Insurance exam review 9. Life Insurance

Using a capital retention calculation, how much life insurance should the client purchase to meet his survivor's yearly income needs ($65,000) so that it will increase with inflation of 6%? HINT: There are only two numbers given. Question options: $650, 000 $1,083,333 $715,000 $1,148,333

$1,148,333 Reason: $65,000 ÷ 6% = $1,083,333 Begin + 65,000 $1,148,333

Cindy purchased a whole life policy 20 years ago. The annual premium is $2,000 a year. She used the dividends to reduce the premium each year. (Dividends paid were $10,000 over 20 years.) If she surrenders the contract for $30,000, what amount of the proceeds will be taxable? Question options: 0 $10,000 $20,000 $30,000

0 Reason: Surrender value $30,000 Premiums billed ($40,000 less dividends ($10,000) $30,000 $ 0

Policy provision which would create a premium loan to pay a premium in default Question options: Paid-up APL Extended term Cash surrender value Grace period

APL Reason: Definition

Tom, a key employee of Action, Inc., participates in a discriminatory plan for key employees. Tom is age 40. He gets $500,000 of group term life insurance. • Table 1 rate = $ .10 per $1,000 per month • Actual premium = $ .09 per $1,000 per month • He actually contributes $ .08 per $1,000 per month. How much is Tom's economic benefit per year for the group term life Question options: $ 60 $108 $120 $480

$120 Reason A key employee in a discriminatory plan must include the higher of the actual cost or the Table 1 cost. In addition, the key employee may not exclude the cost of the first $50,000 of coverage. 0.02* x 12 x 500 = $120 *In this situation, the key employee's economic benefit (income) is the difference between the Table 1 rate ($.10) and the contribution he made toward the insurance ($.08).

An older man owns a life policy with a $50,000 death benefit. He took a $30,000 loan against the policy. Over 10 years, $10,000 in dividends was used to reduce premiums (billed at $4,000 per year). The cash value of the policy is $15,000 (net of loan). If he surrenders the policy, which of the following is true? Question options: $5,000 ordinary loss may be declared. $5,000 ordinary income may be declared. $15,000 ordinary income must be declared. He will incur taxable gain or ordinary loss. $15,000 capital gain must be declared.

$15,000 ordinary income must be declared. Reason: Net Cash Value $15,000 (net of loan) Loan + 30,000 (add loan back) Total cash value $45,000 Less premiums - $30,000 Ordinary income $15,000 * $40,000 billed less $10,000 dividends used to pay premium. The surrender will create ordinary income, not ordinary gain.

A client takes a large loan against his whole life policy. He/she client is concerned about the reduced death benefit. Which dividend option should he/she elect? Question options: Extended term Paid-up additions 5th dividend Reduced paid-up

5th dividend Reason 5th dividend will buy an amount of insurance equal to the amount of the loan. Paid-up additions may or may not be equal to the amount of the loan.

Mrs. Taylor, age 59, is divorced. She has cut her ties with her children. They supported her ex-husband in the divorce settlement. She has met a slightly younger man, also divorced, who is supporting his children and grandchildren due to their financial difficulties. He continues to work, not a problem for her, and is in good health. If she marries him, a good possibility, she plans to do a pre-nup to keep her assets separate. Whatever remains at death she wants to go to her favorite charity. She plans on using her assets to enjoy herself over her life expectancy. She is considering life insurance to benefit him should she die first. What type of policy do you suggest if she is in good health and a non-smoker? Question options: 10-year level term policy A whole life policy Universal life policy paying the minimum premium Annually renewable term insurance policy

A whole life policy Reason: Annual renewable will get increasingly expensive. It is doubtful she will only need coverage for 10 years. Then, she would have to convert the policy in 10 years at age 69. The universal would act much like the annual renewable term (each year more expensive). The whole life would have a guaranteed premium and cash value. She could have a 30-year life expectancy. If he died before her, she could cash the policy in or leave it to her favorite charity.

