iNSURANCE Planning
Gina and Jacque moved into their first new home. They threw a housewarming party and invited a few family and friends. They also invited some of their new neighbors. One of the guests tripped on a stair that was in need of repair and broke her wrist catching herself during the fall. Which coverage under their homeowner's policy will cover the guest's medical expenses? A. Coverage A. B. Coverage B. C. Coverage E. D. Coverage F.
D. Coverage F. Coverage F is for medical payments to others. Stupid trick "They have fallen and can't get up". A is incorrect. Coverage A covers damage to the dwelling. B is incorrect. Coverage B covers unattached structures. C is incorrect. Coverage E is for personal liability, which may come in handy if their new neighbor decides to sue them for the injury.
Which of the following accurately reflect(s) the taxation of an annuity owned by a decedent?
Deferred interest is subject to Income in Respect to a Decedent (IRD) Annuities are a contract and as such avoid probate and pay proceeds to a named beneficiary. Accumulated interest income is taxable. IRD is estate and income taxable, but the income tax will be offset by estate tax paid.
On homeowner policy forms where other structures are covered, the coverage is usually what percent of the dwelling?
On homeowner policy forms where other structures are covered, the coverage is usually 10% of the dwelling.
Where no-fault auto insurance is involved, which of the following is a correct match?
Verbal threshold: Law suits may be allowed when there is a fatal injury. There is no "pure no-fault" in existence in any state in the U.S. Modified no-fault allows suits when verbal and dollar thresholds have been crossed. Dollar threshold is damage occurring above a certain amount, not a limit to actionable compensatory amounts.
Your client is considering the purchase of a Variable Universal Life (VUL) policy and asks for your advice about this type of insurance. Which of the following is NOT a feature of this type of policy?
A VUL policy is unbundled allowing for option "A" and it is variable, allowing for options "B" and "C." Under no circumstances does a variable policy guarantee cash value. It will, however, guarantee a minimum death benefit as long as premiums are paid.
Which of the following accurately reflects the use of split-dollar life insurance in a business setting? I. It can be a fringe benefit to an employee. II. Insurance premiums are usually split between the employer and the employee (insured). III. It may be used to fund a buy-sell stock redemption agreement.
All these statements are correct. Split dollar life insurance is an arrangement where an employee and employer generally share the premium cost and cash value for death benefit of a life insurance policy covering the life of the employee.
Ron asks a CFP® professional, Tara, to help him analyze his disability insurance need. Ron is age 35 and in good health. Which of the following represents the least important information for Tara to obtain to assist Ron with the analysis? A. Ron's existing disability coverage. B. Ron's existing emergency fund. C. Ron's existing medical insurance coverage. D. Ron's current income level.
C. Ron's existing medical insurance coverage. Disability insurance sufficiency analysis requires consideration of multiple factors. These factors include financial needs, existing coverage, and current levels of income. Health insurance coverage is the least relevant coverage in performing a disability insurance sufficiency analysis.
Your client, George Wu, owns a great deal of fine art and antiques. He wishes to know, in such an instance when fine arts or antiques are insured under a homeowners policy by an endorsement, how is the coverage written?
Coverage is usually provided on an appraised value. Fine arts and antiques are generally insured on a homeowners policy with an endorsement known as a "personal articles floater" which is a form of Inland Marine insurance. This coverage is provided on an appraised value.
What is one characteristic of a Comprehensive Personal Liability (CPL) policy?
It may be part of a standard ISO homeowners policy or a stand-alone policy. CPL policies are never used to cover Errors and Omissions types of coverage requirements, nor are they used to cover business pursuits.
Professional liability contracts which provide protection in cases where substandard conduct presents the possibility of bodily injury, is known as: A. CPA liability insurance. B. Errors and omissions insurance. C. Malpractice insurance. D. Lawyers professional liability insurance.
Malpractice insurance. (Malpractice covers bodily injury.) CPA liability, fiduciary liability and even lawyers' liability are specializations of Errors & Omissions coverage involving loss or damage of property or money.
Chalene just graduated from grad school, is starting her first year as a lawyer, and moved into her first apartment. Since she has never lived on her own, she will be purchasing all new furnishings along with a new TV and surround sound system. She is a little concerned about her things since she found out her neighbor downstairs likes to grill on the patio every night, and often leaves the barbeque unattended. What can Chalene do to provide some protection for her belongings?
