Taxation of Life Insurance and Annuities - Premiums and Proceeds

What is the penalty for IRA distributions that are below the required minimum for the year? A. 10% B. 25% C. 50% D. 60%

C. 50% - If there are no distributions at the required age, or if the distributions are not large enough, the penalty is 50% of the shortfall from the required annual amount.

What is the main purpose of the Seven-pay Test? A. It guarantees the minimum interest. B. It determines if the insurance policy is a MEC. C. It requires level premium payments for 7 years. D. It ensures that the policy benefits are paid out in 7 years.

B. It determines if the insurance policy is a 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.

Which concept is associated with "exclusion ratio"? A. Dividend distribution B. How exclusion riders affect an insurance premium C. Policy provisions D. Annuities payments

D. Annuities Payments - Some parts of an annuities payment are taxable, while others are not. The return of the principal paid in is nontaxable. The portion that is taxable is the actual amount of payment, less the expected return of the principal paid in. This relationship is called the "exclusion ratio".

The premiums paid by the employer in a business life insurance policy are A. Always taxable to the employee. B. Never taxable to the employee. C. Tax deductible by the employer. D. Tax deductible by the employee.

C. Tax deductible by the employer - The premiums that an employer pays for life insurance on an employee, whereby the policy is for the employee's benefit, are tax deductible to the employer as a business expense.

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an: A. Nonqualified annuity B. Modified endowment contract (MEC) C. Accelerated benefit policy D. Endowment

B. 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.

When contributions to an immediate annuity are made with before-tax dollars, which of the following is true of the distributions? A. Distributions are taxable B. Distributions are nontaxable C. Distributions cannot begin to age 70.5 D. There are no distributions

A. Distributions are taxable - If contributions are made with before-tax dollars, contributions to this fund are fully taxable. Distributions must begin no later than the age of 70.5 in order for the annuitant to avoid penalties. the penalty is 50% of the shortfall from the required annual amount.

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase? A. Taxes are deferred on withdrawn amounts, but a flat penalty is charged. B. Taxes are deferred on withdrawn amounts. C. Withdrawn amounts are taxed on a last in, first out basis. D. Withdrawn amounts are taxed on a first in, last out basis.

C. 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 a last in first out basis (LIFO). Therefore, all withdrawals will be taxable until the owner's cost basis is reached. After all of the interest is received and taxed the principal will be received with no additional tax consequences.

A policy owner cancels his life policy but instructs the insurance company to transfer the cash value of his policy to an annuity. This non taxable transaction is called A. Qualified distribution B. Premature distribution C. Rollover D. 1035 exchange

D. 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 method is used to determine the taxable portion of each annuity payment? A. The annuity to age ratio B. The marginal tax formula C. The exclusion ratio D. The excise ratio

C. 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.

Which of the following describes the tax advantage of a qualified retirement plan? A. The earnings in the plan accumulate tax deferred. B. Distributions prior to age 59½ are tax deductible. C. Employer contributions are deductible as a business expense when the employee receives benefits. D. Employer contributions are not taxed when paid out to the employee.

A. The earnings in the plan accumulate tax deferred. - Contributions are tax deferred, and earnings on the money in the plan accrue (accumulate) on a tax-deferred basis.

An applicant buys a nonqualified annuity, but dies before the starting date. For which of the following beneficiaries would the contract's interest NOT be taxable? A. Annuitant B. Spouse C. Charitable organization D. Dependents

B. 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 this case, this tax can be deferred.

In life insurance policies, cash value increases A. Are income taxabke immediately B. Are taxed annually C. Are only taxed when the owner reaches age 65 D. Grow tax deferred

D. Grow Tax deferred - Generally life insurance cash values are only income taxed if the policy is surrendered ( totally or partially) and the cash value exceeds the premiums paid.