Life Insurance: Taxation of Life Insurance and Annuities - Premiums and Proceeds

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.

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

Interest

What is the main purpose of the Seven-pay Test?

It determines if the insurance policy is an MEC.

True or False: Money borrowed from the cash value in policy loans is taxable.

False

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.

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

The exclusion ratio

What is the penalty for IRA distributions that are below the required minimum for the year?

50%

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.

Settlement Options

Is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender.

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.

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

Which concept is associated with "exclusion ratio"?

Annuities payments

Which concept is associated with "exclusion ratio"?

Annuities payments Some parts of an annuities payment are taxable, while others are 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".

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 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.

The exclusion ratio

Method of determining which part of an annuity payment is taxable, and which part represents the tax-free return of the annuitant's after-tax cost basis.

Any cash value life insurance policy that develops cash value faster than a seven-pay whole life contract is called a

Modified Endowment Contract.

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

If an annuitant dies during the accumulation period, what benefit (if any) will be included in the annuitant's estate?

Accumulated cash value

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it is

A Modified Endowment Contract.

In life insurance policies, cash value increases

Grow tax deferred.

An individual has been diagnosed with Alzheimer's disease. He is insured under a life insurance policy with the accelerated benefits rider. Which of the following is true regarding taxation of the accelerated benefits?

A portion of the benefit up to a limit is tax free; the rest is taxable income. When accelerated benefits are paid to a chronically ill insured, they are tax free up to a certain limit. Any amount received in excess of this dollar limit must be included in the insured's gross income.

Life insurance death proceeds are

Generally not taxed as income.

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.

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.

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

Not subject to income taxation by the Federal Government.

In which of the following instances would the premium be tax deductible?

Premiums paid by an employer on a $30,000 group term life insurance plan for employees As a general rule, premiums paid for life insurance are not tax deductible. The exception to this rule is when an employer buys group term life insurance for his employees since it is considered a business expense.

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

Exclusion Ratio

Some parts of an annuities payment are taxable, while others are 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.

An applicant buys a nonqualified annuity, but dies before the starting date. For which of the following beneficiaries would the contract's interest 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.

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

Surrendering the annuity for cash

The premiums paid by the employer in a business life insurance policy are

Tax deductible by the employer.

The advantage of qualified plans to employers is

Tax-deductible contributions

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.

If an IRA annuitant dies after the annuity has been paid up, what effect will this have on the annuitant's estate?

The entire value of the contributions and benefits will be included.

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 is true regarding taxation of accelerated benefits under a life insurance policy?

They are tax free to terminally ill insured. When accelerated benefits are paid under a life insurance policy, they are received tax free by terminally ill insured, and tax free up to a limit for chronically ill insured.

True or False: Lump-sum death benefits are not taxable.

True

Under what conditions do life insurance premiums become tax-deductible?

When an employer buys group term life insurance for his employees since it is considered a business expense.

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.

Deferred Compensation Funding

Refers to any employer retirement, savings, or other deferred compensation plan that is not a qualified retirement plan. Funding involves a contractual commitment between the employer and employee to pay compensation in future years. These plans are typically made with selected employees to provide additional retirement benefits.