taxes, retirement, and other insurance concepts.

qualified plans

- contributions currently tax deductible - plan approved by the IRS -plan cannot discriminate - earnings grow tax deferred - all withdrawals are taxed

a participant contributes more than the maximum amount to her Roth IRA. what kind of tax penalty will she have to pay?

6%

noncontributory plan

an employer pays all of the premiums. under this plan, an insurer will require that 100% of the employees be included.

tax qualified plans- a qualified retirement plan

approved by the IRS which then gives both the employer and employee benefits in deductibility of contributions and tax deferral of growth

what does "liquidity" refer to in a life insurance policy?

cash value can be borrowed at any time

cross purchase plan

each partner involved purchases insurance on the life of each of the other partners. with this plan each partner is the owner, premium-payor, and the beneficiary of the life insurance on the lives of the other partners. the amount of life insurance is equal to each partners share of the purchase price of the deceased partners interest in the business.

key person life insurance does not reimburse a company for which of the following?

for increased pension liability resulting from a key persons death

early withdrawals

from an IRA are subject to income taxation and a 10% penalty, unless one of the following conditions is met: -participant is age 59 1/2 -participant is totally disabled -the money is used to make the down payment on a home (not to exceed $10,000, and usually for first time home buyers) -withdrawals are for post secondary education expenses -withdrawals are for catastrophic medical expenses, or upon death in those cases, the 10% penalty is waived, but the money is still subject to income taxation

the cash value under a MEC accumulates

on a tax deferred basis

policy death benefits

paid under a business owned or an employee provided life insurance policy are received income tax free by the beneficiary (in the same manner as individually owner policies)

certificates of insurance

participants (insureds) evidence that they have coverage

fully insured

refers to someone who has earned 40 quartes of coverage (equivalent of 10 years of work), and is therefore entitled to recieve social security retirement, medicare, and survivor benefits.

social security is funded by a payroll tax imposed on a percentage of an employees income. this percentage is called?

taxable wage base

individual life death benefit/policy proceeds

the life insurance policy death benefit is not subject to income tax even if it exceeds the premiums paid

what is the best reason to purchase life insurance instead of annuities

to create an estate

group insurance

usually purchased by a company for its employees

partially insured

when an individual has earned 6 credits (or quarters of coverage) during the 13 quarter period ending with the quarter in which the insured: - dies - becomes entitled to disability insurance benefits - becomes entitled to old age insurance benefits

contributory plan

when the premiums for group insurance are shared between the employer and employees. under this plan the insurer will require that 75% of employees be included

which of the following types of life insurance policies would perform the function of cash accumulation

whole life

which type of life insurance policy performs the function of cash accumulation

whole life

master policy/ contract

issued to the sponsor of the group which is often an employer. the group sponsor is the policy holder and is the one that exercises control over the policy

summary of Roth IRA

- contribute 100% of income to an IRS specified limit -excess contribution penalty is 6% -grows tax free if account is open for at least 5 years -contributions are not tax deductible (made with after tax dollars) -qualified distribution cannot occur until account is open for 5 years and owner is 59 1/2 - distributions are not tax deductible -payouts dont have to begin by 70 1/2

summary of traditional IRA

- contribute 100% of income to an IRS specified limit -excess contribution penalty is 6% grows tax deferred -contributions are tax deductible (made with pre- tax dollars) -10% penalty for nonqualified distributions (some exceptions) -payouts must begin by 70 1/2

403(b) tax sheltered annuities (TSA's)

a qualified plan available to employees of non- profit organizations under section 501(c)(3) of the internal revenue code, and to employees of public school systems. contributions can be made by the employer or by the employee through salary reduction and are excluded from the employees current income, as any other qualified plan, 403(b) limits employee contributions to a maximum amount that changes annually, adjusted for inflation. the same catch up provisions also apply.

policy loans

are not taxable to a business. unlike an individual taxpayer, a corporation may deduct interest on a life insurance policy loans for loans up to $50,000

a tax sheltered annuity is a special tax-favored retirement plan available to

certain groups of employees only, such as public educators

earned income

means salary, wages, and commissions, but would not include income from investments, unemployment benefits, income from trust funds etc. usually an individuals contributions to a traditional IRA are tax deductible fort he year of the contribution. any eligible person not participating in a qualified retirement plan can take a full deduction from taxable income up to the maximum limit.if you are a participant in another retirement plan, there are income limitation tests to determine how much, if any, of ones IRA contribution is tax deductible. Individuals who are not covered by an employer- sponsered plan may deduct the full amoint of their IRA contributions regardless of their income level.

entity plan

the business itself is obligated to buy out the ownership interest of any deceased or disabled partner.

