Unit 10: Taxation of Life Insurance & Annuities Checkpoint Exam

Samantha is 40 years old and wants to withdraw some of the interest earned on her annuity. What is the additional penalty that Samantha will have to pay above the regular tax due on amount received? A) 10% penalty on interest B) No penalty C) 5% penalty on interest D) 25% penalty on interest

A) 10% penalty on interest Explanation: If a person withdraws interest before the age of 59 1/2, she will pay a 10% tax penalty in addition to the regular tax due on taxable income received. The penalty does not apply if the owner is disabled.

Which of the following is considered to be a return of the portion of the premium paid for the policy? A) Dividends B) Surrenders C) Policy loans D) Death benefits

A) Dividends Explanation: Dividends are considered to be a return of the portion of the premiums paid for a policy. They are NOT taxable. Any interest earned on the dividends is taxable.

If a beneficiary chooses the lump sum option at the death of the annuity owner, what amount of money is taxable? A) The gain B) The amount of premiums paid in C) The total value D) The cost bases

A) The gain Explanation: With the lump sum distribution option, the beneficiary can take all proceeds at once. The gain (total value - cost basis) is taxable.

All of the following statements about policy loans are correct EXCEPT A) loans are not repayable B) policy loans reduce the cash value of the policy C) loans are not taxable to the policyowner D) the interest paid on policy loans is not tax deductible

A) loans are not repayable Explanation: Policy loans do reduce the cash value of the policy, however, they are repayable at any time and will restore both the cash value and death benefit.

All of the following statements regarding income tax treatments of life insurance and annuities are correct EXCEPT A) premiums paid for individual life insurance are taxable when the policy is surrendered B) premiums paid for individual life are not taxable when the policy is surrendered C) full surrenders are taxable to the extent of any gain D) partial surrenders are taxable to the extent of any gain

A) premiums paid for individual life insurance are taxable when the policy is surrendered Explanation: Premiums paid are NOT tax deductible. Therefore, at policy surrender, premiums are returned tax-free. When a life insurance policy is surrendered or partially surrendered, any gain in the cash value is taxable. The gain is the cash value minus the amount of premiums paid.

All of the following statements about estate tax treatment are correct EXCEPT A) If the owner of the estate died during the accumulation period, the entire value of the annuity is included in the estate. B) Life insurance death benefits are not counted as value in a deceased insured's estate if they are payable to the estate. C) Estate taxed are owed if an estate's value exceeds a certain value at the time of the individual's death. D) If the owner of the estate died during the annuity period, the present value of future payments is included in the estate.

B) Life insurance death benefits are not counted as value in a deceased insured's estate if they are payable to the estate. Explanation: Life insurance death benefits are counted as value if in a deceased insured's estate if they are payable to the estate, if the deceased possessed any incidents of ownership in the policy at the time of death, or if the deceased assigned or transferred ownership to the policy to another person within 3 years of death.

All of the following statements about modified endowment contract (MEC) are true EXCEPT A) an MEC offers tax-free death benefits B) an MEC is not considered to be life insurance C) an MEC offers tax-deferred cash value accumulation D) once an MEC, always an MEC

B) an MEC is not considered to be life insurance Explanation: An MEC is a special type of life insurance under federal income tax laws.

Accelerated death benefit advance the payment of death benefits to a person if she has been diagnosed with a qualifying event that will lead to her death within A) 48 months B) 6 months C) 24 months D) 12 months

C) 24 months Explanation: Accelerated death benefits are an advance of death benefits. Accelerated death benefits are tax exempt.

Julie has a life insurance policy with a $20,000 cost basis. She makes a withdrawal for $25,000. How much of her withdrawal is considered excess and taxable? A) $20,000 B) $25,000 C) $10,000 D) $5,000

D) $5,000 Explanation: When a withdrawal exceeds the cost basis, the excess is taxable.

Amy receives her father's $100,000 life insurance death benefit in a lump sum. How will Amy be taxed on the lump sum? A) Amy will be taxed on the entire benefit. B) Amy will be taxed on any premiums paid into the policy. C) Amy will only be taxed on the interest earned on the proceeds. D) Amy will not be taxed.

D) Amy will not be taxed. Explanation: When the entire life insurance death benefit amount is paid in one lump sum to a named beneficiary, it is not taxable as income.

Which of the following movements of cash value under a section 1035 has tax consequences? A) Annuity contract to another annuity contract B) Life insurance policy to another life insurance policy C) Life insurance policy to an annuity contract D) Annuity contract to a life insurance policy

D) Annuity contract to a life insurance policy Explanation: Annuity gains are taxable when a person chooses to move an annuity contract to a life insurance policy. The gain in the contract becomes taxable upon surrender of the annuity.

Which of the following situations in a group life insurance policy is tax deductible? A) Premiums paid by the employee of a contributory group plan B) Death benefits to a named beneficiary C) Premiums paid for a key person life insurance policy D) Premiums paid by an employer in a contributory group insurance plan

D) Premiums paid by an employer in a contributory group insurance plan Explanation: The employer can deduct premiums paid for an employee in group insurance. These are considered a business expense provided under an employer group benefit plan. Since the employer is not receiving any benefit from this policy, the employer can deduct the expense.