Federal Tax Considerations for Life Insurance and Annuities

What is the penalty for IRA distributions that are below the required minimum for the year?

50%

Life insurance death proceeds are...

Generally not taxed as income.

Which of the following is not an allowable 1035 exchange

a. A life insurance policy is exchanged for an annuity. *b. A whole life insurance policy is exchanged for a term insurance policy. c. A whole life insurance policy is exchange for a universal life insurance policy. d. An annuity is exchange for another annuity. (The key is that the exchange may not be from a less tax advantaged to contract to a more tax advantaged contract. "Same to same" is acceptable.)

Who can make a fully deductible contribution to a traditional IRA?

An individual not covered by an employer-sponsored plan who has earned income.

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

Interest only.

An employee quits her job where she has a balance of $10,000 in her qualified plan. If she decides to do a direct transfer from her plan to a traditional IRA, how much will be transferred from one plan administrator to another and what is the tax consequence of a direct transfer?

$10,000, no tax consequence. (During an IRA direct transfer (or direct rollover), the full amount gets reinvested from one plan to the other.)

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 (if $100,000 of life insurance proceeds were used in a settlement option paying $13,000 a year for 10 years, $10,000 per year would be income tax free (as principal) and $3000 per year would be income taxable (as interest.)

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an...

Modified endowment contract. (any cash value life insurance policy that develops cash value faster than a seven pay whole life contract is called a modified endowment contract. It loses the benefits of a standard life contract.)

Traditional IRA contributions are...

Tax deductible. (The following taxation rules apply to contributions made to traditional IRA plans: tax-deductible contributions for the year of the contribution (based on the persons income); contributions must be made in "cash" in order to be tax deductible; excess contributions are taxed at 6% per year as long as the excess amounts remain in the IRA; and tax deferred earnings are not taxed until withdrawn.)

During the accumulation period in a nonqualified annuity, what are the tax consequences of a withdrawal?

Taxable interest will be withdrawn first and the 10% penalty will be imposed if under the age of 59 1/2.

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. Dependents. b. Annuitant. *c. Spouse. d. Charitable organization (if an annuities contract holder dies before the effective starting date, the contract interest continues to be taxable, unless the beneficiary is a spouse. In that case, this tax can be deferred.)

When contributions to an immediate annuity are made with before tax dollars, which of the following is true of the distributions?

Distributions are taxable. (if contributions are made with before tax dollars, contributions to this fund are fully taxable. Distributions must begin no later than age 70 1/2 in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.)

An annuitant dies before the effective date of a purchased annuity. Assuming that the annuitant's wife is the beneficiary, what will occur?

The interest will continue to accumulate tax deferred.

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase?

a. Withdrawn amounts are taxed on a first in, last out basis. b. Taxes are deferred on withdrawn amounts, but a flat penalty is charged. c. Taxes are deferred on withdrawn amounts. *d . Withdrawn amounts are taxed on a last-in-first-out basis. (when money is withdrawn from the annuity during the accumulation phase the amounts are taxed on the last in first out basis. Therefore, all withdraws will be taxable until the owners cost basis is reached. After all of the interest is received and taxed the principal will be received with no additional tax consequences.)

Which of the following terms is used to name the non-taxed return of unused premiums?

a. Interest. b. Surrender. *c. Dividend. d. Premium return. (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.)