Book 2 Pages 1 - 101 Flashcards
a device used to manage risk by having a large pool of people share in the financial losses suffered by members of the pool
Insurance
a condition where there is a possibility of an adverse deviation from the desired outcome
risk
The larger the number of members in the group, the ____ the probability that actual losses will equal expected losses
greater
the cause of a financial loss
Peril
examples of perils
flood or illness
a condition that increases the probability that a loss will occur
hazard
physical characteristics of the person or property that increase the probability of a loss occurring
Physical hazards
examples of physical hazards
blood pressure or a location of a house in a flood zone
the chance of loss from dishonesty or when a person intentionally causes a loss or overstates a loss
Moral Hazard
the chance of a loss occurring due to ones indifference or a person lack of caring if a loss occurs because they know they have insurance
Morale Hazard
a stated amount of money the insured is required to pay on a loss before the insurer will make any payments
Deductible
an outline of the perils that are not covered under the policy
Exclusions
Examples of exclusions
earthquake, war, floods
describe written additions to an insurance policy
riders/endorsements
exposure to a risk that may cause financial loss
Financial risk
exposure to a risk that does not cause financial loss
Non-financial risk
losses that are caused by factors other than a change in the economy, i.e. risks that are always present
Static risks
Examples of static risks
natural disasters, death, flood, earthquake
True or False?
Static risks are not insurable
False, they are insurable
losses that are a result of the economy changing
Dynamic risks
Examples of Dynamic risks
Inflation, changes in business cycle
True or False?
Dynamic Risks are insurable
False, they are not
a risk that affects a large group of people
Fundamental risk
examples of fundamental risks
recession, earthquake
a risk that is individual in nature or affects a small number of people
Particular risk
a risk that involves only the chance of a loss or no chance of a loss
Pure risk
Are pure risks insurable?
Yes
loss of income or asset resulting from the loss of ability to earn income caused by disability, death, or sickness
Personal risk
direct or indirect loss to property itself from theft or destruction
Property risk
intentional or unintentional injury to property or others
Liability risk
failure to meet or follow through on an obligation
Risk from failure of others
risk that involves both the chance of loss or gain
Speculative risk
examples of speculative risk
gambling
Is speculative risk insurable?
No
True or False?
Risk management involves managing both insurable and non insurable risks?
True
In risk management, insurance should be justified on the basis of what kind of an analysis?
cost-benefit analysis
What are the 6 steps to risk management?
- Determine the objectives
- Identify the risks that the subject is exposed to
- Evaluate the risks as to the probability of occurrence and potential loss
- Determine alternatives for managing risk and select most appropriate for each risk
- Implement the most appropriate alternative
- Evaluate and review periodically
happens when a person refuses to accept risk by not engaging in an action that creates risk
risk avoidance
examples of risk avoidance
not driving a car or going on a plane
happens when a person chooses to retain the risk and takes no action to avoid the risk
Risk retention
examples of risk retention
self insurance, coinsurance, deductibles
happens when a person transfers the risk through an individual or insurance contract
risk transfer
happens when a person shares the risk with a group of others
Risk sharing
happens when risk is reduced through loss prevention methods or safety improvements
Risk reduction
What are some methods that can be used to decrease the insurance premiums?
increase the deductible increase the elimination period install an alarm system improve health and diet avoid tobacco choose a safer job reduce coverage term (years)
What characteristics must be present for a loss to occur?
- Large homogeneous exposure
- must be measurable and definite
- must be accidental
- can’t be catastrophic to society
the likelihood that parties with the greatest probability of loss are the ones most likely to purchase insurance
Adverse selection
mandatory insurance that seeks to protect individuals against large fundamental risks
Social insurance
What are some examples of social insurance?