Purchase an HO-4 policy. The apartment is a rental, it would have stated she purchased her apartment if she did. While it may be good to speak with the manager and the neighbor, it will not provide any protection of her belongings. HO-4 policy covers renters belongings. HO-6 policy is for condo owners.
The policy where there is an unbundled premium and the client selects the investments is known as:
Universal policies provide for unbundled premiums. Variable allows policy owners to select investments. Variable Universal Life (VUL) allows for both.
Which one of the following accurately describes the characteristics of group term life insurance?
The minimum size group is 10, unless specific requirements are met. Option "B" - Medical exams may not be required for group term. Option "C" - Coverage amounts may be (and many times are) based upon salary level, not job classification and length of service. Option "D" - Payouts are almost always made in lump sum payment, unless otherwise specifically requested by the beneficiary.
In the Commercial General Liability contract, which of the following parts does not belong? Coverage A, bodily injury and property damage liability. Coverage B, personal and advertising liability. Coverage C, medical payments. Coverage D, other structures.
There is no "other structures" coverage on a CGL contract.
Non-forfeiture rights of policyholders guarantee that there will be a:
Cash value. Non-forfeiture rights (or provisions) arrange an orderly legal structure to assure monies paid on an insurance policy are not simply absorbed by the company without recourse in the event that an insured decides to terminate coverage. Two other such provisions include "reduced paid-up" and "extended term."
Your client needs additional insurance. He already has several large permanent policies with your company. Which of the following dividend options should you advise your client to use on his existing policies if he was just told that the new policy he is applying for can be issued, but will be heavily rated? One-year term option. Paid-up additions option. Extended term option. Reduced paid-up option.
Due to the rating, paid-up additions is a dividend option that represents an inexpensive way to add coverage without concern to health risks or ratings. Option "A" is generally NOT the best choice because the client is in poor health (highly rated) and one-year term (or annual renewable term) will be very expensive and Options "C" and "D" are non-forfeiture provisions.
Your client, John Kent, purchased a limited payment whole life policy 15 years ago. He would like to stop paying the premiums on his policy, but continues to need the same amount of insurance. If he did so, which one of the following is a non-forfeiture option he could use?
Extended term insurance. An extended term insurance is correct because extended term insurance is the only choice that is a non-forfeiture option that fits his needs. Option "A" (Reduced paid-up insurance.) - Although this is a non-forfeiture provision, the amount of insurance coverage would be reduced. Option "C" (Installments for a fixed period.) is a settlement option, and Option "D" (One-year term.) is a dividend option.
An HO-3 policy (Special form "open perils") is also known as an "all risks policy". It covers all losses except those specifically named as exclusions in the policy. If there are NO endorsements, which one of the following perils is excluded?
Flood is excluded from homeowners. Remember, water damage done by water coming from the sky down (as in rain) is covered, but water coming from the ground up (as in flood) is not covered. It should be noted that personal property/contents are covered on a named perils basis in an unendorsed HO-3 policy.
Jerry Rivers owns a $250,000 level-term life policy which he purchased five years ago. He has paid premiums of $400 per year for the past five years. He also owns a $125,000 whole life policy which he purchased fifteen years ago. He has paid premiums of $2,000 per year for the past 15 years, and now the policy has a cash surrender value of $40,000. Over the years, the whole life policy has paid cash dividends to Jerry. The cumulative dividends paid to Jerry since inception totals $5,000. Jerry has decided to cancel his $250,000 level-term policy. Which statement is true?
Jerry would have NO taxable gain. There is no cash value on a term policy; therefore, there is no taxable gain upon surrender of this policy.
Jennifer Anton was named by her husband, John Anton, as irrevocable beneficiary of his life insurance policy based on a court order. John would now like to borrow from the policy's cash value. What right does John have to the cash value?
John can only borrow from the cash value with Jennifer's written approval because she has a conditionally vested interest in the policy. Irrevocable beneficiaries have all of the rights of the policy owner. In this case, the insured must secure permission from the irrevocable beneficiary with regard to any activity or dispositive change in the policy.
This particular type of life insurance replacement may be achievable through use of a conversion privilege that is generally available on the original policies.
Replacing term insurance with cash value insurance. Conversion privileges are generally part of the term insurance policy that allows them to be changed over to cash value insurance without proof of insurability.