estate taxation

the death benefit of a life insurance policy may be included in the insureds taxable estate at death and can be subject to the federal estate tax.

two features of group insurance

-evidence of insurability is usually not required -participants (insureds) under the plan do not recieve a policy because they do not own or control the policy

characteristics of concern to a group underwriter

-purpose of the group- the group must be created for a purpose other than to attain insurance -size of the group- the larger number of people in a group, the more accurate the projections of future loss experience will be. -turnover of the group- the underwriter wants a group that has a steady turnover of new employees for older employees. younger, lower risk employees will enter the group as older, higher risk employees leave - financial strength of the group- because group insurance is costly to administer, the underwriter should consider whether or not the group has the financial resources to pay the policy premiums, and whether or not it will be able to renew the coverage

social security benefits and taxes

a federal program enacted in 1935, which is designed to provide protection for eligible workers and their dependants against financial loss due to old age, disability, or death. in other words, social security can be thought of as federal life and health insurance. it is an important factor to consider when determining an individuals needs for life insurance. with a few exceptions, almost all individuals are covered by social security. social security uses the quarter of coverage (QC) system to determine whether or not an individual is qualified for social security benefits. the type and amount of benefits is determined by the amount of credits or QCs a worker has earned. anyone working in jobs covered by social security or operating his/her own business may earn up to a maximum of for credits for each year of work

cash value

the policyowner is not taxed on the annual increase in cash value as this accumulates on a tax deferred basis. if the policyowner withdrawals any of the cash value or surrenders the policy for the cash value, the amount of cash value that exceeds the sum of the total premiums paid will be taxed ti the policyowner as ordinary income (referred to as the cost recovery rule). for example, a life insurance policy has a cash value of $5,000 and the policyowner has paid premiums of $3,000. the taxable portion would be $2,000 of the $5,000 total cash value of the policy.

group life insurance

the premiums that an employer pays for life insurance on an employee, whereby the policy is for the employees benefit, are tax deductible to the employer as a business expense. this includes group. in group term insurance, the premiums that are attributable up to the first $50,000 of life insurance are not taxable to the employee. anytime a business is named the beneficiary of a life insurance policy, or has a beneficial interest in the policy, any premiums that the business pays for such insurance are not tax deductible. therefor, when a business pays the premiums for any of the following arrangements, the premiums are not deductible: - key employee (person) insurance - stock redemption or entity purchase agreement. - split dollar insurance the cash value of a business owned life insurance policy or an employer provided policy accumulates on a tex deferred basis and is taxed in the same manner as an individually owned policy.

individual life premiums

the premiums that an individual pays for his or her own life insurance are considered to be a personal expense and are not tax deductible by the individual

self employed plans (HR 10 or Keogh plans)

to be covered under this plan, the person must be self employed or a partner working part time or full time who owns at least 10% of the business. upon a participants death, payouts can be available immediately if a participant becomes disabled, he or she may collect benefits immediately or the funds can be left to accumulate. when a person enters retirement, distribution of funds must occur no earlier than 59 1/2 and no later than 70 1/2. if withdrawn before 59 1/2 there is a 10% penalty. at any time payments may be discontinued with no penalty and funds can be left to accumulate.

profit sharing and 401(k) plans

under this plan, participants may choose to recieve either taxable cash compensation or have the money contributed into the 401(k), referred to as cash or deferment arrangement plans (CODA). contributions into the plan are excluded from the individual employees gross income up to a dollar ceiling amount. the ceiling amount is adjusted annually for inflation. the plan allows participants age 50 and over to make additional catch up contributions (up to a limit) at the end of the calendar year

Buy- Sell agreements

used to contractually establish the intent of someone else to purchase the business upon the insureds death and sets a value (purchase price) on a business. life insurance is used to fund the buy sell agreement

taxation rules that apply to MECs cash value

- tax deferred accumulations; - any distributions are taxable, including withdrawals and policy loans; - distributions are taxed on LIFO basis (last in, first out) - known as "interest-first" rule. - distributions before age 59 1/2 are subject to a 10% penalty

profit sharing and 401(k) plans

qualified plans where a portion of the companys profit is contributed to the plan and shared with employees. this plan allows employees to take a reduction in their salaries by deferring amounts into a retirement plan. the company can also match the employees contribution, whether its dollar for dollar or on a percentage basis. if the plan does not provide a definite formula for figuring the profits to be shared, employer contributions must be systematic and substantial.

transfer (or direct transfer)

refers to the tax free transfer of funds from one retirement program to a traditional IRA or a transfer of interest in a traditional IRA from one trustee directly to another.

