Federal Tax Considerations for Life Insurance and Annuities Questions

When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income? A Both principal and interest B Neither principal nor interest C Principal only D Interest only

D If a beneficiary receives payments that contain both principal and interest portions, only the interest is taxable 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.

A 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.

Which of the following statements regarding the taxation of Modified Endowment Contracts is FALSE? A Distributions before age 59 1/2 incur a 10% penalty on policy gains. B Policy loans are taxable distributions. C Accumulations are tax deferred. D Withdrawals are not taxable.

D Any distributions from MECs are taxable, including withdrawals and policy loans. All of the other statements are true.

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 become immediately taxable. B The premiums will increase. C The premiums will decrease. D The interest will continue to accumulate tax deferred.

D 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 the owner of a $250,000 life insurance policy died, the beneficiary decided to leave the proceeds of the policy with the insurance company and selected the Interest Settlement Option. If at the time of withdrawal the interest paid was $11,000, the beneficiary would be required to pay income tax on A None, because the beneficiary has not received the death benefit. B $261,000. C $239,000. D $11,000.

D The death benefit is not income taxable; any interest earned is income taxable.

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

D 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.

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 Settlement option. B Nontaxable exchange. C Nonforfeiture option. D Rollover.

A A settlement option is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender.

A policyowner cancels his life policy but instructs the insurance company to transfer the cash value of his policy to an annuity. This nontaxable transaction is called A Premature distribution. B Rollover. C 1035 exchange. D Qualified distribution.

C In accordance with Section 1035 of the Internal Revenue Code, certain exchanges of life insurance policies and annuities may occur as nontaxable exchanges.

Which of the following is used to determine the annuity amounts that are not taxable? A Pro rata ratio B Exclusion index C Market-adjusted annuities index D Exclusion ratio

D The "exclusion ratio" is used to determine the annuity amounts that should be excluded from taxes. During the accumulation phase, the contributions to the annuity have already been taxed. Therefore, the contributions are not taxed during the income period.

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.

A Life insurance death benefits are generally not taxed as income.

An applicant buys a nonqualified annuity, but dies before the starting date. For which of the following beneficiaries would the interest accumulated in the annuity NOT be taxable? A Annuitant B Spouse C Charitable organization D Dependents

B 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.

What is the penalty for IRA distributions that are below the required minimum for the year? A 10% B 25% C 50% D 60%

C If there are no distributions at the required age, or if the distributions are not large enough, the penalty is 50% of the shortfall from the required annual amount.

A 60-year-old participant in a 401(k) plan takes a distribution and rolls it over to an IRA within 60 days. Which of the following is true? A The amount of the distribution is reduced by the amount of a 20% withholding tax. B No taxes are due since the plan participant is over age 59 1/2. C There is a 10% early withdrawal penalty. D The amount distributed is subject to ordinary income tax.

A Distributions from 401(k) plans are taxable as ordinary income in the year of the distribution. However, if the distribution is rolled over to a Traditional IRA, taxes are deferred until the required minimum IRA distributions begin. Since this client actually took a distribution (instead of making a trustee-to-trustee roll over), the distribution is subject to 20% withholding tax.

Which of the following is NOT an allowable 1035 exchange? A A whole life insurance policy is exchanged for a term insurance policy. B A whole life insurance policy is exchanged for a Universal life insurance policy. C An annuity is exchanged for another annuity. D A life insurance policy is exchanged for an annuity.

A The key is that the exchange may not be from a less tax-advantaged contract to a more tax-advantaged contract. "Same to same" is acceptable.

What type of annuity activity will cause immediate taxation of the interest earned? A Surrendering the annuity for cash B Using the contract as collateral for a loan C Changing a settlement option D Failing to make a planned contribution

A One-sum cash surrenders give rise to immediate taxation of the interest earned.

What type of tax is associated with death proceeds from a life insurance policy? A State tax B Income tax C Federal estate tax D Personal tax

C The death benefit or face amount of a life insurance policy may be included in the insured's taxable estate at death and subject to the federal estate tax.

Which of the following best describes taxation during the accumulation period of an annuity? A The annuity is subject to both state and federal taxation. B The growth is subject to immediate taxation. C Taxes are deferred. D The annuity is subject to state taxes only.

