Life- Chapter 7

Self-Employed Plans (HR 10 or KEOGH Plans)

Available to unincorporated sole proprietors and their eligible employees. Silent partners are not eligible.

Any amount received in excess of its cost basis is taxable as ordinary income

If a non-qualified variable annuity owned for 15 years is surrendered, what is the income tax consequence?

Policy Loans

If a policyowner takes out a loan against cash value of a life insurance policy, the amount of the loan is not taxable. The loan is not taxed as long as the policy is in force.

After-tax

If an annuity is annuitized, then the ___________ investment is recovered income tax-free over the income benefit payment period.

ERISA Qualified Plans

Must benefit employees & beneficiaries May not discriminate in favor of highly compensated employees Must be approved by the IRS Have a vesting requirement

Qualified Plans

Must meet the requirements of ERISA (Employee Retirement Income Security Act), which is a federal law that sets minimum standards for pension plans in private industry.

Corporate-Owned Annuities

No tax benefits when an annuity is owned by a corporation.

Roth IRA

Nondeductible tax-free retirement plan for anyone with earned income.

State College Tuition Plans- 529 Plans

Operated by a state or educational institution.

50

The IRS allow for "catch up" IRA contributions for those age __________ and older.

Cost Basis

The amount of premiums paid into the policy less any dividends or withdrawals previously taken. Any withdrawals in excess of basis will be taxed as ordinary income.

Individual Retirement Accounts (IRAs)

They are not considered "qualified plans". IRAs are described in Section 408 of the Tax Code and have their own set of rules.

24

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?

Life Insurance Transfer for Value Rule

To discourage business transfers of ownership between parties looking to take advantage of the tax free status of life insurance death benefits.

If the policy lapses or is surrendered, any loan amount in excess of cost basis is taxable

Under what circumstance would a policy loan in a life insurance policy be taxable?

The percentage or amount of an employee's deposits to the plan

What is "defined" in a defined contribution plan?

To allow for continued tax-deferral on any gains in an existing policy when a policyowner moves into a new one

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

A non-qualified plan

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?

7-Pay Test

When a contract does not pass the 7-pay test, it will be deemed a MEC. The 7-pay test is a limitation on the total amount that can be paid into a policy in the first 7 years.

Defined Benefit

When an employee receives a fixed and known benefit at retirement, it comes from a(n) ___________ plan.

401(k) or IRA

When establishing a SIMPLE, what two different types of qualified plans must employers choose between?

As long as the business does not derive a direct benefit from the policy

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

Traditional IRAs

Anyone under age 70.5 who has earned income may open an IRA.

Earned income

Anyone under the age of 70 1/2 who has _________ can open up a Traditional IRA.

The policy failed the 7-pay test

If a life insurance policy becomes a MEC, what was the cause?

Exclusion Ration

The way in which taxation of annuities is computed.

Cash Values

A cash value policy will experience increases in the cash value annually. The interest or gains are not taxable at the time they are credited to the policy

Qualifications

A physician must give a prognosis of 24 months or less life expectancy for the named insured.

Not tax-deductible

Any employee-paid group life insurance premiums are __________.

Profit-Sharing and 401(k) Plans

A 401(k) is a defined contribution plan for employees of for-profit companies. It is an elective deferral plan or salary reduction.

Contributions are nondeductible and distributions are nontaxable

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

A not-for-profit community hospital association

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

$50,000

All employer-paid premiums for amounts above $_________ of group life insurance are reported as taxable income to the employee.

Plans can discriminate in favor of highly compensated employees

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

When a policy loan is taken out

All of the following are times in which life insurance policy cash values can become taxable, except:

Employers must establish a pension plan

All of the following are true regarding ERISA qualified plans, EXCEPT:

Annuity to life insurance

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

Defined Benefit

All of the following types of qualified plans provide an employee with a retirement benefit based on the value of the employee's account at retirement, except:

Section 1035 Exchanges

Allows for the exchange of an existing insurance policy or contract for another without incurring any tax liability on the interest and/or investment gains in the current contract.

Life Insurance

An IRA may be funded with all of the following except:

Does not provide any additional tax-deferral benefit

An annuity held within a traditional IRA ___________.

Immediately at 100%

An employer's contribution to a SIMPLE plan is vested ______________.

Through an absolute assignment.

By what means is a transfer for value made?

Increase

Cash values within an ordinary straight whole life insurance policy _______ over time.

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

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:

Premiums

Considered a personal expense and are not deductible. They are paid with after-tax dollars. This establishes a cost basis in the policy for tax purposes.

Executive Bonus Plan

Considered to be nonqualified plans.

Dividends

Consists of the amount of premium that is returned to the policyowner if the insurance company achieves lower mortality and expense costs than expected.

The beneficiary is the estate.

Death benefits are paid to the estate of the policyowner/insured in which of the following situations?

Income tax-free

Death benefits paid from an employee group life insurance plan to an employee's named beneficiary are received __________.

An IRA account owner may take an early withdrawal without a penalty tax when certain qualified events occur, such as:

Death or permanent disability up to $10k for the down payment on a home as a first time home buyer. Medical expenses not covered or reimbursed by health insurance, or to pay health insurance premiums Qualified educational expenses

Nonqualified Plans

Do not meet requirements of federal law to be eligible for favorable tax treatment.

