Taxation of Life Insurance and Annuities - Premiums and Proceeds (chapter 10)

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

$3,000 - If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for 10 years, $10,000 per year would be income tax free (as principal) and $3,000 per year would be income taxable (as interest).

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 70½ in order for the annuitant to avoid penalties. The penalty is 50% of the shortfall from the required annual amount.

An insured decides to surrender his $100,000 Whole Life policy. The premiums 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?

$3,000 - The difference between the premiums paid and the cash value would be taxable. In this example, the difference between the premiums paid ($15,000) and the cash value ($18,000) is $3,000.

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Taxable interest will be withdrawn first and the 10% penalty will be imposed if under age 59 ½. - When money is withdrawn from the annuity during the accumulation phase, the amounts are taxed on a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached.

A policyowner cancels his life policy but instructs the insurance company to transfer the cash value of his policy to an annuity. This nontaxable transaction is called

1035 exchange - In accordance with Section 1035 of the Internal Revenue Code, certain exchanges of life insurance policies and annuities may occur as nontaxable exchanges.

What is the main purpose of the Seven-pay Test?

It determines if the insurance policy is an MEC. - The Seven-pay Test determines whether an insurance policy is "over-funded" or if it's a Modified Endowment Contract. In other words, the cumulative premiums paid during the first seven years of a policy must not exceed the total amount of net level premiums that would be required to pay the policy up using guaranteed mortality costs and interest.

Life insurance death proceeds are

Generally not taxed as income - Life insurance death benefits are generally not taxed as income.

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

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.

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?

Spouse - If an annuities contract holder dies before the effective starting date, the contract's interest continues to be taxable, unless the beneficiary is a spouse. In that case, this tax can be deferred.

Which of the following is true regarding taxation of accelerated benefits under a life insurance policy?

They are tax free to terminally ill insured - When accelerated benefits are paid under a life insurance policy, they are received tax free by terminally ill insured, and tax free up to a limit for chronically ill insured.

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

It is only taxable if the cash value exceeds the amount paid for premiums. - The cash value of a surrendered policy is only considered to be taxable as income if the cash value exceeds the amount of premiums paid for the policy.

Which of the following statements regarding the taxation of Modified Endowment Contracts is FALSE?

Withdrawals are not taxable - Any distributions from MECs are taxable, including withdrawals and policy loans. All of the other statements are true.