Steven just bought his 16-year old son a $1,200 used van with 125,000 miles on it. With respect to collision coverage, what is the most appropriate risk management technique?
Retain. Steven should not purchase collision insurance due to the low amount at risk ($1,200) and the high cost of the insurance.
Mrs. Ketchenbaum owns a life insurance contract on her life that is a modified endowment contract. If Mrs. Ketchenbaum dies, which of the following statements is correct concerning the tax consequences of paying the death benefit to the designated beneficiary?
The beneficiary receives the death benefit free of income tax but the death benefit is includible in Mrs. Ketchenbaum's gross estate for estate tax purposes. Life insurance contracts, even a modified endowment contract, acts as a life policy in that there are NO income taxes levied on the proceeds to the beneficiary, while the proceeds MUST be included in the ESTATE value of the Decedent for Calculation of the GROSS estate.
A client recently purchased a new home from a builder for $150,000 including the lot valued at $40,000. How much insurance would you recommend that your client purchase to cover full replacement of the house in the event of a loss?
This is the value of the entire package minus the value of the land (e.g., $150,000 - $40,000 = $110,000). Full replacement cost requires the full value of the property be insured (the house burned to the ground). For partial loss coverage, 80% of the value can be used (some fire or water damage, not a full loss).
Which of the following are uses of term life insurance?
To provide coverage for temporary needs To provide more immediate death protection per premium dollar
The following type of insurance would be described as an unbundled policy where the company selects the places of investment: Universal life insurance. Interest sensitive life insurance. Variable universal life insurance. Adjustable life insurance.
Universal life insurance. In all of these coverages, the monies above and beyond mortality and expenses are invested by the company in its general fund. Only variable life allows the investor to select investments. A universal policy is unbundled. The way this question is asked ("unbundled and selected by the company") points one toward the correct answer of universal life.
Lisa is a condo owner and has an HO-6 policy. She purchased the condo for $400,000. Her HO-6 policy is an open peril policy and has a face value of $360,000. Her contents are covered on a named peril basis with $100,000 in coverage. She also has an 80% coinsurance requirement. A tornado hits the building and completely destroys the roof of the condo. The cost to repair the roof is $50,000. How much would her condo policy cover for the roof damage?
$0. An HO-6 policy does not provide coverage for the building or roof. The building and roof are covered by the condo association policy, which covers all exterior walls and roof. The HO-6 policy covers all interior walls for a condo.
Dave is 46, married and has an annual salary of $60,000. His employer offers group term life insurance coverage equal to 2 times his annual salary. The employer's cost for Dave is $.40 per $1,000 of which Dave pays $.08 per month per $1,000. The Table 1 (Section 79) rate for 45-49 year olds is $0.15 per $1,000. What additional income must Dave include in his taxable income this year resulting from the group term insurance?
$10.80 Dave is paying $115.20 each year for the coverage Dave's calculation: 120,000 / 1,000 = 120 units of coverage x .08 per unit of coverage = 9.6 x 12 months = $115.20 The Table I cost is calculated by subtracting $50,000 (the tax-free amount allowed under Section 79) from the $120,000 actually purchased, dividing the remainder by $1,000, multiplying the Table 1 rate of 0.15 times 12. $120,000 - $50,000 = 70,000 / $1,000 = 70 units of coverage × 0.15 (Table 1 rate) = 10.50 × 12 months = $126 taxable to Dave. So, the Table 1 premium is $126. Subtract the $115.20 already paid by Dave from the $126 Table 1 premium to determine the additional taxable income: $126 - $115.20 = $10.80
Health Insurance Question: Rodney is being admitted to the hospital with a preapproved covered expense for procedures that will cost $12,225. Rodney's policy has a $300 deductible per person. This deductible must be met by two family members. This requirement has been satisfied already this year. The policy also has a $5,000 coinsurance feature with an 80/20 split. What is the amount the insurer will pay for the procedure that Rodney is about to receive?
$11,225 If the deductible has been satisfied, then Rodney has only the 20% of the $5,000 coinsurance amount to satisfy (5,000 x 20% = 1,000). This means that the insurer will cover $11,225 ($12,225 - $1,000).
