ADBANKER_Chapter 7: Federal Tax Considerations and Retirement Plans

A Tax-Sheltered Annuity may be established and funded by which of the following?

A not-for-profit community hospital association 403(b) plans are established for nonprofit organizations.

All of the following tax-free exchanges of life insurance and annuities are permitted, except:

Annuity to life insurance

A Roth IRA is unique for which of the following reasons?

Contributions are nondeductible and distributions are nontaxable

____________ do not meet requirements of federal law to be eligible for favorable tax treatment. A Nonqualified retirement plans B Qualified retirement plans C Keogh plans D IRAs

Nonqualified retirement plans Nonqualified retirement plans do not meet requirements of federal law to be eligible for favorable tax treatment.

Which of the following is a qualified retirement plan that bases an employee's retirement benefit upon length of service and highest attained salary?

Defined Benefit

Which of the following plans is commonly known as a pension? A 401(k) B Defined benefit C Profit-sharing D Keogh

Defined benefit The company assumes the responsibility for making sure money will be available to fund a pension for retiring workers when a defined benefit plan is in place.

Which is true regarding the taxation of the cash value in a Universal Life Policy prior to withdrawal? A Tax deductible B Tax interpolated C Tax deferred D Tax free

Tax deferred All life insurance cash value accumulations are tax deferred. The primary benefit of Universal Life is the potential of a higher interest crediting rate than the fixed rate in whole life policies.

Sherman is the custodian at an elementary school and participates in its qualified retirement plan. This describes a:

403(b) Tax-Sheltered Annuity

Unless a direct rollover (transfer) occurs, a ______% withholding is required.

20 A rollover is a payment made directly to the IRA owner. The owner has 60 days to deposit the check into a new IRA to avoid taxes and penalties. This type of transaction is reported to the IRS and is only allowed once in a 12-month period. A 20% withholding of funds is required unless a direct rollover occurs.

When may an employer deduct the premiums it pays for an employee's life insurance benefit?

As long as the business does not derive a direct benefit from the policy As long as the insurance death benefit is not payable to the employer when an employee dies, the premiums paid for the life insurance are deductible to the business.

Nancy has an IRA and wants to move her funds directly from one financial institution to another while still maintaining the assets within an IRA account. How many times can she do this?

As often as she likes

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? A Monthly B Annually C Quarterly D Semi-annually

Monthly The insurer is required to provide the report monthly.

All of the following are TRUE regarding qualified plans, except:

Plans can discriminate in favor of highly compensated employees In an ERISA-qualified plan, there can be no discrimination in favor of highly compensated employees.

When an annuitant annuitizes their annuity that has a cost basis in it, the amount of the income benefit payment subject to tax is determined by using the: A Annuity rule B Exclusion ratio C Exception rule D Superannuation ratio

Exclusion ratio The exclusion ratio allows the annuitant to account for the cost basis overtime so that the initial payments are not 100% taxable until all cost basis has been fully accounted for.

When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at _________ tax rates. A Short-term capital gain B Long-term capital gain C Alternative Minimum Tax (AMT) D Ordinary income

Ordinary income When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at ordinary income tax rates

Why are dividends not taxable as income when paid out to a participating policyholder? A To create parity with nonparticipating policies under the tax code B Because they are often the sole source of a policyholders' income C They are paid from a non-profit organization D They represent a return of a portion of the premium paid

They represent a return of a portion of the premium paid A participating insurance company's dividend consists of the amount of premium that is returned to the policyowner if the insurance company achieves lower mortality and expense costs than expected.

H has an annuity funded with after-tax contributions. So far, H has placed $10,000 into the policy and it is now worth $25,000. If H cashes out the annuity, what is H's cost basis?

$10,000 The amount contributed is after tax dollars and is considered the cost basis.

A public school teacher may contribute part of his or her paycheck income into a ____ plan and defer income taxes on not only the contribution but also the growth in the plan.

403(b) A 403(b) is specifically intended for public school employees and employees of certain other non-profit organizations.

All of the following are characteristics of a 401(k) plan, except:

Post retirement distributions are made federal income tax free Because 401(k) accounts are funded with untaxed contributions, all distributions are fully taxable in the year received.

KEOGH plans have been largely replaced by ________ plans, which have the same contribution limits, but much less paperwork. A 401(k) B SEP IRA C Profit sharing D SIMPLE

SEP IRA KEOGHs have been largely replaced by SEP IRAs, which have the same contribution limits, but much less paperwork.

What is "defined" in a defined contribution plan?

The percentage or amount of an employee's deposits to the plan In a defined contribution plan, the employee chooses how much of their pay to contribute to the plan each payroll period. The employer deducts that amount from the employee's pay before income tax is calculated and remits that amount to the plan's custodian for the benefit of the employee.

