Chapter 8Fedeal tax considerations for life insurance and annuties
What is the name for an over funded life insurance policy?
MEC - Modify Endowment Contract
Life insurance death proceeds are A Generally not taxed as income. B Taxable to the extent that they exceed 7.5% of the beneficiary's adjusted gross income. C Taxed as a capital gain. D Taxed as ordinary income.
Generally not taxed as income. - Life insurance death benefits are generally not taxed as income.
In life insurance policies, cash value increases A Grow tax deferred. B Are income taxable immediately. C Are taxed annually. D Are only taxed when the owner reaches age 65.
Grow tax deferred. - Generally life insurance cash values are only income taxed if the policy is surrendered (totally or partially) and the cash value exceeds the premiums paid.
What is the main purpose of the 7-pay test
To determine if life insurance policy is a Modified Endowment Contract
If an immediate annuity is purchased with the face amount at death or with the cash value at surrender, this would be considered a A Rollover. B Settlement option. C Nontaxable exchange. D Nonforfeiture option.
Settlement option. - A settlement option is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender.
What is the general taxation rule for death benefits payable to the beneficiaries of a life insurance policy?
Death benefits are generally not subject to income taxes
What portion of a nonqualified annuity payment would be taxed?
Interest earned on Principal
According to the taxation rules of life insurance policies, how are cash value increases taxed?
Cash value growth is taxed deferred
Why are dividends in life insurance policy not taxable?
Dividends are not considered income tax for tax purposes; they're a return of unused premium
In a direct rollover, how is the money transferred from one retirement plan to a new one?
From trustee and trustee
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? A Section 457 Deferred Compensation Plan B Section 1035 Policy Exchange C Modified Endowment Exchange D 401(k) Plan
Section 1035 Policy Exchange - As long as the funds are transferred intact and the form is filed, taxation is deferred.
An annuitant dies before the effective date of a purchased annuity. Assuming that the annuitant's wife is the beneficiary, what will occur? A The interest will continue to accumulate tax deferred. B The interest will become immediately taxable. C The premiums will increase. D The premiums will decrease.
The interest will continue to accumulate tax deferred. - If the contract holder dies before the annuity starting date, the contract's interest becomes taxable. If the beneficiary of the annuity is a spouse, the tax can continue to be deferred.
When would life insurance policy proceeds be included in the insured taxable estate?
When there is an incident of ownership at the time of death
If the beneficiary of a life insurance policy receives death benefit payments that consist of principal and interest, which portion, if any, will be taxed?
Interest only
If taken as a lump sum, life insurance proceeds to beneficiaries are passed A Part tax-free and part taxable. B Without interest. C Free of federal income taxation. D Tax-deductible.
Free of federal income taxation. - Life insurance proceeds to beneficiaries are passed free of federal income taxation if taken as a lump sum distribution. If the proceeds are taken as other than lump sum, part of the proceeds will be tax-free and part will be taxable. When paid in installments, part of the proceeds contains principal and some interest, so the interest portion is subject to federal income taxation.
Which of the following terms is used to name the nontaxed return of unused premiums? A Surrender B Dividend C Premium return D Interest
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.
All of the following are TRUE of the federal tax advantages of a qualified plan EXCEPT A Funds accumulate on a tax-deferred basis. B Employee and employer contributions are not counted as income to the employee for income tax purposes. C At distribution, all amounts received by the employee are tax free. D Employer contributions are tax deductible as ordinary business expense.
At distribution, all amounts received by the employee are tax free. - Funds in a qualified plan accumulate on a tax-deferred basis; however, at distribution any amount received by the employee will be treated as ordinary income for tax purposes.
What method is used to determine the taxable portion of each annuity payment? A The excise ratio B The annuity to age ratio C The marginal tax formula D The exclusion ratio
The exclusion ratio - The ratio of the total investment in that contract to the expected return is developed to determine the portion of the annuity payment that will be taxable and nontaxable.
Which concept is associated with "exclusion ratio"? A Dividend distribution B How exclusion riders affect an insurance premium C Policy provisions D Annuities payments
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".
Is the death benefit of a life insurance policy taxed on the beneficiary if it received as a lump sum?
No, Lump um benefits are received tax free
If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for ten years, which of the following would be taxable annually? A $10,000 B $7,000 C $3,000 D $13,000
3,000 - If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for 10 years, $10,000 per year would be income tax free (as principal) and $3,000 per year would be income taxable (as interest).
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? A Dependents B Annuitant C Spouse D Charitable Organization
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.
Upon surrender of a life insurance policy, what potion of the cash value will be taxed?
Only the portion in excess of the premium paid
J transferred his life insurance policy to his son two years before his death. Which of the following is true? A The unpaid premiums on the policy will be deducted from J's taxable estate. B Because the policy has been transferred, it will not be included in J's taxable estate. C The entire face value of the policy will be included in J's taxable estate. D The interest portion of the policy will be included in J's taxable estate.
The entire face value of the policy will be included in J's taxable estate. - If a policyowner transfers or gives away a life insurance policy within 3 years prior to his/her death, the entire face amount of the policy will be included in his or her taxable estate.
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? A $50,000 B $18,000 C $15,000 D $3,000
$3,000 - The difference between the premiums paid and the cash value would be taxable. In this example, the difference between the premiums paid ($15,000) and the cash value ($18,000) is $3,000.
What is the main purpose of the Seven-pay Test? A It ensures that the policy benefits are paid out in 7 years. B It guarantees interest minimum. C It determines if the insurance policy is an MEC. D It requires level premium payments for 7 years.
It determines if the insurance policy is an MEC. - The Seven-pay Test determines whether an insurance policy is "over-funded" or if it's a Modified Endowment Contract. In other words, the cumulative premiums paid during the first seven years of a 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.