QBank Questions: Course 102 Ch: 4

Paul was the beneficiary of his father's variable life insurance policy. The policy had a face amount of $500,000, and Paul's father had a basis in the policy of $300,000. During his life, Paul's father had invested the cash value in subaccounts containing blue-chip stocks, which achieved significant capital appreciation during most of the years the policy was in effect. When his father died, Paul received the $500,000 death benefit in a lump sum. How much of the $500,000 death benefit must Paul include in his gross income? A) $0. B) $500,000. C) $200,000. D) $300,000.

A. Lump-sum death benefits received from a life insurance policy as a result of the insured's death are generally excludable from gross income. (QB.102.4)

Arlene is 70 years old. She owns a life insurance policy with a face amount of $250,000 and a cash value of $75,000 on her own life. She gives the policy to her niece, Shawna, who names herself as policy beneficiary. Shawna pays premiums of $5,000 on the policy before Arlene dies. When Arlene dies, what amount of the $250,000 death benefit must Shawna include in her gross income? A) $250,000. B) $245,000. C) $0. D) $70,000.

C. Arlene's transfer of the policy to Shawna is not subject to the transfer-for-value rule because the transfer was a gift. Therefore, the entire death benefit remains tax free. (QB.102.4)

Leona owns a whole life insurance policy. The policy is not a modified endowment contract (MEC). Leona has paid total policy premiums of $20,000 over the life of the policy. This year, the cash value of the policy increases by $7,000 and she takes out a policy loan of $25,000. What amount must Leona report as gross income? A) $7,000. B) $5,000. C) $0. D) $12,000.

C. Leona has no gross income from the life insurance policy. The increase in the cash value of a life insurance policy is not taxable as long as it remains in the policy. Because the policy is not a MEC, the loan is not taxable even though it exceeds Leona's basis in the policy. (QB.102.4)

David has a universal life A (Option 1) life insurance policy. The face amount is $300,000, and the current cash value is $125,000. The beneficiary is his daughter, Lisa. If David dies today, what amount will Lisa receive as a death benefit? A) $425,000. B) $125,000. C) $300,000. D) $175,000.

C. Under a universal life A (Option 1) policy, the death benefit is simply the face amount of the policy. (QB.102.4)

Angela has a life insurance policy that allows her to vary the amount of her premium payments and invest the cash value in subaccounts. The amount of the death benefit is not guaranteed, and the cash value could possibly decline to zero because there is no guaranteed rate of return. What type of policy does Angela have? A) Modified life. B) Variable life. C) Whole life. D) Variable universal life

D. Angela has a variable universal life insurance policy. Variable universal life combines the features of variable and universal life, by providing flexible premium payments, an adjustable death benefit, and the ability to invest the cash value in subaccounts. (QB.102.4)

Which of the following insures 2 lives and pays the death benefit upon the death of the second insured? A) Universal life insurance. B) Limited pay life insurance. C) First-to-die life insurance. D) Second-to-die life insurance.

D. Premiums on second-to-die, or survivorship, life insurance policies are lower than those on other types of policies because the insurer does not pay until the death of the second insured. First-to-die life insurance pays a death benefit upon the death of the first insured. (QB.102.4)

Grant is the owner of a life insurance policy on himself. His MAGI is $66,000 and the cash surrender value of the policy is $100,000. Grant surrenders the policy and leaves the cash with the insurer under the interest-only option, but retains the right to withdraw the proceeds at any time. If the total premiums he paid during the life of the policy were $30,000 and the total policy dividends he received in cash were $2,000, how much of a gain must Grant report for the year in which the policy was surrendered? A) $72,000. B) $100,000. C) $70,000. D) $0.

A. When the policyowner chooses the interest only option and retains the right to withdraw the proceeds, the policyowner has constructive receipt of the proceeds when received. Therefore, the policyowner must pay taxes on the gain, in addition to any interest income received. Because Grant's cost basis in the policy is $28,000 (premiums paid − dividends received) and he has access to $100,000, he must recognize a gain of $72,000 ($100,000 − $28,000). Because Grant's MAGI is below the Medicare surtax thresholds, the $72,000 is not subject to the Medicare 3.8% surtax. (QB.102.4)

Jack purchased a $200,000 whole life insurance policy on his life and designated his wife, Judy, as beneficiary. Several years later, Jack surrendered the policy for the lump-sum cash value of $100,000. Jack had paid gross premiums of $90,000 and had received dividends of $20,000. What are the tax consequences to Jack upon receipt of the cash surrender proceeds from the policy? A) Jack receives $70,000 tax free and $30,000 as ordinary income. B) Jack receives $100,000 tax free. C) Jack receives $90,000 tax free and $10,000 as ordinary income. D) Jack receives $70,000 tax free and $20,000 as ordinary income.