Becky, age 53, was married to Herman for 16 years before their divorce. Becky has not remarried, and she and Herman had no children. Herman worked for a bottling company for 33 years before retiring last month. Shortly after retiring, he died in a car accident. The earliest Becky could collect Social Security benefits is age:
60 Social Security survivor benefits (widow/widower benefits) are available to a surviving spouse beginning at age 60, whether they are divorced or not. The benefits are available to a former spouse, if the marriage lasted at least 10 years, and the surviving spouse has not remarried.
All of the following require a special endorsement rider or a separate policy for coverage to be effective, except: A house involved in flooding. A house involved in an earthquake. A car involved in flooding. A piece of jewelry valued at $10,000.
A car involved in flooding. Personal auto policies are the only ones that offer coverage for flooding. On a homeowners policy, water damage is covered "from the sky coming down," but not "from the ground coming up."
The best life insurance policy for the payment of federal estate taxes for a 50-year old couple with illiquid assets is:
A joint and last-to-die life insurance policy owned by an irrevocable trust. The "last-to-die" will pay on the second death, and if it is held in a trust, it will not add to the insured estate tax due because it will not increase the taxable estate.
Your client, John Hotas, owns a whole-life insurance policy with a death benefit of $100,000 on the life of his wife Mary. The policy has a cash value of $6,500. The dividends are used to purchase additional paid-up life insurance. Their daughter, Ester, is the named beneficiary. If Mary were to die today, which of the following is true?
A taxable gift of the life insurance proceeds has been made from John to his daughter. Because John OWNS the policy on Mary's life, when Mary DIES and the Proceeds go to Ester, their daughter, as beneficiary, they are considered a GIFT from the policy owner (John) to his daughter. Had Mary OWNED the policy on HER life, the Proceeds would have Passed to her daughter TAX-FREE.
Joe is a CFP® professional and property-casualty agent. Joe's client, Sarah, recently purchased an HO-3 policy on her $500,000 home. This home is Sarah's primary residence. The policy has a 1% deductible and includes a replacement cost rider on her personal property. Sarah recently spent $50,000 of cash and built a stable, unattached to the home, on her property. Sarah's property experienced an earthquake, and the stable was destroyed. How much should Sarah expect to recover from her HO-3 policy? A. $0. B. $45,000. C. $49,500. D. $50,000.
A. $0. Earthquake damage is excluded from HO-3 policies. B is incorrect. If the damage was from a non-excluded peril (such as fire, wind or accident) this answer would be correct. C is incorrect. Sarah's 1% deductible is $5,000 and applies to any loss. D is incorrect. A deductible is applied to any claim, even unattached structure or personal property.
Which of the following life insurance transactions would result in the death benefit being subject to income tax under the transfer-for-value rule? A. Kerri's irrevocable life insurance trust purchases a new universal life policy with Kerri as the insured and her grandchildren as beneficiaries. B. Danny sells an existing $300,000 whole life insurance policy on his life to his former business partner for $60,000. The policy had a gift tax value of $45,000 at the time of the sale. C. Ross buys an 8-year-old $700,000 policy on his life from Mike, his brother-in-law and former business associate, in return for its $110,000 gift tax value. Ross names his wife Anne as beneficiary of the policy. D. Kate sells her son a $100,000 policy on her life for $1,000. At the time of the sale, the policy had a gift tax value of $4,000 and the mother had paid net premiums of $5,000.
B. Danny sells an existing $300,000 whole life insurance policy on his life to his former business partner for $60,000. The policy had a gift tax value of $45,000 at the time of the sale. A is incorrect. Since the ILIT purchased a new insurance policy, this does not represent a transfer-for value. C is incorrect. The transfer of a policy to the insured represents an exception to the transfer for value rule. Therefore, the proceeds will remain income-tax free to Anne. D is incorrect. This represents a "part gift part sale." There has been a gift of $3,000 ($4,000 value of the policy less $1,000 paid by the son), and a sale for $1,000 of a policy worth $4,000. In this example, the transaction will be within the "carryover basis" exception of the transfer-for-value rule, because Kate's $5,000 basis was greater than the $1,000 she received (so there was no gain or adjustment to her basis by the son), and the gift value is greater than the consideration. Where the transferor's basis is GREATER than the consideration received, the transferee carries over the transferor's basis. Here, the son's basis (for purposes of determining gain or loss on subsequent policy transactions) will be the basis he can carry over from that of his mother's, i.e., $5,000. So, in spite of the valuable consideration paid by the son, he will receive the proceeds income-tax free.