tax considerations for life insurance and annuities

- premiums - not deductible (personal expense) - death benefit - not income taxable (except for interest) - cash value increases - not taxable (as long as policy is in force) - cash value gains - taxed at surrender - dividends - not taxable (return of unused premium; however, interest is taxable) - accumulations - interest taxable - policy loans - not income taxable - surrenders - surrender value - past premium = amount taxable - partial surrenders - first in, first out (FIFO) - settlement options - death benefit spread evenly over income period (averaged). interest payments in excess of death benefit portion are taxable. - estate tax - if the insured owns the policy, it will be included for estate tax purposes. if the policy is given away (possibly to a trust) and the insured dies within three years of the gift, the death benefit will be included in the estate. -NOTE - FIFO APPLIES TO LIFE INSURANCE ONLY. ANNUITIES FOLLOW A LIFO FORMAT.

roth IRAs

a form of an individual retirement account with after tax contributions. in contrast with a traditional IRA, Roth contributions can continue beyond age 70 1/2 and distributions do not have to begin at age 70 1/2. roth IRAs grow tax free as long as the account is open for at least 5 years. roth IRA contributions are not tax deductible. one can contribute 100% of earned income up to a specified maximum of $5,000 as with traditional IRAs. should a tax payer make an excess contribution to a roth IRA, there is a 6% penalty. a traditional IRA can be converted to a Roth IRA if a persons adjusted gross income is less than $100,000. income tax will have to be paid on all deductible contributions and earnings during the year that the traditional IRA is rolled over to a roth IRA, but the 10% early distribution penalty is waived. distributions from a Rothe IRA are not included in taxable income; however, qualified distributions cannot be made prior to the fifth year of the accounts existence. qualified distributions include those made after 59 1/2, those made to the estate or beneficiary at the owners death, those made to a disabled owner, those made to a first time home buyer, or if paying qualified higher educations expenses for the owner, the owners spouse, children or grandchildren. with qualified distributions, there is no 10% penalty for early withdrawals. nonqualified distributions are subject to the same tax consequences as a traditional IRA

individual retirement accounts

anyone with earned income who has not attained age 70 1/2 can have an IRA. an individual can contribute 100% of earned income up to a specified amount (currently $5000). a married couple could contribute a specified amount that is double the original amount, even if only one person had earned income, but each must maintain a seperate account not exceeding the individual limit. a married couple could contribute $10,000 per year to two seperate IRA's. the excess contributions penalty is 6% until withdrawn.

disability benefits

available for the fully insured worker who becomes totally or permanately disabled prior to reaching age65. social security benefits are extremely difficult to qualify for as they require the covered worker to be unable to engage in any substantial, gainful enployment, regardless of what the persons predisability occupation or income was. the disability must be expected to last for at least 12 months or be expected to end in the workers death. there is also a 5 month waiting period before benefits begin. no benefits are payable for partial disability. the spouse and dependant children of a disabled worker may also qualify for disability benefits. as with the retirement benefits, these amounts are usually equal to 50% of the disabled workers PIA

modified endowment contracts (MECs)

following the elimination of many traditional tax shelters by the tax reform act of 1984, single premium life insurance remained as one of the few financial products offering significant tax advantages. consequently, many of these types of policies were purchased solely for the purposes of setting aside large sums of money for the tax deferred growth as well as tax free cash flow available via policy loans and partial surrenders. to curtail this activity and determine if if an insurance policy is overfunded, the IRS established what is known as the 7- pay Test. the cumulative premiums paid during the first 7 years of this 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 all life policies are subject to the 7 pay test, and at any time there is a material change to a policy (any increase in the death benefit), a new 7 pay test is required. any life insurance policy that fails a 7 pay test is classified as a modified endowment contract (mec), and loses the standard tax benefits of a life insurance contract. the death benefit recieved by the beneficiary is tax free.

conversion privileges

if an employee terminates membership in the insured group, the insured has the right to convert to an individual whole life policy without evidence of insurability at a standard rate based upon the insureds attained aged.

nonqualified plans

- contributions not currently tax deductible - plan does not need IRS approval - plan can discriminate - earnings grow tax deferred - excess over cost basis is taxed

a 401(k) plan may be arranged as

- pure salary reduction plan -bonus plan -reduction plan under the bonus or thrift plan, the employer will contribute a certain amount or percentage for each dollar contributed by the employee; however, employee contributions are not always required. plans permit early withdrawal for specified hardship reasons such as death or disability. loans are also permitted in certain instances up to 50% of the participants vested accrued benefit or $50,000

eligibility requirements for self employed plans ( HR 10 or Keogh)