To be considered terminally ill, federal law defines a terminal illness as one which is expected to result in the person's death within how many months?

24 months Federal law establishes 24 months as a person's maximum life expectancy to be defined as terminally ill. For the activation of an accelerated death benefit rider, and for the purpose of limiting such claims, insurance companies often define terminal illness as one which would result in death within 12 months.

If a policyowner of a life insurance policy accidentally pays in premiums in excess of the MEC guidelines, the insurer can refund the excess within ______ days of the end of the contract year. A 10 B 30 C 45 D 60

60 Any excess premium can be refunded by the insurer within 60 days after the end of the contract year.

All of the following are true regarding IRA transfers, except: A Funds are directly transferred from one financial institution to another B They can only take place once a year C Transfers are not taxable events D It is a transaction between the same types of plan, such as two IRA accounts

They can only take place once a year An IRA transfer is the movement of funds between the same type of plan, such as two IRA accounts. The money is transferred directly from one financial institution to another. Transfers are not taxable and can take place as often as desired.

An insured has paid $1,000 in annual premiums for her permanent life insurance policy for 12 years. Now upon surrendering the policy she is due to receive $15,000 of cash value. How much of this cash value is taxable?

$3,000 The Cost Recovery Rule states that at surrender, cash values will be recovered tax-free to the extent of the cost basis of the policy. The cost basis is $12,000 (i.e. 12 years x $1,000 annual premium). The $3,000 excess over cost basis ($15,000 of CSV less $12,000 cost basis) is taxed as ordinary income.

A SIMPLE plan is available to companies that have ______ employees or less.

100 A SIMPLE Plan is designed for companies with less than 100 employees. Employee participation is entirely voluntary and there is no minimum participation requirement. SIMPLE plans are much less costly to administer than 401(k) plans, but contribution limits are also smaller.

SIMPLE plans are only available to companies that have ______ employees or less, and must be the only type of plan the company has available for the employees. A 500 B 250 C 100 D 35

100 SIMPLE plans are only available to companies that have 100 employees or less and must be the only type of plan the company has available for the employees. An advantage of a SIMPLE plan is the elimination of high administrative costs.

Concerning eligibility for a 403(b) retirement plan, which of the following would not qualify? A School teacher B School janitor C School principal D Student athlete receiving a scholarship and a stipend

Student athlete receiving a scholarship and a stipend A 403(b) Tax Sheltered Annuity is a retirement plan specifically for public school employees, not students.

Clayton is asking his life insurance producer about any potential taxation issues related to his $100,000 personal Whole Life policy. All of the following are TRUE, except: A The interest that he pays on policy loans is tax-deductible B Since his policy is a personal policy, he cannot deduct the premiums he pays for the policy C Annual increases in the policy's cash value are not taxable at the time they are credited to the policy D Upon surrender of the policy, he will be taxed on any amount by which the cash value exceeds the cost basis (premiums paid) of the contract

The interest that he pays on policy loans is tax-deductible

What type of retirement plan is not required to have a vesting schedule, is not approved by the IRS, can discriminate in favor of highly compensated employees, and can benefit the employer? A A pension plan B An ERISA plan C A qualified plan D A non-qualified plan

A non-qualified plan A qualified plan is not allowed to have those features or requirements. Only a non-qualified plan can.

Which of the following persons may contribute to an HR-10 Keogh Plan? A An unemployed person B A self-employed musician C A corporate executive D An employee of the YMCA

A self-employed musician An HR-10 Keogh plan is designed to provide unincorporated self-employed individuals the opportunity to fund retirement in a tax-advantaged method.

If a non-qualified variable annuity owned for 15 years is surrendered, what is the income tax consequence? A Any amount received in excess of its cost basis is taxable as ordinary income B The amount received in excess of cost basis is taxed as a long-term capital gain C The entire amount received is subject to ordinary income tax D Any amount that represents an excess over cost basis that has been held for over 1 year is treated as long-term capital gain with the balance considered short-term capital gain

Any amount received in excess of its cost basis is taxable as ordinary income The same tax rules apply to both fixed and variable annuities. The funds received in excess of the cost basis are taxable as ordinary income.

How are employer paid premiums on a group life insurance plan treated for tax purposes? A A barter transaction B As an ordinary and necessary business expense C As compensation in lieu of cash D As a personal expense paid on behalf of the employee

As an ordinary and necessary business expense Employer paid premiums on a group life insurance plan are treated as an ordinary and necessary business expense which is why it qualifies for tax deductibility.

In which of the following plans does the company assume all of the investment risk? A Profit-sharing B Defined contribution C Simplified Employee Pension (SEP) D Defined benefit

Defined benefit The company assumes the responsibility for making sure money will be available to fund a pension for retiring workers when a defined benefit plan is in place.