Which of the following drivers are likely to have the highest premium for auto insurance? A. Martha, age 20, living at home, commuting to a local college and has a 750 credit score. B. Janice, age 18, living in NYC, working at a night club while going to school and has a 650 credit score. C. Karen, age 30, married and living in the suburbs. She is a new driver since she never needed a car living in the city. She has a 725 credit score D. Naveed, age 35, married, works from home as a computer programmer and has a credit score of 770.
B. Janice, age 18, living in NYC, working at a night club while going to school and has a 650 credit score. Janice has a few things going against her, she is young, lives in the city and has a low credit score. A is incorrect. Martha most likely has the next highest premium due to her age. C and D are incorrect. Both Karen and Naveed are older with good credit scores.
All of the following statements are correct regarding Health Savings Accounts (HSAs) EXCEPT: A. HSAs can be established by self-employed individuals who are covered under a high deductible health plan. TRUE B. The 10% penalty associated with non-qualified distributions from an HSA will be waived once the participant attains age 59½. FALSE C. The tax benefits of HSAs are greatest for highly compensated employees. TRUE D. The balance in an employee's HSA can be carried forward if unused for expenses incurred during the tax year. TRUE
B. The 10% penalty associated with non-qualified distributions from an HSA will be waived once the participant attains age 59½. If a non-qualified distribution is made from an HSA, the distribution will be subject to income tax and a 20% penalty. The penalty will be waived if the individual has attained age 65 (not 59½).
Which of the following definitions of disability used in a group disability income plan is the most restrictive to the employee? A. The inability of the employee to perform each and every duty of his or her own occupation. B. The inability of the employee to engage in any occupation for compensation. C. The inability of the employee to engage in any occupation for which he or she is qualified by training, education, or experience. D. The inability of the employee to engage in his or her own occupation for 24 months and any occupation for which he or she is qualified thereafter.
B. The inability of the employee to engage in any occupation for compensation. The most restrictive definition of disability is "the inability of an employee to engage in any occupation for compensation." A is incorrect. "The inability of the employee to perform each and every duty of his or her own occupation" is the most liberal definition for the employee, since the inability to perform one major duty would constitute a disability. C is incorrect. "The inability of the employee to engage in any occupation for which he or she is qualified by training, education, or experience" is more liberal for the employee than "the inability of an employee to engage in any occupation for compensation." D is incorrect. A split definition of disability is more attractive to an employee than "the inability of an employee to engage in any occupation for compensation."
Extreme Co, a C corporation, has implemented a tax qualified group long-term care insurance plan and a cafeteria plan for its employees. Which of the following statements is correct regarding the group long-term care plan? A. Premiums paid by the company for the long-term care plan are included in the taxable income of the employees. B. The long-term care insurance cannot be included in the cafeteria plan. C. Benefits from the long-term care plan are taxable to the employees. D. The deduction for premiums is limited to 50% of the company's taxable income.
B. The long-term care insurance cannot be included in the cafeteria plan. A is incorrect. Premiums paid by the company for the long-term care plan are excluded from the taxable income of the employees C is incorrect. Benefits from the long-term care plan will be received tax-free by the employees. D is incorrect. There is no such limit on the deduction for long-term care premiums for a corporation.
Charlie and Craig are brothers and business partners. They launched a successful coffee chain, Brother's Coffee, in a non-community property state, three years ago. Brother's Coffee comprises a majority of their assets. Charlie and Craig consulted with Jovan Smyth, CFP® as they were opening their business. Jovan's financial guidance was helpful to them, and he continues to help them with retirement planning for their employees. They wanted to meet with him to determine next steps before deciding if they should franchise their business. Which should be the CFP® professional's course of action? A. Create Wills leaving Brother's Coffee to their alma mater B. Purchase key employee policies on one another. C. Help set up a buy-sell agreement funded with life insurance. D. Gather data on the company and personal financial situations of the brothers.
C. Help set up a buy-sell agreement funded with life insurance. A buy-sell agreement is paramount to protect the business ownership. A is incorrect. The brothers have not given any indication that they have charitable planning goals. B is incorrect. This may offer some protection, but a buy-sell agreement would be more effective. D is incorrect. As this is a long-standing relationship, we can conclude the data gathering has been done. The client is the business, not the owners individually.