Social security
Medicare
Workers comp
Medicaid
insurance that seeks to enhance public trust and is usually mandatory
Public insurance
What are some examples of public insurance?
federal deposit insurance corp (FDIC)
Pension benefit guarantee corp (PBGC)
securities investor protection corp (SIPC)
What insurance coverage should a client have during the asset accumulation phase?
health, disability, life, property and casualty
What insurance coverage should a client have during the conservation phase?
health, disability, life, property and casualty
may consider long term care
What insurance coverage should a client have during the gifting/distribution phase?
health, property and casualty, long term care, and life to lesser extent
an organization made up of the states’ insurance commissioners, whose purpose is to discuss industry problems that may require legislation or regulation
National Association of Insurance Commissioners (NAIC)
What are the 5 elements of an insurance contract?
- Offer and acceptance
- Consideration
- Legal Object
- Legal Capacity
- Legal Form
acts that are prosecuted by the state and are punishable by fine, imprisonment, or death
Criminal acts
Are criminal acts insurable?
generally no
an infringement on the rights of another; the wrongdoer creates a right in the damaged party to bring a civil action
Tort
What are examples of intentional torts?
battery, assault, libel, slander, false imprisonment, trespass, etc
an act or failure to act in a reasonably prudent manner, and such act or failure to act causes harm to another
unintentional tort
happens when one person becomes legally liable for the torts of another
Vicarious liability
examples of vicarious liability
an employer becomes liable due to an employees actions
the failure to act in a way that a reasonably prudent individual would have acted in a similar situation
Negligence
liability that may be imposed without proof of an individual’s negligence or bad intent
Strict (absolute) Liability
What are some examples of strict liability?
workers comp
product liability
extraordinarily dangerous activities (handling hazardous materials)
What are the two forms of injury that can result from a tort?
Bodily injury and property damage
type of injury that may lead to medical expense, loss of income, pain and suffering, mental anguish and loss of consortium
bodily injury
damages used to compensate for measurable losses
special damages
damages used to compensate for intangible losses (pain and suffering)
general damages
damages exceeding simple compensation and awarded to punish the defendant
punitive damages
True or False?
Property damage is usually measured by the actual monetary loss
True
a rule that states that damages assessed to a negligent party should not be reduced simply because the injured party has other sources of recovery available, such as insurance or employee benefits
Collateral Source Rule
a defense of negligence stating that the injured party fully understood and recognized the dangers involved in an activity and voluntarily chose to proceed
Assumption of Risk
examples of assumption of risk
a fan got hit by a baseball while sitting behind first base at a game
a defense of negligence stating that the injured party’s negligence also contributed to their injury
Contributory negligence
a defense of negligence where the amount of damages is adjusted to reflect the extent to which the injured party’s own negligence contributed to the injury
Comparative negligence
the actual authority that an insurance company gives representatives
Expressed authority
the authority that is reasonably necessary to carry out the agent’s duties
Implied authority
the authority that the agent is not expressly given by the principal but that an agent in a similar situation normally possesses
implied authority
when the insured is led to believe the agent has authority, either express or implied, where no such authority actually exists
Apparent authority
principle that states the insured may only recover from the insurance company the amount of financial loss they experienced
Indemnity
a relationship where the person applying for insurance will incur a loss from the destruction, damage, or death of the insured subject
insurable interest
When does an insurable interest for property have to exist? i.e. at the time of issuance or the time of the loss?
Both
When does an insurable interest have to exist for life insurance? i.e. at the time of issuance or the time of loss?
Time of issuance
Do life insurance policies follow the indemnity rule? Why or why not?
No because the recovery amount is the death benefit or face value of the policy not the actual value of the insured’s life
the amount that can be recovered under a contract that provides for the repairs or replacement needed
replacement cost
contracts that set an agreed upon value of the property at issuance and at the time of the loss the insurer must pay that value to the insured
Started value contracts
True or False?