A. Jack's basis in the policy is $70,000 ($90,000 premiums paid − $20,000 dividends received). The taxable amount of $30,000 is the difference between the cash value received and his basis ($100,000 − $70,000). (QB.102.4)

Which of the following is a method of calculating the cost of life insurance in which the time value of money is taken into consideration by applying an interest factor to each cost element? A) Net cost. B) Contingent. C) Equity-indexed. D) Interest-adjusted.

D. The interest-adjusted method considers the time value of money in measuring the cost of life insurance. (QB.102.4)

Which of the following statements is(are) CORRECT with regards to guaranteed interest rates and values versus nonguaranteed policy minimums and values within life insurance policy illustrations? 1. If prospective policyowners are concerned about the financial ability of insurance companies to pay the future cash values illustrated on the computer generated illustrations, they should consider universal life. 2. The cash values within a universal insurance policy illustration are considered assets of the insurance company. 3. Variable universal life provides policyowners with a guaranteed minimum interest rate which can be reviewed on the policy illustration. A) 2 only B) 1 and 3 C) 1, 2, and 3 D) 1 and 2

A. If prospective policyowners are concerned about the financial ability of insurance companies to pay the illustrated cash values, they should consider variable universal life because VUL subaccounts are owned by the policyowners versus the cash values within a universal life policy which are owned by the insurance companies. Variable universal life insurance provides policyowners with rates of returns based on the performance of subaccounts which the policyowners choose to invest the premiums. (QB.102.4)

Bernard Mead has had lung cancer for the past 6 months. He has been on a regimen of chemotherapy and radiation treatments, and is not expected to survive beyond the next 3 months. Bernard's health insurance coverage has expired and he needs money to pay for his remaining medical treatments. Bernard has a $300,000 whole life insurance policy that he purchased on himself 20 years ago. The policy has a cash value of $23,000. If immediate access to cash is his major concern at this time, which of the following actions would be justified on his part? A) Save money by not paying the life insurance premiums. B) Surrender the policy for the $23,000 cash value. C) Donate the policy to a qualified charity. D) Sell the policy to a viatical company for $200,000.

D. Because Bernard needs the money to pay for current medical expenses, his best course of action is to sell the policy for $200,000. If he simply stops paying the premiums, the automatic premium loan or nonforfeiture options come into play. If he surrenders the policy, he will only receive the cash surrender value, which is significantly less than what he could obtain by selling the policy. Donating the policy to a qualified charity will not provide him with liquid funds. (QB.102.4)

The traditional net cost method of life insurance policy cost comparison is not recommended because it does not take into account: A) the premiums that will be paid. B) the dividends that may be received. C) cash surrender values. D) the time value of money.

D. The traditional net cost method is not a recommended method for comparing life insurance policies because it does not take into account the time value of money. (QB.102.4)

Edwina, age 48, owns a modified endowment contract (MEC). Her basis in the policy is $20,000, and the cash value is $35,000. This year, she takes out a policy loan of $10,000. Which of the following statements regarding the income tax consequences of this loan is CORRECT? A) Edwina must include $10,000 in her gross income; the $10,000 is also subject to a 10% penalty. B) Edwina must include $10,000 in her gross income, but the 10% penalty does not apply. C) Edwina must include $5,000 in her gross income; the $5,000 is also subject to a 10% penalty. D) Edwina incurs no income tax consequences as a result of the loan.

A. Loans from MECs are subject to LIFO (last in, first out) basis recovery. In other words, loans are considered to consist of taxable earnings until all the taxable earnings have been withdrawn. Edwina must include the entire $10,000 in her gross income. Because the contract is a MEC and Edwina is younger than 59½, the taxable amount is also subject to a 10% penalty. (QB.102.4)

Carol, age 37, is a graphics designer with aspirations to be an entrepreneur. She currently lives in a new personally designed 4,000 square foot lakefront home. She is making a modest living with her job at ABC Creations but she eventually wants more control over her future. She may need funds within the next ten years to help get her dream started. Carol has come to her financial planner for life insurance advice. She wants a permanent life insurance plan with flexible premiums to provide for her disabled grandchild in the event her death. Which of the following would be the best choice for Carol? A) A single premium life insurance policy. B) A term life insurance policy. C) A whole life insurance policy. D) A universal life insurance policy.

D. A universal life insurance policy would help Carol solve her permanent life insurance needs and also give her the flexibility to vary the premiums and death benefit in the future. She could also borrow against the universal life insurance policy in the future without incurring a possible tax burden or penalty if she needed some extra funds for her new business. A term life insurance policy would not provide her with permanent life insurance coverage. The single premium life insurance policy would be classified as a modified endowment contract so she may be taxed and penalized on any withdrawals from the cash value above basis. A whole life insurance policy would not provide her with flexibility. (QB.102.4)

Daniele has a universal life B (Option 2) life insurance policy. The face amount is $500,000, and the current cash value is $225,000. The beneficiary is her son, Richard. If Daniele dies today, what amount will Richard receive as a death benefit? A) $275,000. B) $500,000. C) $225,000. D) $725,000.

