Federal Tax Considerations for Life Insurance and Annuities

If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for 10 years, which of the following would be taxable annually?

(A) $3,000 * (B) $13,000 (C) $10,000 (D) $7,000

An insured decides to surrender his $100,00 Whole Life Policy. The premium 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 * - The difference between the premiums paid and the cash value would be taxable.

Which of the following is TRUE concerning whole life insurance?

(A) Dividend interest is not taxable (B) Premiums are tax deductible (C) Policy loans are tax deductible (D) Lump-sum death benefits are not taxable * - Policy loans and premiums are not tax deductible.

Which of the following is true regarding taxation of dividends in participating policies?

(A) Dividends are not taxable * - Since they are the return on unused premiums. The interest earned on the dividends, however is subject to taxation as ordinary income. (B) Dividends are taxable only after a certain amount is accumulated annually (C) Dividends are taxable in some life insurance policies and nontaxable in others (D) Dividends are considered income for tax purposes

When must an IRA be completely distributed when a beneficiary is not named?

(A) Due date of beneficiary's tax return including extensions (B) December 31 of the year following the year of the owner's death (C) Due date of the deceased owner's final tax return including extensions (D) December 31 of the year that contains the fifth anniversary of the owner's death * - If the owner dies before distributions have begun, the entire interest must be distributed in full on or before December 31 of the calendar year that contains the 5th anniversary of the owner's death, unless the owner named a beneficiary.

In a direct rollover, how is the money transferred from one plan to the new one?

(A) From trustee to the participant (B) From the participant to the new plan (C) From the original plan to the original custodian (D) From trustee to trustee * - The distribution is made directly form the trustee of the first plan to the trustee or administrator. custodian of the new IRA plan.

When a beneficiary receives payments consisting of both principal and interest portions, which parts are taxable as income?

(A) Interest only * - If a beneficiary receives payments that contain both principal and interest portions, only the interest is taxable as income (B) Both principal and interest (C) Neither principal nor interest (D) Principal only

If an insured surrenders his life insurance policy, which statement is true regarding the cash value of the policy?

(A) It is only taxable if the cash value exceeds the amount paid for premiums * (B) It is not considered to be taxable (C) It is only taxable if it exceeds the amount paid for premiums by 50% (D) It is automatically taxable

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) No taxes are due since the plan participant is over the age 59 1/2 (B) There is a 10% early withdrawal penalty (C) The amount distributed is subject to ordinary income tax (D) The amount of the distribution is reduced by the amount of a 20% withholding tax * - If the distribution is rolled over to a Traditional IRA, taxes are deferred until eh required minimum IRA distributions begin (which is generally no later than age 70 1/2). Since this client actually took a distribution (instead of making a trustee-to-trustee rollover), the distribution is subject to a 20% withholding tax.

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) Nonforfeiture option (B) Rollover (C) Settlement option * - This is exercised when an immediate annuity is purchased with the face amount at death or with the cash value at surrender. (D) Nontaxable exchange

Which of the following is NOT true regarding policy loans?

(A) Policy loans can be repaid at death (B) An insurer can charge interest on outstanding policy loans (C) A policy loan may be repaid after the policy is surrendered (D) Money borrowed from the cash value is taxable * - Policy loans can be repaid at any time, including surrender and death. An insurer can charge interest on outstanding policy loans.

Death benefits payable to the beneficiary under a life insurance policy are generally:

(A) Subject to income taxation by the Federal Government (B) Exempt from income taxation if under $10,000 (C) Exempt from income taxation if over $10,000 (d) Not subject to income taxation by the Federal Government * - When premiums are paid with after tax dollars, the death benefit is generally not subject to federal income taxation

If taken as a lump sum, life insurance proceeds to beneficiaries are passed

(A) Tax deductible (B) Part tax-free and part taxable (C) Without interest (D) Free of federal income taxation * - But, if the proceeds are taken as other than lump sum, part of the proceeds with 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.

Life Insurance death proceeds are:

(A) Taxed as ordinary income (B) Generally not taxed as income * - Life insurance death benefits are generally not taxed as income (C) Taxable to the extent that they exceed 7.5% of the beneficiary's adjusted gross income (d) Taxed as a capital gain

What method is used to determine the taxable portion of each annuity payment?

(A) 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 (B) The excise ratio (C) The annuity to age ratio (D) The marginal tax formula

Taxation of Annuities: Individually Owned

- A portion of each annuity benefit payment is taxable, and a portion is not - Tax base is the interest earned which is taxable - Cost base is the anticipated return of the principal paid in which is not taxable

Policy Loans, with interest, can be repaid in any of the following ways:

- By the owner while the policy is in force - At the policy surrender or maturity, subtracted from the cash value or - At the insured's death, subtracted from the death benefit *Policy loans from the cash value are NOT income taxable*

Cash Value Increases

- Cash value grow tax deferred - Upon surrender or endowment, any cash value in excess of cost basis is taxable as ordinary income - Upon death, the face amount is paid and there is no more cash value - Death benefits generally are paid to the beneficiary income tax free

Roth IRAs

- Contributions are not tax deductible - Excess contributions are subject to a 6% tax penalty

Corporate-Owned Annuities

- Growth in the annuity is not tax deferred - Interest income is taxed annually unless the corporation owns a group annuity for its employees & each employee receives a certificate of participation

Amounts received by beneficiary: general rule and exceptions

- Lump-sum cash payment of life policy proceeds are tax free for the beneficiary * There is an exception to this rule if the benefit payment results from a transfer for value, meaning the life insurance policy is sold to another party prior to the insured's death

Taxation of Individual Retirement Annuities (IRAs)

- Tax deductible contributions for the year of the contribution (based on the person's income) - Contributions must be made in "cash" in order to be tax deductible: cash, check, money order - Excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA - Tax-deferred earnings (the money that accumulates in the account) are not taxed until withdrawn

Death Benefit Taxation Rules

- Tax free if taken as a lump-sum distribution to a named beneficiary - Principal is tax free; interest is taxable if paid in installments (other than lump sum)

Dividends

- The return of unused premiums - Money borrowed against the cash value is not income taxable

A distribution from an IRA is subject to income taxation in the year the withdrawal is made

In case of an early distribution (prior to age 59 1/2), a 10% penalty will also apply

Policy Proceed

In life insurance, this is the death benefit

Exclusion Ratio

The calculation method used to determine the annuity amounts to be excluded from taxes

Surrender

The early termination of a policy by the policyowner

Policy Endowment

The maturity date

Last In, First Out (LIFO)

The principle applied to asset management in life insurance products, under which it is assumed that the funds paid into the policy last will be paid out first

First In, First Out (FIFO)

The principle under which it is assumed that the funds paid into the policy first will be paid out first

Settlement Options

When the beneficiary receives payments consisting of both principal and interest, the interest portion of the payments received is taxable as income *Principle is tax free, but the interest is taxable