Insurance contracts, other than life insurance, cannot be transferred to another person without the written consent of the insurance company
True
an oral or written statement that is false and intended to defraud, which induces a party to enter a contract
Misrepresentation
type of misrepresentation where the statement is false and material
misrepresentation of fact
type of misrepresentation where the statement is false, material, and fraudlent
Misrepresentation of opinion
failure to disclose material facts relative to the application for insurance
Concealment
the intentional relinquishment of a known right by the insured
waiver
prevents denying a fact that was previously admitted
Estoppel
An insurance contract is a _________ contract meaning that the insurer promises to perform, but the policy owner does not promise to pay the premiums
unilateral
an insurance contract is a _____ contract meaning that the insurer will make pay benefits, but only if the insured is paying premiums
conditional
an insurance contract is an _____ contract meaning that if no loss occurs the insurer will pay nothing, but if a loss does occur the insurer will pay more than the premiums received
aleatory
states that if an insurer pays the insured for a loss caused by a third party, the insured is required to assign his right to recover from the third party to the insurer
subrogation
insurance contracts are contracts of _____ meaning you can’t negotiate, it’s take it or leave it
adhesion
Who is said to be making the offer under an insurance contract when the application includes the first premium?
The applicant/future insured
when the policy owner assigns all or a portion of the death benefit to a creditor as security for a loan
Collateral assignment
how long is the period of time before the incontestable clause for a life insurance policy kicks in?
usually 2 years
What is the typical grace period under a life insurance policy to pay premiums?
30 or 31 days
What happens when the insured dies during the grace period?
The amount of premium due will be deducted from the death benefit
How long does a typical suicide clause in an insurance policy last?
Two years
True or False?
If suicide occurs within two years the beneficiary receives the premiums paid plus any interest accumulated
False, only premiums paid, interest does not get paid out
4 rules for a life insurance policy to be reinstated
- lapse can’t be longer than 3-5 years as stated in policy docs
- policy must not have been surrendered
- acceptable proof of insurability must be provided
- all premiums due from the time of the lapse must be paid
What is the maximum loan size under a life insurance policy?
an amount equal to the cash surrender value
What does the automatic premium loan provision do?
It pays the premium from the cash value of the policy if the premium is not paid by the due date
Rules involved with an accidental death benefit rider?
death must occur within 90 days of accident
cause of death must be related to accident
age limitation is usually imposed
excludes suicide, death from disease, and acts of war
a rider that permits the policyowner to purchase additional life insurance at specific intervals without providing evidence of insurability
guaranteed insurability rider
a rider that offers additional life insurance as inflation protection
cost of living rider
a clause that provides protection against the beneficiary’s alienation of the policy proceeds by denying the beneficiary the right to convey, alienate, or assign his interest in the policy proceeds
Spendthrift clause
clause that stipulates that settlement of the policy is withheld for a specified number of days (usually 30) after the death of the insured; furthermore any surviving beneficiary who dies within this period is considered to predecease the insured
Common disaster clause
How long can most term insurance policies be renewable without having to provide evidence of insurability?
until age 70
provision involved with term insurance policies that allow you to convert to a permanent insurance policy without evidence of insurability up to a specified age
Convertible
type of term insurance that has a level face amount and exponentially increasing annual premiums
annual renewable term
type of term insurance that has a level face amount and premiums that remain constant for the term then increase if the policy is renewed at the end of the term
Level term
type of term insurance that has exponentially increasing premiums and policy cannot be renewed beyond specified age
Term to age 65 or 70
type of term insurance that has level premiums and a decreasing face amount
Decreasing term
type of term insurance that is used to protect ones mortgage
decreasing term
type of term insurance used in buy-sell agreements, mortgage protection, paying off debt, and education expenses
first to die or joint term life
life insurance policies that pay the face value of the policy only if the insured survives the endowment period
Pure endowment policies
True or False?