Sammy, age 67, purchased a qualified long-term care policy 14 years ago. The policy currently pays him a $125 daily benefit. His adjusted gross income is $60,000, and he has incurred unreimbursed medical expenses of $7,000 this year. In addition, he pays $3,000 per month to stay in a nursing home. Based on this information, the long-term care benefit would be:
Completely nontaxable. Since the policy is qualified, the long-term care benefit received is nontaxable.
Derek Baldwin purchased a 20-year limited payment whole life policy 15 years ago. He would like to stop paying the premiums on his policy. If he does so, which one of the following is a nonforfeiture option he could possibly use?
Extended term insurance. Ideally the insured should simply use dividends to meet premium obligations over the next five years and have a fully paid-up policy. However, this is not one of the choices. Therefore, the best possible answer would be extended term, Option "D". Options "A", "B" and "C" are settlement options.
If a permanent life policy provides a guaranteed option to purchase additional insurance on the original policy, that option will include all of the following features in the new policy, except:
Guaranteed purchase option. Guaranteed purchase options cannot be purchased with guaranteed purchase option provisions. It would be like making the third wish for three more wishes.
Which of the following Homeowners Forms is known as Special Form and provides open peril coverage on both dwelling and appurtenant structures?
HO-1 is almost non-existent basic coverage. HO-4 is renter's coverage. HO-6 is condominium owner coverage. HO-3 is special form coverage with open peril on coverage A and B. HO-5 (not listed) is comprehensive form coverage.
Which of the following statements is correct regarding modified endowment contracts (MECs)? I. The income tax treatment of the death benefit is similar to the income tax treatment of the death benefit of a policy that is not a MEC. TRUE II. Policies issued prior to June 21, 1988 are grandfathered and can never become a MEC. FALSE III. Loans and withdrawals taken from the cash value of the MEC during the insured's lifetime are subject to LIFO basis recovery. TRUE IV. MECs issued on or after June 21, 1988 are not considered insurance for tax purposes because they do not satisfy the 200% test. FALSE
I and III. II is incorrect. Policies issues prior to June 21, 1988 are grandfathered, but they can still become a MEC if they undergo a material change. IV is incorrect. MECs are considered insurance contracts for tax purposes.
Terry Madden purchased a 15-year old compact car with 100,000 miles for his teenage son who recently received his license. Which of the following auto insurance coverages should be included in the policy for this auto? I. Part A - liability coverage. II. Part B - medical payments coverage. III. Part C - uninsured motorist coverage. IV. Part D - damage to insured's auto.
I, II and III only. Being a 15-year old car with such high mileage, there are few insurers who would provide physical damage coverage. The other coverages are necessary.
A lump sum of cash is paid to an annuity with payments to the annuitant slated to begin within one payment interval from purchase and proceeds are invested in a portfolio generating rates similar to current market rates. I have purchased: I. Immediate annuity. II. Variable annuity. III. Deferred annuity. IV. Single premium annuity.
I, II and IV only. Lump sum is single premium. Annuity beginning one payment interval later is immediate (this effectively eliminates Options "III" - deferred annuity), and market rates refers to variable rather than fixed annuities.
Of the following vehicles, which are excluded from coverage from the personal automobile policy? I. Motorcycles. II. Company cars. III. A car borrowed from a friend for one-time use. IV. A vehicle used in auto racing competition.
I, II and IV only. Option "I" - Motorcycles must have their own coverage. Option "II" - Company cars must be covered under a company business auto policy. Option "IV" - Racing vehicles are not covered on personal auto policies.
George, age 45, is the beneficiary of his deceased father's $250,000 life insurance policy. The insurer has requested that he select a settlement option for payment of the proceeds. What factors should he consider before making the election? I. His current income needs. II. His asset management ability. III. His net worth. IV. His tax liability on the $250,000. V. His estate planning goals.
I, II, III and V only. Based on the information given, there is no estate tax (barring an amount above the exemption equivalent) or income tax on the proceeds of the policy. All other factors should be of concern and impact his decision.
Reasons to use life insurance to fund business continuation agreements include which of the following: I. It provides sufficient assets for the buyer to perform on the contract. II. Insurance protects the company and its shareholder because the IRS cannot challenge value of stock if provided in a Shareholders Agreement (SHA). III. The insurance gives the agreement efficacy. No money . . . No deal. IV. The insurance strengthens the commitment of the buyer when it must follow through on the agreement.
