Taxation of Life Insurance & Annuities

Pam is a vice president employed by Gulf, Inc., where she has $300,000 in coverage under the company's noncontributory group life insurance plan. What portion of that coverage is taxable to Pam? a. $300,000 b. $0 c. $250,000 d. $50,000

c. $250,000 The IRS Table I value of the first $50,000 of employer-paid group life coverage is tax exempt for employees. Employees are liable for income taxes only on the Table I value of coverage exceeding $50,000.

In accordance with Section 1035 of the Tax Code, a deferred fixed annuity may be exchanged on a tax-free basis for all the following types of products EXCEPT: a. a tax-qualified long-term care insurance policy b. a deferred variable annuity c. an immediate fixed annuity d. a whole life insurance policy

d. a whole life insurance policy Section 1035 permits the tax-free exchange of an annuity for a tax-qualified long-term care insurance policy.

What is another name for the annuitization phase of an annuity contract? a. the accumulation stage b. the ownership stage c. the payout stage d. the conservation stage

c. the payout stage The annuitization stage is also called the payout stage, not the accumulation stage.

According to the Health Insurance Portability and Accountability Act (HIPAA), which of the following most correctly describes how accelerated life insurance benefits are taxed? a. Accelerated benefits are not taxable if the insured meets the definition of being terminally ill or chronically ill. b. Accelerated benefits are taxable unless the accelerated benefits are paid out through a viatical settlement. c. Accelerated benefits are not taxable as long as the insurance company certifies the insured as being terminally ill. d. Accelerated benefits paid to the insured are taxable unless the insured can prove financial hardship.

a. Accelerated benefits are not taxable if the insured meets the definition of being terminally ill or chronically ill. HIPAA states that accelerated benefits paid to the insured are not taxable if certain qualifications are met. These qualifications require the insured to meet the definition of terminally ill or chronically ill.

At age 49, Caleb took a $15,000 distribution from his deferred annuity. In addition to paying income tax on the $15,000 withdrawal, what else will Caleb probably have to pay? a. a penalty tax of $1,500 b. no penalty c. a penalty tax of $7,500 d. a penalty tax of $1,000

a. a penalty tax of $1,500 In addition to paying income tax on the $15,000 withdrawal, Caleb also pays a 10 percent penalty, or $1,500.

All of the following statements about the taxation of annuities are correct EXCEPT: a. Interest that accumulates in a deferred annuity is not taxed while the funds remain in the annuity. b. Qualified annuities are taxed no differently than nonqualified annuities. c. An annuity's basis-essentially the sum or premiums paid-is not subject to taxation however it is withdrawn. d. If an annuity owner withdraws funds as full or partial surrenders before the contract annuitizes, then any withdrawn annuity interest earnings are taxable.

b. Qualified annuities are taxed no differently than nonqualified annuities. Basis is not taxable because the premiums that the annuity owner paid into the annuity have already been taxed.

The tax-free exchange of a life insurance policy for an annuity is sometimes called a: a. Section 403(b) exchange b. Section 1035 exchange c. Section 401(k) exchange d. Section 79 exchange

b. Section 1035 exchange Section 1035 of the Tax Code deals with the exchange of life insurance policies and annuities.

Under the life insurance transfer-for-value rule, to what extent are death benefits from a policy sold to another party considered taxable income to the new owner? a. The taxable portion equals the death benefit minus the policy's cash value at the time of the transfer. b. The taxable portion equals the death benefit minus the sum of the initial purchase price and all subsequent premiums paid by the new owner. c. The taxable portion equals the death benefit minus the initial purchase price paid by the new owner. d. The full death benefit is taxable.

b. The taxable portion equals the death benefit minus the sum of the initial purchase price and all subsequent premiums paid by the new owner. In a transfer-for-value policy, taxable gain equals the death benefit minus the new owner's cost basis, which is equal to the initial price paid for the policy by the new owner plus all subsequent premiums paid by the new owner.

All the following statements regarding an employer's group life insurance plan are correct EXCEPT: a. The employer owns the master policy. b. The employees are the insured individuals. c. The amount of insurance coverage provided for each employee is typically some percentage of his or her salary. d. Employee contributions are not permitted.

d. Employee contributions are not permitted. Like all group insurance plans, group life insurance plans may be contributory or noncontributory.

If Sam makes a full or partial withdrawal from his deferred annuity before the contract annuitizes, which of the following statements applies? a. Withdrawals are tax free up to Sam's investment in the contract (i.e., his basis), after which all subsequent withdrawals are fully taxable as a distribution of gain. b. Withdrawals are fully taxable until they equal the contract's gain (i.e., interest earnings), after which all subsequent withdrawals are tax free. c. Withdrawals are fully tax free. d. The taxable portion of the withdrawal is determined after calculating the exclusion ratio.

b. Withdrawals are fully taxable until they equal the contract's gain (i.e., interest earnings), after which all subsequent withdrawals are tax free. Non-annuitized distributions are subject to LIFO rules, which means withdrawals are fully taxable until all gain has been distributed. If the contract is annuitized, then taxable gain is spread out over the annuitant's life expectancy.