A client wants to stop paying the premiums on his whole life policy. What are his options? Cash it in Take a reduced amount of paid-up whole life Take a paid-up term (extended term) insurance policy Use APL to cover the premium (if elected by policyholder) Annuitize the cash value

All of the above Reason: All the options are available. The APL option is elected by the policyholder at issue or any time by the policyholder. It creates a loan to pay the premium. The loan is not a demand loan.

Toby Smith bought a universal life policy in 1998. He has paid the minimal premium since 1998. He needs $200,000 more life insurance coverage for a limited period of time. His health is good and he now has enough money to pay more premiums. What would you suggest he do? Question options: If he adds $200,000 of coverage to his existing policy it will become a MEC. Buy a level term policy of $200,000 based on the time element. If he adds $200,000 of coverage to his existing policy, the premium of his existing policy will adjust to his current age. 1035 his existing policy into a new policy with $200,000 more coverage.

Buy a level term policy of $200,000 based on the time element. Reason: If he adds $200,000 of coverage his existing policy may become a MEC. Actually, a MEC, is doubtful because he has been paying the minimal premium and it will not have much cash value. It is cash value that creates a MEC. UL is always adjusting your age. He could 1035 his existing policy into a new policy with $200,000 more coverage, but why? The level term policy fits the need, a limited period of time.

Mr. Vick, age 60, is a widower. He does not plan to get remarried. His children are grown and on their own. As he approaches retirement he is trying to reduce his expenses. He plans to retire in 2+ years and drop all his company benefits. He will elect COBRA to take him to age 65 and Medicare. But, his other benefits including group life (3 times salary) and group disability will cease. Many years ago he bought a $100,000 whole life policy. He has accumulated substantial amount of dividends that are buying additional paid-up insurance. What do you suggest he do if he would like to retain some life insurance and not pay any premium? Question options: Each year surrender enough existing paid-up insurance (dividends are released) and stop paying premium. Cash the policy in and use the proceeds to buy a single premium variable universal life policy. Elect the nonforfeiture provision - reduced paid-up Use future dividends to pay the premium in full

Elect the nonforfeiture provision - reduced paid-up Reason: Cash the policy in and use the proceeds to buy a single premium variable universal life policy." is not a bad idea, but it will trigger an income tax effect and new underwriting. "Use future dividends to pay the premium in full" and "Each year surrender enough existing paid-up insurance (dividends are released) and stop paying premium." would be good answers if he wanted to retain the whole $100,000. With "Elect the nonforfeiture provision - reduced paid-up", the death benefit will be reduced and premiums cease. This question/answer is definitely subjective. Be careful with the word "some".

R.J. is tired of paying premiums on his whole life insurance policy. Besides cashing the policy in, what other non-forfeiture option is available? Question options: He can choose the one-year term rider option. He can exchange (1035) it into a second-to-die policy and avoid the tax on gain. He can let the dividends pay the premium. He can choose the extended term option. He can let the dividends buy paid-up insurance.

He can choose the extended term option. Reason A 1035 isn't a non-forfeiture option. In addition, he would be required to continue making premium payments. The only non-forfeiture option shown is extended term option.

Toby is considering purchasing either a whole life or a variable universal life policy. What would be the most important reason for buying the whole life policy? Question options: He will have a cash value he can borrow from should he need money. He has a low risk tolerance. He must pay premiums until age 100. He will get permanent protection until age 100.

He has a low risk tolerance Reason: Paying premiums until 100 does not sound like the most important reason. Some policies now go beyond age 100. "He will get permanent protection until age 100". and "He will have a cash value he can borrow from should he need money." are true for both whole life and variable. Risk tolerance is the most important factor.

Your client is thinking about buying a new life insurance policy from a new carrier and canceling his old policy. As a CFP® practitioner, what do you suggest? The client should get updated proposals on his existing policies. Then compare proposals for both companies. The client should check out the financial position of both companies. The client should check with the NAIC to find out if the new company is on the watch list. The client should determine if the new carrier uses only agents or brokers to sell policies./li> The client should ask if the new policy will have incontestable and suicide clauses.

