SD Life and Health Ch 7 Federal Tax Considerations and Retirement Plans

An insured has contributed $12,000 in premiums toward a universal life policy. She decides to cancel the policy and take the cash value of $15,000. What are the tax consequences of this distribution?

$12,000 is a return of after tax dollars (i.e. cost basis), $3,000 is taxable as ordinary income. Upon surrender of a permanent life insurance contract, cash value received is taxable to the extent it exceeds total premium paid (i.e. CSV - cost basis = equity). The equity is taxed as ordinary income.

To be a qualified accelerated death benefit the benefit must meet the following conditions:

-a physician must give a prognosis of 24 months or less life expectancy for the named insured -the amount of the benefit must at least be equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit -the insurer provides a monthly report for the insured showing the amount paid and the amount of benefit remaining in the life insurance policy.

G, being undecided on what to do with $100,000 just received on F's policy, decides to leave the proceeds on deposit with the insurer at interest. The rate being paid is 5%. In one year, what amount will be taxable to G?

5000

All employer-paid premiums for amounts of group life insurance over $__________ are reported as taxable income to the employee.

50000

If a policyowner of a life insurance policy accidently pays in premiums in excess of the MEC guidelines, the insurer can refund the excess within ______ days of the end of the contract year.

60

When a life insurance policy does not pass the ______-pay test, it becomes classified as a MEC.

7

If, as the result of an injury or illness, the insured is deemed to be terminal (i.e., expected to die within 1 or 2 years), what rider added to a life insurance policy would advance a portion of the face value?

Accelerated Benefit (Living Need)

The exception to the rule concerning the non-deductibility of life insurance premiums is:

All employer paid group life insurance premiums (An employer may deduct 100% of the total group life premium it pays as a business expense, but the value of premiums for any employee's coverage in excess of $50,000 must be 'imputed' to the employee and income tax paid on that amount.)

True about MEC (Modified Endowment Contract)

Any funds distributed are subject to a last-in, first-out (LIFO) tax treatment, meaning gains will be taxed before principal.

_________ consist(s) of the amount of premium that is returned to the policyowner if the insurer achieves lower mortality and expense costs than expected.

Dividend

___________ are not taxable because they are considered a return of excess premium.

Dividends

If a policyowner unintentionally pays premiums in excess of the MEC guidelines, the excess premium can be refunded by the insurer within 60 days after the ________.

End of the contract year

The only time a policy loan is taxable is in which of the following situations?

Having the policy lapse with a loan outstanding in excess of cost basis

E has a $10,000 traditional whole life policy with a $4,000 cash value. Premiums paid to date are $3,500. If the policy lapses with a $4,000 loan outstanding, what amount will be taxable as income to E?

If a policy lapses with an outstanding loan greater than the premium paid in, tax must be paid on the difference. In E's case, that's $500 ($4,000 - $3,500).

When would a life insurance policy loan be subject to income taxation?

If the policy lapses when there is a policy loan outstanding which is in excess of the policy's cost basis

In a qualified plan, when are employer contributions tax-deductible?

Immediately after they are made

Cash values within an ordinary straight whole life insurance policy _______ over time.

Increase

The Modified Endowment Contract (MEC) rules were put into place because:

Individuals were overfunding life insurance policies and using them as tax-free investment vehicles instead of a way to protect survivors against the financial cost of one's death

Which of the following scenarios will trigger an income tax due?

Interest earned on dividends left on deposit with the insurer

If a life insurance policy does not pass the 7-pay test, it will be deemed a(n) _________.

MEC

MEC stands for

Modified Endowment Contract. Any funds distributed are subject to a last-in, first-out (LIFO) tax treatment, meaning gains will be taxed before principal. The 7-Pay Test compares the premiums paid for the policy during its first 7 years with the annual net level premiums of a 7-Pay Policy Funds distributed before age 59 1/2 are subject to a 10% penalty on any gains Taxable distributions include cash value surrenders and policy loans

If an accelerated death benefit is in effect, how often must the insurer provide a report showing the amount paid and the amount of the remaining benefit?

Monthly

ERISA sets minimum standards for ________ pension plans.

Private

ERISA requires which of the following?

Qualified plans must meet certain minimum standards

Which of the following policies would be deemed a MEC?

Single Premium Whole Life (Since a single premium life insurance policy clearly does not pass the 7-pay test, it will automatically be deemed a MEC.)

Generally, the payment of an accelerated death benefit is _______ to a recipient if the benefit payment is qualified.

Tax Free

Under the Modified Endowment Contract rules the 7-Pay Test is defined as:

The comparison of premiums paid during the first 7 years with the net level premiums that would have been paid on a 7 year pay whole life of the same death benefit

Joe had $500,000 of life insurance at work. He has an additional $40,000 life insurance policy the company purchased on all employees. His wife is the primary beneficiary and their four children are contingent beneficiaries. Upon Joe's death, what are the tax consequences to his beneficiaries?

The death benefit (face amount) of both individual and group policies received in a lump sum by a named beneficiary(s) is income tax-free.

If dividends are left on deposit with an insurer to earn interest:

The dividend is tax-free, but the interest is taxable

What portion of an employee's pension plan withdrawal is subject to tax?

The entire withdrawal (Since the contributions were pre-tax and all earnings were tax deferred, then the entire withdrawal would be subject to taxation unless one of the exceptions apply.)

Which of the following scenarios will cause the value of a life insurance policy death benefit to be included in the insured's estate?

The insured is also the policyowner

Clayton is asking his life insurance producer about any potential taxation issues related to his $100,000 personal Whole Life policy

The interest on policy loans is not tax-deductible.

Once a policy is classified as a MEC, it will maintain that classification for ____________.

The life of the policy

The life insurance policy cost basis consists of:

The premiums paid in

Participating policy dividends become taxable as income when:

The total amount of dividends received by a policyowner exceeds the total amount of premium he/she has paid

Why are dividends not taxable as income when paid out to a participating policyholder?

They represent a return of a portion of the premium paid

Contributions to a nonqualified plan are:

not tax deductible