I, III and IV only. The IRS may challenge the valuation of stock in business continuation agreements, with or without insurance; the IRS is not bound by any contractual agreement between the company and its shareholders.
Which of the following is true of a Modified Endowment Contract (MEC)? I. No money can be withdrawn from the contract without incurring a 10% penalty. II. Once a contract is a MEC, it remains so even after a 1035 Exchange for a different policy. III. Any withdrawals are made on a LIFO basis. IV. The contract owner can borrow the money out of the policy without incurring the penalty.
II and III only Option "I" is false because once all the earnings are withdrawn and tax and penalty paid on them, the basis is not taxed, nor is there a penalty. Option "IV" is false because even loans from a MEC are taxable and the penalty is applied.
Which one of the following statements about life insurance, endowments, and annuity products and their tax attributes is correct?
If a person purchased a life and 20-year term-certain immediate annuity at age 50, there would be NO premature distribution penalty. Option A is an incorrect statement. Death benefits from a MEC are tax-free to the beneficiary Option B is an incorrect statement. Corporation do not get deferred taxes on annuities. Option C is an incorrect statement. Life insurance owned by a pension plan pays to the plan. The plan benefits paid to employees are taxable distributions. Option "D" is correct because immediate annuities are not subject to a premature distribution penalty tax (equal and substantial payments lasting the greater of 5 years or age 59 1/2 penalty exception covers immediate annuities). The 10% penalty only applies to deferred annuities.
All the following statements describe benefits of a typical buy-sell agreement, EXCEPT: A. It provides liquidity to the deceased's estate for paying death taxes and other debts. TRUE B. It provides for continuation of the business by the surviving owners. TRUE C. It can establish the estate tax value of the business interest in the deceased's estate. TRUE D. It provides the surviving owners with the option to buy the deceased's business interest. FALSE
It provides the surviving owners with the option to buy the deceased's business interest. A buy-sell agreement SHOULD provide for a commitment of the surviving owners to buy the deceased's interest, NOT just an option to buy. The owner wants to be assured that there will be a sale of the interest at the time of death, NOT just an option. The other statements are benefits of a buy-sell agreement.
Jerry Rivers owns a $250,000 level-term life policy which he purchased five years ago. He has paid premiums of $400 per year for the past five years. He also owns a $125,000 whole life policy which he purchased fifteen years ago. He has paid premiums of $2,000 per year for the past 15 years, and now the policy has a cash surrender value of $40,000. Over the years, the whole life policy has paid cash dividends to Jerry. The cumulative dividends paid to Jerry since inception totals $5,000. Jerry has decided to cancel his $125,000 whole life policy. Which statement is true?
Jerry has a taxable gain of $15,000. This gain will be treated as ordinary income. Upon surrendering his whole life policy, Jerry received $40,000 cash value where he had paid only $30,000 - $5,000 (dividends) = $25,000 (basis). $40,000 - $25,000 = $15,000 is treated as ordinary income, taxable in the year it is received.
Your client, Dennis and Daughter, Inc. (often referred to as DAD by the owners) is a C corporation with gross receipts of $3,000,000 for the past four years. The net earnings to the firm for the most recent fiscal year were $120,000. There are two shareholders, Dennis and his daughter, Denise. They have recently had an outside consultant perform a valuation of the firm using the capitalization method and a .10 capitalization rate. Based on this information, Dennis and Denise have decided to execute a buy-sell agreement. Using the above information, answer the following question. All the following would be true in a cross-purchase plan, if Dennis passed away first, EXCEPT: A. Life insurance owned by Denise will not be included in Dennis' probate estate. B. Life insurance and/or disability insurance premiums to fund the agreement are tax deductible as an ordinary business expense. C. Denise would receive an increased cost basis in Dennis' stock equal to the amount paid to redeem the shares from Dennis' estate. D. The transaction side-steps the entity and thus avoids constructive dividend concerns.
Life insurance and/or disability insurance premiums to fund the agreement are tax deductible as an ordinary business expense. Insurance premiums to fund buy-sell agreements in a cross-purchase plan are not tax deductible. In the case of an entity agreement, where the firm owns the policies, the premium would also NOT be tax deductible.