I II and III Reason: The method of sale (agent or broker) should have little impact on the policy owner in the long run. All policies have uncontestable and suicide clauses.

Which of the following are life insurance riders? Disability Waiver Provision - Company agrees to waive all premiums due after the insured has become totally and permanently disabled. Conversion Provision - Insured is granted option to exchange term contract for some type of permanent insurance without having to prove evidence of insurability. Accidental Death Benefit - If the death of the insured is caused by an accident, an additional sum equal to the face value of the policy will be paid. Guaranteed Insurability - Insured may purchase additional amounts of insurance at stated intervals without providing evidence of insurability.

I III and IV Reason Conversion provision is not a rider. It's a standard contract provision. (Picky)

What are the reasons an insurance company would send an owner a 1099? The dividends were being held under the dividend option- accumulate with interest. The dividends were being held under the dividend option- paid-up additions The owner cashed in the policy with a basis greater than the cash value The policy was a MEC and the owner made a withdrawal The whole life policy was a MEC and dividends were used to reduce premiums.

I III and IV? Reason: In answer I, the interest is taxable. In answer II, the dividends are not taxable. In answer III, the policy would have been taxable if the cash value exceeded the basis. Answer IV and V are both MEC taxable answers.

Patricia buys a whole life policy. She pays the normal level premium. Which of the following is not true? Question options: She can borrow money from the contract tax free. If she surrenders the contract, the cash value paid to her will be tax-free. If she borrows money from the contract, the loan interest is personal interest and is not deductible. If she dies, the death proceeds are income tax-free.

If she surrenders the contract, the cash value paid to her will be tax-free. Reason: "If she surrenders the contract, the cash value paid to her will be tax-free." is not always true. If the policy has a gain above basis, the gain is ordinary income. Interest on policy loans is no longer deductible. The policy is not a MEC.

Which of the following is true about term insurance? Question options: It can provide permanent protection (30 or more years). It can have a limited amount of cash value. It is usually guaranteed renewable (limited number of years). It is only good for an insured that has a need for a large amount of death benefit.

It is usually guaranteed renewable (limited number of years). Reason: Term insurance is renewable for a period of years.

Many years ago John Little's parents bought a whole life policy for him. When he got married they changed the ownership to him. Face $100,000 Premium paid $10,000 Dividends Buying paid-up insurance He continued to pay the premium ($750 per year) for 20 years). He needs some cash to pay for his daughter's education but he wants to keep the full death benefit of the original policy in force. Current Face $100,000 Dividends Buying paid-up insurance ($25,000 DB and $15,00 CV) Cash Value $35,000 (not including dividends What would be the most cost effective method of getting $10,000 in cash? Question options: Make a loan of $10,000 from the policy Withdraw $10,000 from the policy cash value Surrender paid-up insurance equal to $10,000 of cash value Surrender the policy and buy a new more cost effective policy

Make a loan of $10,000 from the policy Reason: If he makes a loan, the loan will reduce the net death proceeds and the interest on the loan is not deductible. You cannot withdraw $10,000 with a whole life policy. He has to make a loan. If he surrender paid-up insurance, the proceeds will be mainly tax-free and the only the dividend death benefit (DB) will be reduced.

Mr. Williamson purchased a $200,000 universal life policy years ago with a $150,000 guaranteed insurability option (GIO). He will exercise the $150,000 option to increase the death benefit. Will the policy become a MEC? Question options: It may if he increases the death benefit by more than $150,000. Yes, it will become a MEC. It always has been a MEC. No, it retains its grandfather status.

No, it retains its grandfather status Reason: While "It may if he increases the death benefit by more than $150,000." is true, it doesn't answer the question. He is only increasing the death benefit by $150,000, and he does not have to prove insurability. NOTE: Material change may also affect policies issued after 1988.