-must be at least 21 years of age -has worked for a self employed person for one year or more -worked at least 1000 hrs per year (full time) -the employer must contribute the same amount of funds into the employees account as he contributes to his own account

permanent life features vs. tax treatment

-premiums = not tax deductible -cash value exceeding premiums paid = taxable at surrender -policy loans = not income taxable -policy dividends = not taxable -dividend interest = taxable in the year earned -lump-sum death benefit = not income taxable

policy loans

a loan from the cash value of a life insurance policy is not taxable to the policyowner. an individual cannot receive a tax deduction for interest paid on a life insurance policy loan.

rollover

a tax free distribution of cash from one retirement plan to another. generally IRA rollovers must be completed within 60 days from the time the money is taken out of the first plan. if the distribution from the first plan is paid directly to the participant, 20% of the distribution must be withheld by the payor. the 20% withholding of funds can be avoided if the distribution is made directly from the first plan to the trustee or administrator/custodian of the new IRA plan. this is known as a DIRECT ROLLOVER.

retirement benefits

begin when a worker has earned the required work credits (40 calendar quarters or 10 years of work), reaches age 65. reduced benefits are available at age 62 (approximately 80% of the benefits that would have been payable at age 65).

in a direct rollover, how is the money transferred from one plan to the new one?

from trustee to trustee

primary insurance amount (PIA)

the amount of retirement benefits a worker will recieve under social security, and is based on the workers average earning, the workers age at retirement, and any additional earnings the worker makes after retirement. in addition to the worker, the workers spouse and dependants (children under 18 or disabled prior to age 22) also qualify for retirement benefits. these dependant benefits are equal to 50% of the workers PIA. the amount of social security benefits will be reduced for an individual under the full retirement age who continues to work and earns more than a specific amount thay is adjusted periodically.

characteristics of qualified plans

-designed for the exclusive benefit of employees and their beneficiaries -are formally written and communicated with the employees -use a benefit or contribution formula that does not discriminate in favor of the prohibited group- officers, stockholders, or highly paid employees -are not geared exclusively towards the prohibited group -are permanent -are approved by the IRS -have a vesting requirement IF THE general requirements for qualified plans are met, the following tax advantages apply: -employer contributions are tax deductible and are not taxed as income to the employee -the earnings in the plan accumulate tax deferred -lump sum distributions to employees are eligible for favorable tax treatment

partnership buy- sell agreements

allow the surviving partner or partners to purchase the deceased partners share of the business from the deceased's family. a buy sell agreement can either be a cross-purchase plan or an entity plan.

survivor benefits

death benefits paid to the workers survuving spouse and dependant children under specified circumstances. a lump sum burial benefit of $225 is available for a spouse living with the worker at the time of death, or a spouse or child who is eligible for social security in the month of the workers death. monthly income payments may also be paid to the following in the event of a fully insured (covered) workers death: - surviving spouse, limited benefits available at age 60, full benefits payable upon reaching retirement age - surviving or divorced spouse, if caring for inor children under age 16 or disabled children, sometimes called a parents benefit. once the minor reaches age 16, the parent is not eligible for social security benefits again until retirement or age 60 (blackout period) - dependants parents, age 62 or older. - unmarried children under age 18, or up to age 19, if full time high school students

executive bonus (also known as IRS section 162 plan)

is an arrangement where the employer offers to give the employee a wage increase in the amount of the premium on a new life insurance policy on the employee. the employee owns the policy and therefore has all control. since the employer treated the premium payment as a bonus, that amount is tax deductible to the employer and income taxable to the employee. it is assumed that if the employee was not willing to accept these conditions, the employer would not provide the benefit.

a unique benefit life insurance has over other types of insurance

it performs the function of cash accumulation

qualified retirement plans

most qualified plans provide that a 10% penalty be assessed if the individual attempts to take out money prior to the IRS retirement age of 59 1/2. many will also mandate that distributions must begin by age 70 1/2 in order to avoid penalties. it is important to note that contributions into qualified retirement plans is voluntary and may be ceased without penalty so long as the monies are left to accumulate (or moved into another qualified account) until retirement.`

IRA contributions

must be made in cash in order to be tax deductible. the money invested in the account can be used to buy stocks, bonds, mutual funds or annuities. the money used for IRA contributions cannot be used to purchase life insurance policies or collectibles such as art, antiques, or stamps. the current annual maximum IRA contribution is $5,000. taxpayers who are age 50 or older are entitled to make additional catch- up contributions. currently, the catch- up amount is an additional$1,000 per year

rollovers and transfers

ways to move monies from one qualified retirement plan to another qualified retirement plan.