Under the basic approaches commonly in use in the no-fault auto insurance dilemma, which of the following best describes the plan where injured parties do not give up the right to sue, but simply refrain from such action until either a dollar threshold or a verbal threshold is reached?
Modified no-fault coverage is the plan where injured parties do not give up the right to sue, but simply refrain from such action until either a dollar threshold or a verbal threshold is reached.
Insured buy-sell agreements have the following characteristics, except: A. Stock redemptions (entity agreements) increase the cost basis of the surviving shareholders. FALSE B. Insured cross-purchase plans involve shareholders buying life insurance on each other. TRUE C. Parties to a cross-purchase agreement can agree to the purchase of remaining life insurance policies from the decedent's estate. TRUE D. Under a stock redemption (entity agreements) plan, life insurance owned by the corporation on the shareholder's life is not included in the decedent's estate. TRUE
Stock redemptions (entity agreements) increase the cost basis of the surviving shareholders. The cost basis of surviving shareholder does not increase in an "entity" or stock redemption buy-sell, but would increase, in part, in a cross-purchase.
Your client's employer has recently adopted a group universal life insurance plan. The advantages of such a plan for your client typically include all of the following EXCEPT that: It allows employees to borrow or withdraw cash. It provides an opportunity to continue coverage after retirement. The entire premium cost is borne by the employer. It provides flexibility in designing coverage to best meet individual needs
The entire premium cost is borne by the employer. Plans may vary, but "typically" employees also contribute to group life plans. An employee can choose a multiple of their salary to fit their coverage needs. Most companies limit coverage to 3xs salary with no evidence of insurability, and up to 5xs salary with evidence of insurability.
Which of the following statements concerning the choice of an entity versus a cross-purchase partnership buy-sell agreement funded with insurance is FALSE? The use of existing insurance to fund the agreement causes a transfer-for-value problem if an entity agreement is selected, but does NOT cause this problem if a cross-purchase approach is used. A cross purchase should be selected if the surviving partners expect to sell their interests during their lifetimes. An entity approach may solve the affordability problem if one partner is significantly older than the other. An entity agreement becomes more desirable as the number of partners included in the agreement increases.
The use of existing insurance does not cause a transfer-for-value situation in both entity and cross-purchase situations because the entity is presumed the same as the individual in a partnership. (B) is correct because if you do the cross purchase then each owner would have to sell, surrender, or hold onto the policy on the departing (not deceased, but retiring or fired) owner. Also, the departing owner would have multiple policies, each covering the other owners that (s)he would need to do something with. (C) is correct because the if we have owners significantly older than other owners then the young owners will have to pay a lot more in premiums to insure the older owners' lives in a cross-purchase agreement. (D) is correct because the number of policies needed in a cross purchase is N * (N-1).
Which of the following statement(s) concerning the choice of a stock redemption (entity agreement) versus a cross-purchase corporate buy-sell agreement funded with insurance is FALSE? A. The use of existing insurance to fund the agreement causes a transfer-for-value problem if an entity agreement is selected, but does NOT cause this problem if a cross-purchase approach is used. FALSE B. A cross-purchase agreement should be selected if the surviving owners expect to sell their interests during their lifetimes. TRUE C. An entity approach may solve the affordability problem if one owner is significantly older than the others. TRUE D. An entity agreement becomes more desirable as the number of owners included in the agreement increases. TRUE
The use of existing insurance to fund the agreement causes a transfer-for-value problem if an entity agreement is selected, but does NOT cause this problem if a cross-purchase approach is used. Transfer-for-value problems can be created if existing policies are transferred between shareholders of a corporation in a cross-purchase agreement. An exception to transfer-for-value exists for transfers from a shareholder or officer to the corporation (to fund an entity purchase agreement), but not for transfers between shareholders. B) is a true statement because when surviving owners expect to sell their business interest during lifetime, they will prefer a cross-purchase agreement to allow them to increase their cost basis in the business upon the death of one of the owners. C) is a true statement because the business will be the owner, premium payer, and beneficiary of the policies in an entity purchase agreement. Since the business will be paying the high premium on the policy covering the older owner, the other owners are relieved of that financial hardship. D) is a true statement because with an entity purchase agreement only one life insurance policy is needed for each owner. With a cross-purchase agreement the number of policies needed = n(n-1).