When Andy purchased a whole life contract, he wanted the death benefit to increase from year to year. Which dividend option did he elect? Question options: Pure life Accumulated with interest One-year term Extended term Paid-up insurance

One-year term Reason: The one-year term dividend option pays a death benefit equal to the guaranteed cash value (which is increasing). Since the death benefit is based on the cash value, it increases yearly. This is true even if the client borrows against the policy. Paid-up insurance is a non-forfeiture option, not a dividend option. It does not increase; the death benefit is fixed. Accumulated with interest isn't truly a death benefit. (Dividends are paid in addition to the face amount of the policy.) Paid-up additions would be a correct answer, but it isn't a choice.

Lilly is comparing the policy provisions, features, and options of two whole life insurance policies. What should be least important to her? Question options: The settlement options The guaranteed cash values of the policy The insurance company rating Whether the carrier pays dividends or not The non-forfeiture options

The insurance company rating Reason: This is a stem-type question asking about policy provisions, features, and options. A company rating is not a provision, feature, or option. The answer must relate to the question.

Under an insured cross-purchase buy-sell agreement, what is the major problem at the death of one shareholder (Tom - owner #1) with five other owner-shareholders? Question options: The sale of the policies Tom owns to the other owners affects taxation of the death benefits. It is cumbersome to get all the money together. The purchase of shares from the estate will cause income tax problems to the estate. The life insurance will be subject to the creditors of the corporation.

The sale of the policies Tom owns to the other owners affects taxation of the death benefits. Reason: When the policies are sold by Tom's estate to the other owners, not the insured, transfer for value problems occur. Please review the 3- person business case example on page 7-6. The deceased's estate gets a step-up in basis, so there should be no income tax problem. The insurance isn't owned by the corporation, so the creditors can't attach the insurance.

Mr. X (age 50), owner and president of X Inc., wants to be bought out by Mrs. T in 15 years. Which type of policy will best fit Mrs. T's needs? Question options: 10-year level term Whole life Annual renewable term Variable life

Variable Life? Reason: The cash value component along with the growth potential of the variable life policy is the best solution for funding a buy-sell agreement. Mrs. T could use the cash value to fund the buy-sell if Mr. X doesn't die. Normally a buy-sell arrangement ultimately becomes a 10- year installment sale. Then the time element becomes more like 25 years (15 + 10). The question is subjective, but Answer A seems like the best choice.

Timmy, age 30, is considering four different policies for his family's needs. Timmy's dad and mother have already died due to health problems. If he makes it to retirement, he would like the policy to meet some of his retirement needs. Lastly, Timmy has a high paying job, but the company is very shaky. Which policy is his best option? Question options: Variable universal Variable universal life Whole life Universal life

Variable Universal Life Reason: Variable universal could meet his family needs, insurability, and retirement needs with flexible premiums. If Timmy pays a higher premium up front (but not a MEC) for a few years, then if the company fails, he could stop paying premiums.

When will the proceeds from a life insurance policy be subject to income tax? Question options: When a client gifts his policy to his ex-spouse When a client gifts her policy to her daughter When a client sells his policy to a viatical company When a client buys her policy from her corporation

When a client sells his policy to a viatical company Reason Gifts are not "transfers for value." When the client buys her policy and the client dies, the death benefits paid to the viatical company will be subject to income tax above basis.

Sue, age 32, is a single mother with two children ages 6 and 8. She makes $46,000 per year. Her employer gives her two times salary (maximum $50,000) group life insurance. She has a minimum amount of debt but very little in the way of assets. Which of the following types of insurance is most suitable for Sue? Question options: 15-year level term Whole life Variable universal life Universal life

Whole Life? Reason: Although she has limited assets and some form of cash value type policy would seem to apply, her need is for substantial amounts of protection. Her ability to pay large premiums seems doubtful on $46,000 raising two children.