All of the following are characteristics of a qualified retirement plan, EXCEPT:

Employers in private industry are required to establish pension plans Qualified retirement plans receive favorable tax treatment, such as deductible premiums to the employer, pretax or deductible premiums to the employee, and waived penalties for the listed situations. ERISA is a federal law that sets minimum standards for employers who establish pension plans in private industry, but does not require employers to establish a plan.

A person may contribute to a Traditional IRA if they ________.

Have taxable income

If life insurance proceeds are paid to the deceased's estate they may be subject to ________ taxes. A State Income B Probate C Federal Estate D Federal Income

Federal Estate While the death benefit is income tax free, the amount in the deceased's estate may be subject to Federal Estate taxes.

All of the following are defined contribution plans, except: A 403(b) B Profit-sharing C 401(k) D Pension

Pension There are several defined contribution retirement plans available including a 401(k) Plan, a 403(b) Plan, and a Profit-Sharing Plan. Variations of an IRA-based defined contribution plan include the Simplified Employee Pension Plan (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE).

If money is paid when a change of ownership in a life insurance policy takes place, this is generally known as a ____________. A 1035 Exchange B Transfer for value C Life settlement D Viatical settlement

Transfer for value A transfer for value takes place when money is paid for a change in ownership.

Employer-paid premiums for employee group term life do not constitute taxable income to the employee for coverage up to ___________. A $25,000 B $40,000 C $30,000 D $50,000

$50,000 Employer-paid group life insurance premiums for coverage up to $50,000 are not taxable as income to the employee.

A $500,000 policy is sold for $50,000. After the sale, the new owner pays $10,000 in life insurance premiums while the insured is alive. Upon death of the insured, how much of the death benefit is taxable? A $440,000 B $450,000 C $500,000 D $60,000

$440,000 A $500,000 policy is sold for $50,000. After the sale the new owner pays $10,000 in life insurance premiums while the insured is alive. Upon death of the insured $60,000 ($50,000 + $10,000) of the death benefit is received income tax free to the beneficiary while $440,000 is taxable ($500,000 - $60,000).

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? A $6,000 B $4,000 C $3,500 D $500

$500 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).

A SIMPLE plan may be established either as a(n): A IRA or a 401(k) plan B IRA or TSA plan C 401(k) or Keogh plan D TSA or Keogh plan

IRA or a 401(k) plan A SIMPLE plan may be established either as an IRA or a 401(k) plan.

Which of the following plans is designed for employees of non-profit organizations, which includes schools and other 501(c)(3) entities?

Tax-Sheltered Annuity (TSA) A Tax-Sheltered Annuity established under IRC section 403(b) is designed for employees of nonprofit organizations and public schools under which all monies invested and interest earned are tax-deferred until received.

A permanent policy is surrendered for its cash value, and that sum is greater than the amount of premiums paid in. How is the excess taxed? A No tax is due B Taxed as long term capital gain C Taxed as a short term capital gain D Taxed as ordinary income

Taxed as ordinary income Upon surrender, any equity (i.e., amount above total premiums paid) is taxed as ordinary income. The premiums paid are also referred to as 'cost basis.'

All of the following are characteristics of a 401(k) plan, except: A Employees can elect to defer some of their salary into the plan on a pre-tax basis B Typical investment choices for 401(k)s include mutual funds C Earnings on the investments grow tax deferred D Employers must match employee contributions

Employers must match employee contributions Employer matching contributions are up to the employer when the plan is first put into place.

All of the following statements regarding a Modified Endowment Contract are correct, EXCEPT:

If the contract is a MEC, all cash value transactions are SUBJECT TO TAXATION and penalty. Funds are subject to a 10% penalty on gains withdrawn prior to age 59 ½. This is considered a premature distribution. Distributions made on or after age 59 1/2, and distributions paid out due to death or disability, are not subject to the penalty

Which of the following distributions in a life insurance policy is taxable?

Interest paid on a death benefit settlement option Policy loans, cash dividends, and withdrawal of cost basis are not subject to taxation. Interest paid as part of a death benefit settlement option is taxed as ordinary income.

When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at _________ tax rates. A Ordinary income B Long-term capital gain C Alternative Minimum Tax (AMT) D Short-term capital gain

Ordinary income When the annuitant dies during the accumulation phase of the annuity, the beneficiary receiving the death benefit must pay income tax on any gain from the policy at ordinary income tax rates.

All of the following are the benefits of having an employer sponsored retirement plan be ERISA qualified, except:

Plan withdrawals are tax free Employer contributions are immediately tax deductible to the employer at the time the contribution is made. These contributions are not taxable to the employee until withdrawn. Earnings grow tax deferred.

What is the main purpose that IRC section 1035 was enacted?

To allow for continued tax-deferral on any gains in an existing policy when a policyowner moves into a new one The main purpose of section 1035 is to allow for the continuation of tax-deferral from an old policy into a new policy.