Pure endowment policies are available in the US
False
type of life insurance policy that pays the face value of the policy only if the insured dies within the endowment period or pay the face value (usually in the form of an annuity) if the insured survives the endowment period
regular endowment contract
type of life insurance where premiums are level and are paid for life, the face amount also remains constant for life
whole ordinary life
type of life insurance where premiums are paid for a specific number of years but the death benefit remains constant for life
limited pay life
type of insurance policy where there premium is low in the first year then increases each year for early policy years then levels off after 5-1o years
Graded premium whole life
type of insurance policy where premiums are lower for the first 3-5 years then increase to a premium slightly more than what a whole life policy would cost at that age but less than what a level premium whole policy would be at that age
Modified life
type of insurance policy where premiums are fixed but the face amount may vary with no guarantee of cash value
Variable life
True or False?
A client should have higher risk tolerance if they want to use variable life
True
Does the death benefit of variable life have a minimum guaranteed?
Yes
a life insurance policy that is interest sensitive in which the insurer’s current investment experience under nonparticipating policies is credited to the cash values
Current assumption whole life (CAWL)
under (CAWL) favorable experience relative to assumptions may make the insured have a ____ premium
lower
unfavorable experience under a (CAWL) relative to assumptions may make the insured have a ______ premium
higher
life insurance that has a flexible premium, adjustable death benefit, and is an unbundled life insurance policy
Universal Life
universal life policy that has a level death benefit
Universal Life A or Option 1
universal life policy where the death benefit equals face amount of policy plus cash value (increasing DB)
Universal Life B or Option 2
true or false?
universal life B is more expensive than universal life A
True
an universal life policy with investment options for the cash value and no minimum guarantee rate of return or interest
Variable Universal Life
Are death benefits under VUL guaranteed?
No
are premiums greater for first to die or second to die policies?
first to die
second to die has cheaper premiums
life insurance that protects the lender or borrower from financial loss in the event the borrower dies before completing payment of debt
Credit Life
what does the death benefit under credit life usually equal?
the loan balance
True or False?
Credit life premiums are high relative to the amount of coverage provided
True
life insurance that has a known maximum cost and a minimum death benefit
whole life
life insurance that has a know maximum costs and minimum death benefit but allows for investment options
Variable Life (Whole)
a method of evaluating a person’s need for capital resources upon death
Programming for Life Insurance
a method of determining the amount of life insurance needed that uses interest only to furnish the continued support of the family
Capital Retention
True or False?
Capital Retention method accounts for inflation
False, it does not
under this method, the original principal or capital saved by the client still remains at the end of the income period
Capital Retention
a method of determining the amount of life insurance needed by projecting the income of the individual through the remaining work life expectancy, including raises - then discount it back to PV
Human Life
a method of determining the amount of life insurance needed by examining all recurring expenses to dependent survivors and any unusual expenditures that may result from the death of the individual
Financial Needs
What are the factors that should be considered if using the financial needs method?
marital status, role of spouses (work or not), size of family, and dependents’ willingness to work
in regards to life insurance this is a fund of pooled death benefit that includes last medical costs and funeral costs
fund for final expenses
in regards to life insurance this is a fund of pooled death benefit that covers the period following death and may include nonrecurring costs as the family adjusts to the death of a provider
fund for readjustment
in regards to life insurance this is a fund of pooled death benefit that covers the period with highest needs because dependents require income for living and other expenses
dependency period income fund
in regards to life insurance this is a fund of pooled death benefit used to pay of debts
the mortgage payment fund
in regards to life insurance this is a fund of pooled death benefit that establishes money for education
the education fund
in regards to life insurance this is a fund of pooled death benefit that establishes a way for the surviving spouse to have income for life if they do not work or does not have the skills necessary to work
life income for the spouse fund
True or false?
Guaranteed values in an insurance contract mean that the insurance company holds the risk
True
what is the largest component of price and performance in a term life policy?
Mortality assumptions
what is the largest component of price and performance is a whole life policy?