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

c. A deferred annuity exchanged for a whole life insurance policy. Section 1035 permits the exchange of any type of permanent life insurance policy for any other type of 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? a. Allowing a tax-free exchange of an annuity for life insurance would result in the life insurance death benefit becoming taxable. b. Allowing a tax-free exchange of an annuity for life insurance would jeopardize the financial strength of insurance companies. c. 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. d. The IRS wants to encourage people to own annuities, not life insurance.

c. 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. Section 1035 prohibits the exchange of any type of annuity product for any type of life insurance product, because to do so would enable taxable annuity gain to escape taxation via the life insurance death benefit.

Which statement correctly describes how corporate-owned deferred annuities are taxed? a. Income taxation of the contract's gain is deferred until distributed, the same as with personally owned annuities. b. Interest earnings are tax deferred and are tax free if the contract is annuitized. c. Income tax is payable annually on that year's gain in the contract. d. They are income tax free, though capital gains tax may be payable when funds are distributed.

c. Income tax is payable annually on that year's gain in the contract. Not only are they not tax free, corporate-owned annuities are not even tax deferred. Corporate-owned deferred annuity interest is taxable in the year earned at the corporate income tax rate, not capital gains rate.

Any after-tax contributions Tom makes toward the cost of his group life insurance coverage are treated in which of the following ways? a. They are subtracted from his taxable income. b. They are added to his taxable income. c. They are subtracted from the imputed income of the employer's contributions on a dollar-for-dollar basis. d. They are added to the imputed income of the employer's contributions on a dollar-for-dollar basis.

c. They are subtracted from the imputed income of the employer's contributions on a dollar-for-dollar basis. Any after-tax contributions Tom makes toward the cost of his group life coverage are subtracted from the imputed income of the employer's contributions on a dollar-for-dollar basis.

Annuity contracts include a provision to pay a death benefit if the owner or annuitant dies before the contract annuitizes. What does this death benefit typically equal? a. the contract annuity amount or the owner's imputed value amount, whichever is greater b. either the contract's accumulated value or the amount of any outstanding loans, whichever is greater c. either the contract's accumulated value or the amount of premium the owner invested, whichever is greater d. either the contract's accumulated value or the amount of premium the owner invested, whichever is less

c. either the contract's accumulated value or the amount of premium the owner invested, whichever is greater The death benefit typically equals either the contract's accumulated value or the amount of premium the owner invested, whichever is greater.

The IRS encourages the use of annuities for long-term retirement savings, which is why it imposes a penalty tax on deferred annuity withdrawals that occur before: a. the annuitant reaches his or her Social Security full retirement age b. the contract owner reaches age 62 c. the contract owner reaches age 59½ d. the contract owner begins collecting Social Security retirement benefits

c. the contract owner reaches age 59½ It has nothing to do with when a person starts collecting Social Security benefits. With few exceptions, non-annuitized withdrawals from a deferred annuity before age 59½ are subject to a 10 percent penalty tax in addition to ordinary income taxation.

Under which of the following circumstances might life insurance policy dividends represent a taxable event? a. when the insured uses them to buy additional insurance b. when paid in cash to the policyowner c. the interest earned on dividends left with the insurer to accumulate interest d. when used to reduce future premiums

c. the interest earned on dividends left with the insurer to accumulate interest While life insurance policy dividends are generally not taxable, interest earned on dividends left with the insurer under the "accumulate at interest" dividend option is taxable in the year credited

What part of employer-funded group life insurance coverage-if any-is tax exempt for employees? a. $0 b. the value of the first $25,000 of coverage c. the value of the first $50,000 of coverage d. the full amount of coverage

c. the value of the first $50,000 of coverage The IRS Table I value of the first $50,000 of coverage is tax exempt for employees. In other words, the imputed value for the first $50,000 of coverage is not taxable to the employee. But the value of any amount over that level of coverage is taxable.

Ben owns a $100,000 policy on his life, which sells to his younger brother, Bart, for $50,000. Bart names himself beneficiary and pays the policy's annual $1,500 premium. Four years after the sale, Ben dies, and Bart receives the policy's $100,000 death benefit. Under the transfer-for-value rule, what is Bart's taxable "gain" on the policy? a. $50,000 b. $6,000 c. $38,000 d. $44,000

d. $44,000 Bart's gain in the policy is $44,000: the $100,000 death benefit less the $50,000 purchase price and $6,000 premiums paid.

In accordance with Section 1035 of the Tax Code, which of the following exchanges is permitted on a tax-free basis? a. an equity-indexed annuity for an equity-indexed life insurance policy b. a variable annuity for a variable life insurance policy c. a market-value adjusted annuity for a whole life insurance policy d. a deferred market-value adjusted annuity for an immediate variable annuity

d. a deferred market-value adjusted annuity for an immediate variable annuity Section 1035 prohibits the exchange of any type of annuity product for any type of life insurance product, because to do so would enable taxable annuity gain to escape taxation via the life insurance death benefit.

With respect to annuities, the basic purpose for the exclusion ratio is to: a. determine the taxable portion of each annuity payment b. determine if annuity payments are taxable c. determine the tax rate to be used in calculating the annuitant's tax liability of each annuity payment d. determine the non-taxable portion of each annuity payment

d. determine the non-taxable portion of each annuity payment Annuities are taxed as ordinary income at the annuitant's marginal tax rate. The exclusion ratio determines the portion of each payment that is excluded from taxation.