10 - Taxation of Life Insurance & Annuities

Question 1

Premiums Paid

How are they treated for tax purposes?

Answer 1

• Premiums are not tax-deductible

Question 2

Interest Earned on Cash Value

How is it treated for tax purposes?

Answer 2

• Interest not taxed while in the policy
• If the gain is withdrawn then tax assessed

Question 3

Withdrawals

How are they treated for tax purposes?

Answer 3

• Taxed only if withdrawal exceeds premiums paid
• Only the gain is taxed

Question 4

Policy Loans

How are they treated for tax purposes?

Answer 4

• Not taxed while the policy is in force
• Taxed if policy is surrendered and there is a gain
• Interest paid on loans is not tax-deductible

Question 5

Dividends

How are the treated for tax purposes?

Answer 5

• Considered a return of premium and not taxed
• Interest earned is taxed

Question 6

Death Benefits

How are lump-sum payments and other settlement options taxed?

Answer 6

• Lump sum payments are not taxed
• If payment under other settlement option then original death benefit is not taxable but any interest earned it

Question 7

Accelerated Death Benefits

What are they and when are they allowed? How are they treated for tax purposes?

Answer 7

• Death benefits in advance of death paid out to the policy owner, not the beneficiary
• Payments will they be reduced to the beneficiary
• If the following is certified by a physician
  
  • Critically ill
  • Terminally ill
  • Death impending 24 months
• Not taxed

Question 8

Modified Endowment Contracts (MECs)

What are they and how are they taxed?

Answer 8

• Too much premium paid in the first seven years of the policy allowing it to be paid up.
• Flexible premium policies are at risk
• Single premium policies automatically a MEC
• Interest on cash values not taxed while in the policy
• Withdrawals and loans are taxed on a LIFO basis
• 10% penalty on interest taxed if withdrawn before 59.5
• Once a MEC always a MEC

Question 9

1035 Exchange

What is it and what is allowed?

Answer 9

• Exchanging life insurance policies without having the policy to be considered surrendered and having to pay taxes on the surrendered amount.
• Actions allowed
  
  • Life to Life
  • Annuity to Annuity
  • Life to Annuity
• Actions not allowed
  
  • Annuity to life