Minimum

ERISA sets ________ standards for pension plans in private industry.

Minimum

ERISA sets _________ standards for pension plans in the private industry.

$50,000

Employer-paid premiums for employee group term life do not constitute taxable income to the employee for coverage up to ___________.

Death Benefit Proceeds (Claims)

Generally not considered taxable income when paid as a lump sum benefit to a named beneficiary.

Premiums paid by the Employer and the Employee

Group Term Life premiums paid by an employer are tax deductible to the business as an ordinary and necessary business expense. Any employee paid premiums are not eligible for a tax deduction.

Once a year

How often may a person perform a rollover from one IRA to another?

Taxation

If a contract is deemed to be a MEC, then any funds that are distributed are subject to a "last-on, first-out" (LIFO) tax treatment, rather than the normal "first-in, first out" tax treatment.

Penalties

If the contract is a MEC, all cash value transactions are SUBJECT TO TAXATION and penalty.

Estate Taxation

If the contract owner dies, the value of the annuity is included in the owner's estate for valuation.

Rollover

If the payment is made directly to the IRA owner, he/she will have 60 days to deposit the check into a new IRA to avoid taxes and penalties.

Immediately at 100%

In a SIMPLE plan, employer contributions vest:

Modified Endowment Contracts (MECs)

Individuals could place large sums of money into a cash value policy and the cash would grow tax deferred until the insured died at which point a death benefit paid income tax free.

Receive the claim amount in a lump sum

Janelle is the beneficiary of a life insurance policy in which the insured has died. What is the only way she can receive the claim amount totally free from income taxes?

The $540,000 lump sum proceeds will be received income tax-free

Joe had $500,000 of life insurance at work. He has an additional $40,000 life insurance policy the company purchased on all employees. His wife is the primary beneficiary and their four children are contingent beneficiaries. Upon Joe's death, what are the tax consequences to his beneficiaries?

Cost basis

Life insurance policy premiums establish a ____________ in the policy for tax purposes.

Types of exchanges the IRS will allow on a tax-free basis

Life insurance to life insurance Life insurance to an annuity Annuity to an annuity Life insurance or annuity to long-term care NEVER an annuity to life insurance

Savings Incentive Match Plan for Employees (S.I.M.P.L.E.)

May be established as an IRA or a 401(k) plan. Employer's contribution must be immediately vested at 100%. Employee is entitled to all the employers' contributions immediately.

Defined Benefit Plan

Provides employees with a fixed and known benefit at retirement, the amount of which depends upon length of service and highest attained salary.

Defined Contribution Plan

Provides employees with a retirement benefit based on the value of the employees account at retirement.

Tax-Sheltered Annuities (TSAs)

Qualified annuity plans benefitting employees of public schools under the IRC Section 403(b), as well as other nonprofit organizations qualified under Section 501(c)(3).

Death Benefit Proceeds

Received income tax free.

70.5

Required Minimum Distributions must begin from Traditional IRAs by April 1 of the year following the year the account owner turns ______.

Simplified Employee Pensions (SEPs)

Set up by any private sector company that does not offer another type of qualified plan. Very popular with self-employed individuals.

403(b) Tax-Sheltered Annuity

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

Accelerated Death Benefits

Tax free to a recipient if the benefit payment is qualified.

Individual Annuities

Tax-qualified annuities are generally funded with pre-tax dollars. They're also fully taxable at ordinary income rates when money is withdrawn because the premiums paid and subsequent premiums do not establish a cost basis.

ERISA

The federal law that governs the rights of plan participants and beneficiaries of most employer-sponsored benefit plans is ____________.

IRA Transfer

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.

Estate Taxes and Benefits Included

The policyowner may name the estate as a beneficiary, or by default, if no beneficiary is living at the time of the insured's death, the benefit will automatically be paid into the insured's estate.

Distributions at Death

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

First-In, First-Out (FIFO)

When withdrawing cash from a cash value life insurance policy, the amount of the withdrawal up to the policy's cost basis is tax-free. This tax accounting rule is referred to as:

If the policy lapses when there is a policy loan outstanding which is in excess of the policy's cost basis

When would a life insurance policy loan be subject to income taxation?

Generally, the difference between the amount of cash value received and the amount of premium paid in is subject to income tax upon surrender

Which of the following best defines the 'Cost Recovery Rule'?

Lump sum death benefit paid to the beneficiary

Which of the following is NOT a taxable event for a Modified Endowment Contract (MEC)?

Defined Benefit

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

The insured is also the policyowner and at death no beneficiaries are alive

Which of the following scenarios will cause the value of a life insurance policy death benefit to be included in the insured's estate?

If a contract is deemed a MEC, any funds distributed are subject to a first-in/first-out (FIFO) tax treatment

Which of the following statements about a Modified Endowment Contract (MEC) is FALSE?

As long as the account owner is under age 59 1/2 there is no maximum contribution limit

Which of the following statements regarding Roth IRAs is FALSE?

Single Premium Whole Life

Which of the following would always be considered a Modified Endowment Contract?

Keogh Plan

Which of these is a qualified plan designed specifically for unincorporated self-employed individuals?

Premature Distributions

Withdrawals before age 59.5 generally are subject to a 10% penalty tax.

Distributions

Withdrawals from the account must start by April 1 of the year following the year the owner turns 70.5.

Non-qualified

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