C The interest accumulated in an annuity is the tax base, but the taxes are deferred during the accumulation period. The cost base is the premium dollars that have already been taxed and will not be taxed again when withdrawn from the contract.

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 $7,000 B $3,000 C $13,000 D $10,000

B 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).

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase? A Taxes are deferred on withdrawn amounts, but a flat penalty is charged. B Taxes are deferred on withdrawn amounts. C Withdrawn amounts are taxed on a last in, first out basis. D Withdrawn amounts are taxed on a first in, last out basis.

C When money is withdrawn from the annuity during the accumulation phase the amounts are taxed on a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached. After all of the interest is received and taxed the principal will be received with no additional tax consequences.

In a direct transfer, how is money transferred from one retirement plan to a traditional IRA? A From the original plan to the original custodian B From trustee to trustee C From trustee to the participant D From the participant to the new pla

B In a direct transfer, the distribution is made directly from the trustee of the first plan to the trustee or administrator/custodian of the new IRA plan.

Who can make a fully deductible contribution to a traditional IRA? A A person whose contributions are funded by a return on investment B An individual not covered by an employer-sponsored plan who has earned income C Anybody; all IRA contributions are fully deductible regardless of income level D Someone making contributions to an educational IRA

B Individuals who are not covered by an employer-sponsored plan may deduct the amount of their IRA contributions regardless of their income level.

Which of the following is NOT true regarding policy loans? A A policy loan may be repaid after the policy is surrendered. B Money borrowed from the cash value is taxable. C Policy loans can be repaid at death. D An insurer can charge interest on outstanding policy loans.

B Money borrowed from the cash value is not taxable. Policy loans can be repaid at any time, including surrender and death. An insurer can charge interest on outstanding policy loans.

Which of the following is true regarding taxation of dividends in participating policies? A Dividends are taxable in some life insurance policies and nontaxable in others. B Dividends are considered income for tax purposes. C Dividends are not taxable. D Dividends are taxable only after a certain amount is accumulated annually.

C Dividends are not considered to be income for tax purposes, since they are the return of unused premiums. The interest earned on the dividends, however, is subject to taxation as ordinary income.

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.

C 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.

If an annuitant dies during the accumulation period, what benefit (if any) will be included in the annuitant's estate? A No benefits B Policy loans C Accumulated cash value D Full annuity benefit

C If the annuitant died during the accumulation period, the insurer is obligated to return all or a portion of the annuity cash value (values accumulated in the annuity in accordance with contract terms), which will be included in the deceased annuitant's estate.

What is the tax consequence of amounts received from a Traditional IRA after the money was left in the tax-deferred account by the beneficiary? A Capital gains tax on distributions and no penalty. B Capital gains tax on distributions plus 10% penalty. C Income tax on distributions and no penalty. D Income tax on distributions plus 10% penalty.

C If the beneficiary chooses to leave the money in the tax-deferred account until the calendar year in which the owner would have attained age 72, the distributions would be subject to income taxation at the rate at the time of withdrawal.

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 the minimum interest. C It determines if the insurance policy is a MEC. D It requires level premium payments for 7 years.

C 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.

Which of the following is NOT true of Section 1035 Policy Exchanges? A It requires an absolute assignment of the existing policy to the replacing company who surrenders the contract and issues a replacement policy. B It is an IRS Code which permits like kind exchanges of property. C It is typically used when exchanging or replacing a less competitive life policy with a more competitive life policy. D Any exchange made under Section 1035 of the Internal Revenue Code must be completed within 30 days.

D Section 1035 of the Internal Revenue Code does not give a specific time limit to complete such an exchange.

If an insured surrenders his life insurance policy, which statement is true regarding the cash value of the policy? A It is not considered to be taxable. B It is taxable only if it exceeds the amounts paid for premiums by 50%. C It is automatically taxable. D It is only taxable if the cash value exceeds the amount paid for premiums.

D The cash value of a surrendered policy is only considered to be taxable as income if the cash value exceeds the amount of premiums paid for the policy.

An IRA uses immediate annuities to pay out benefits; the IRA owner is nearly 75 years old when he decides to collect distributions. What kind of penalty would the IRA owner pay? A No penalties, since the owner is older than 59 ½ B 10% for early withdrawal C 15% for early withdrawal D 50% tax on the amount not distributed as required

D When immediate annuities are used to pay IRA benefits, distributions must begin no later than age 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.