Investment experience
how to calculate the net cost of an insurance policy
Face Value - total premiums paid - total dividends paid - cash value at end of term - cost per year = net cost per year
then take net cost per year divided by (policy face value divided by 1,000) to get cost per $1,000
problems associated with net cost of insurance method
does not account for TVM
assumes future cash value, premiums, dividends
assumes policy lasts until expiration
how to calculate the interest adjusted method
(surrender cost) index
face value
- total premiums that have been inflated by an interest rate
- dividends that have been inflated by same interest rate
- cash value at end of term
= insurance cost
calculate pmt using annuity due with n selected terms and i interest rate
take that pmt and divide it by (Face value/1,000)
what is the difference between the surrender cost index method and net payment cost index method
the net payment cost index does not account for the cash value of policy
company that rates insurance companies based on public info and interviews with management
AM Best
company that rates insurance companies based on public info and management interviews, but public info alone may be enough to assign a rating
Fitch
company that rates insurance companies based on the basis of public info alone
Moody’s or Fitch
company that rates insurance companies only upon request
Standard and Poor’s
what is the risk of superannuation?
the risk of running out of money
type of annuity that has a lump sum premium with an annuitization period deferred until some point in the future
Single Premium Deferred Annuity (SPDA)
type of annuity that allows for periodic, nonfixed contributions/premiums and earnings accumulate tax free and are then distributed at somepoint in the future
Flexible premium deferred annuity (FPDA)
type of annuity where the annuitant pays a single premium then the payments begin
SPIA (Single premium immediate annuity)
true or false?
with fixed annuities the insurer bears the investment risk?
True
true or false?
fixed annuities are better for high risk tolerance clients
false, fixed annuities are better for low risk tolerance
an annuity contract that is credited with a return based on changes in an equity index
Equity Index Annuity (EIA)
Do equity index annuities usually have a guaranteed minimum rate of return?
Yes, usually
a type of annuity that offers a credit based on a percentage of the premium paid
Bonus annuity
the practice of using misrepresentations to induce a policyowner with one company to lapse/forfeit/surrender a life insurance or annuity policy for the purpose of taking out a policy with another company
Twisting
the practice by which policy values in an existing life insurance policy or annuity contract are used to purchase another policy or contract with that same insurer for the purpose of earning additional premiums or commissions
churning
formula for investment in an insurance contract
premiums paid - dividends received - outstanding loans or withdrawals
formula for basis in an insurance contract
premiums paid - dividends received - outstanding loans or withdrawals - cost of insurance before the sale
formula for gain at surrender in an insuarnce contract
cash surrender value - investment in contract
formula for gain at sale of an insurance contract
sale price - basis
True or False?
The general rule is that the annual cash value increase in a life insurance policy is not subject to current income taxation
True
True or FAlse?
Invetment gains in variable life contracts are tax deferred
True
True or FAlse?
life insurance premiums that are considered as alimony payments resulting from a divorce or separate maintenance decree are tax deductible by the payor and taxable to the payee
True
True or False?
Dividends distributed from an insurance contract are taxable
False, generally speaking
True or False?
Dividends distributed from an insurance contract are considered a return of basis
True
True or FAlse?
If dividends distributed under an insurance contract exceed the owner’s premiums paid then they are taxable
True
True or FAlse?
No gain is realized if you exchange a life insurance policy for another life insurance policy, an endowment policy, an annuity contract, or a qualified ltci policy
True
True or false?
no gain is realized if you exchange an endowment contract for for a life insurance policy, an endowment policy, an annuity contract, or a qualified ltci policy
false, only no gain if exchanged for last 3 listed
In order for no gain to be realized from an annuity exchange, the annuity must be exchanged for what kind of policy or policies?
another annuity or qualified LTC event
in order for no gain to be realized from a ltci policy the policy must be exchanged for what type of policy or policies?
another LTC policy
Withdrawals under a non Modified Endowment Contract use what taxation method?
First in First out
basis comes out first
withdrawals under a modified endowment contract use what taxation method?
Last in First out
taxed until it gets down to basis
what is the taxation of the cash surrender value?
ordinary income if cash surrender value exceeds the investment in the contract
if the beneficiary chooses to receive interest only payments instead of the lump sum death benefit, will the interest payments be taxable?