D. Under a universal life B (Option 2) policy, the death benefit is the face amount of the policy plus the cash value. Richard will receive $725,000 ($500,000 + $225,000). (QB.102.4)

Which of the following definitions describes accelerated benefits found in insurance policies? A) Life insurance death benefits that are paid to the policyowner prior to the insured's death under certain circumstances, such as when the insured needs long-term care. B) A benefit under a long-term care insurance policy that continues to pay a long-term care facility for a limited time if a patient must temporarily leave because of hospitalization. C) A provision for the replacement of lost earnings due to less-than-total disability. D) Benefits under long-term care insurance that provide reimbursement for occasional full-time care at home for a person who is receiving home health care.

A. Accelerated benefits are life insurance death benefits that are paid to the policyowner prior to the insured's death under certain circumstances, such as when the insured needs long-term care. (QB.102.4)

Which of the following are characteristics of a viatical agreement? 1. One party purchases the life insurance policy on the life of another party. 2. The insured party is usually terminally ill. 3. The insured receives payment in exchange for the life insurance policy. 4. The purchaser of the policy continues to pay the premiums on the policy until the insured is deceased. A) 1, 2, 3, and 4. B) 2, 3, and 4. C) 1 and 2. D) 1 and 4.

A. All of these are characteristics of a viatical agreement. Viatical agreements have arisen out of the need for cash by terminally ill individuals. Under viatical agreements, the terminally ill insured sells his/her life insurance policy to another party or parties for approximately 60%-90% of the death benefit depending on life expectancy. The insured receives immediate cash and the buyer receives the death benefit when the insured is deceased. The buyer must continue paying premiums on the contract until the death of the insured. (QB.102.4)

Which of the following is NOT a defect of the net cost method of comparing the cost of life insurance policies? A) The net cost method does not consider the effect of policy dividends and the cash value at the end of the selected term. B) The net cost method bases calculations on projected premiums, dividends, and cash values that are not guaranteed. C) The time value of money is ignored. D) The net cost method is not a good method for comparing policies.

A. The net cost method does consider the effect of policy dividends and the cash value at the end of the selected term. (QB.102.4)

Michelle purchased a $100,000 life insurance policy on her life. To date, she has paid $50,000 in total premiums and received $10,000 in dividends. The policy currently has a net cash value of $15,000 and is subject to a $30,000 outstanding loan. If Michelle decides to surrender the policy, she will realize a gain of: A) $10,000. B) $5,000. C) $15,000. D) $0.

B. Michelle's gain upon the surrender of the policy would be $5,000. Michelle has a basis in the policy of $10,000, calculated as follows: total premiums paid ($50,000) minus outstanding loan ($30,000) minus dividends received ($10,000) equals $10,000. Dividends received represent a return of premiums and, therefore, reduce the policyowner's basis in the policy. Michelle has a gain upon surrender of $5,000, calculated as follows: net cash value ($15,000) minus basis in policy ($10,000) equals gain upon surrender ($5,000). (QB.102.4)

Jeff owns a life insurance policy on his own life. The policy is not a modified endowment contract (MEC). His basis in the policy is $10,000. This year, he pays premiums of $1,000 on the policy, receives dividends of $300 in cash, and takes a withdrawal of $5,000. In addition, the cash value of the policy increases by $2,000. Which of the following statements regarding the income tax consequences of this policy is (are) CORRECT? 1. The premiums of $1,000 are tax deductible. 2. The $2,000 increase in cash value is excluded from gross income. 3. The dividends of $300 are included in gross income. 4. The withdrawal of $5,000 is included in gross income. A) 1 and 3. B) 2 only. C) 1, 2, 3, and 4. D) 2 and 4.

B. Statement 2 is correct; the increase in cash value of a life insurance policy is not taxable to the owner of the policy as long as it remains in the policy. Statement 1 is incorrect because premiums on individual life insurance policies are not tax deductible. Statement 3 is incorrect because dividends are generally considered to be a return of premium and are not taxable. Statement 4 is incorrect because withdrawals from non-MEC contracts are not taxable unless they exceed the owner's basis. (QB.102.4)

Claire, age 49, owns a life insurance policy. Her basis in the policy is $50,000, and the cash value is $75,000. The policy is not a modified endowment contract (MEC). Claire is dissatisfied with the policy and is interested in surrendering it or exchanging it for another financial product, but she does not want to incur an income tax liability. Which of the following transactions would most likely allow Claire to accomplish her goal? 1. Surrender the policy for $75,000 in cash and purchase another policy. 2. Exchange the policy for another life insurance policy. 3. Exchange the policy for a variable annuity. 4. Exchange the policy for a qualified long-term care insurance policy. A) 2 and 3. B) 2, 3, and 4. C) 1 and 3. D) 2 only.

B. Statements 2, 3, and 4 describe transactions that can be accomplished under Section 1035 of the Internal Revenue Code without recognizing any gain or loss. Statement 1 (surrendering the policy for cash and purchasing another policy) would result in taxable income of $25,000. (QB.102.4)