy loans?

1. Policy loans can be repaid at death.- 2. An insurer can charge interest on outstanding policy loans.- 3. A policy loan may be repaid after the policy is surrendered.- 4. Money borrowed from the cash value is taxable.+

Which of the following best describes taxation during the accumulation period of an annuity?

1. The growth is subject to immediate taxation.- 2. Taxes are deferred.+ 3. The annuity is subject to estate taxes only.- 4. The annuity is subject to both state and federal taxation.-

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.

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

From Trustee to Trustee

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.

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Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 1/2.

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.

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?

1. Charitable organization.- 2. Dependents.- 3. Annuitant.- 4. 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.

Traditional IRA contributions are tax deductible based on which of the following?

1. IRA limit.- 2. Owner's income+. 3. How long the plan has been in force.- 4. Owner's age.-

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.

When must and 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 a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an

Modified endowment contract. (MEC) 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.

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.

When contributions to an immediate annuity are made with before-tax dollars, which of the following is true of the distributions?

1. Distributions are nontaxable.- 2. Distributions cannot begin prior to age 72.- 3. There are no distributions.- 4. 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.

Which of the following describes the tax advantage of a qualified retirement plan?

1. Employer contributions are not taxed when paid out to the employee.- 2. The earnings in the plan accumulate tax deferred.+ 3. Distributions prior to age 59 1/2 are tax deductible.- 4. Employer contributions are deductible as a business expense when the employee receives benefits.- Contributions are tax deferred, and earnings on the money in the plan accrue on a tax-deferred basis.

Which of the following statements regarding the taxation of Modified Endowment contracts is FALSE?

1. Withdrawals are not taxable.+ 2. Distributions before age 59 1/2 incur a 10% penalty on policy gains.- 3. Policy loans are taxable distributions.- 4. Accumulations are tax deferred.-

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?

50% 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.

Which of the following is true regarding taxation of dividends in participating policies?

Dividends are not taxable.

In life insurance policies, cash value increases

Grow tax deferred.

What is the 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.

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.

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.

What type of annuity activity will cause immediate taxation of the interest earned?

Surrendering the annuity for cash

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

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.