Yes
If Karen took an annuity settlement option for a $100,000 face policy that would pay her $644.30 per month for the rest of her life (25 years life expectancy), how much of each monthly payment would be taxable?
$310.94
True or false?
An annuity from life insurance proceeds retains its original exclusion ratio after the annuitant/beneficiary lives past the original life expectancy
True
True or false?
Life insurance death benefit proceeds avoid probate if there is a named beneficiary
True
3 situations where the death benefit proceeds are included in the gross estate
- the policy was gifted to someone else within 3 years of death
- the proceeds are payable to the estate, executor of the estate, or creditors of estate
- the decendent (person who died) retained incidents of ownership such as the right to assign the policy, the right to change bene, the right to change policy provisions
an agreement that states the insured is expected to die within 24 months and the proceeds received from the sale of the policy are not subject to income tax
viatical agreement
True or false?
an insured who is chronically ill can exclude the gain from a sale of life insurance policy if the proceeds are used for the insured ltc.
True
When did annuities change from FIFO to LIFO
August 1982
calculation for fixed annuity exclusion ratio
investment in the contract / expected return
Jimmy has a basis of $400,000 in his non qualified fixed annuity. His life expectancy at age 65 is 25 years, and his monthly payment is expected to be $2,000. What is his expected return on the contract and his exclusion ratio?
expected return = 25 x 12 x 2,000 = $600,000
exclusion ratio = 400 / 600 = .6667
True or false?
Payments beyond the projected life expectancy of an individual under a fixed annuity are fully taxable
True, unless payments began before 1986
calculation for variable annuity exclusion ratio
investment in contract / annuitant’s life
William purchased a variable annuity at age 63. The total cost of the contract was $15,000. The annuity starting date was january 1 of the year he purchased the annuity. His annuity will be paid annually starting on july 1 of the year he purchased it. His life expectancy is 21.6 years. What is his exclusion ratio?
$15,000 / 21.6
$694.44 per year is tax free
True or False?
if an annuity contact is held by an entity who is not a natural person (i.e. a corporation), the earnings or loss on that contract are included in taxable income for the year
True
Group life insurance premiums up to the first $_____ of coverage paid by the employer are tax exempt to the employee
$50,000
ABC company maintains a group life insurance policy for its employees. An employee age 56 is provided with $200k worth of coverage. The cost per $1,000 of protection per month is $.43 for someone in his age bracket. If the employee contributes $350 annually towards the cost of his coverage, how much will be included in his gross income
excess coverage - cost per $1,000 - monthly cost of coverage multiplied by 12 = annual cost of coverage - employee contribution =taxable amount
True or FAlse?
health insurance premiums paid by the employer for health insurance are taxable to the employee
False, they are tax exempt
True or False?
health insurance premiums paid by the employer are tax deductible for the employer
true
an arrangement between an employer and an employee, where the costs and benefits of the life insurance policy are shared
Split-dollar life insurance
True or false?
under a split dollar life insurance plan, the employer receives a tax deduction for the premium payments it makes
false
True or false?
A split dollar life insurance plan can be effective for employees who fear a post retirement death
false, helps protect pre retirement death more
what are the three ways to split a split dollar life insurance policy?
premium
cash value
policy ownership
split dollar plan where the employer pays a portion of the premiums equal to the increase in cash surrender value
the classic or standard split dollar plan
split dollar plan where the employee’s premium share is level for a number of years
level premium plan split dollar
True or false?
under key employee life insurance, the premiums are tax deducitble by the employer
FAsle
split dollar policy ownership where the the employee is the owner
collateral assignment
split dollar policy ownership where the employer is the owner
endorsement method
True or false?
under an executive bonus life insurance plan, the employer has an income tax deduction in the year the bonus is paid
True
True or false?
under an executive bonus life insurance plan, the employee does not recognize taxable income when the bonus is received
False
True or false?
the cost of life insurance is deductible for self employed individuals
FAlse
True or false?
IRA’s are not permitted to hold life insurance
True
In regards to life insurance in qualified plans, no more than ___% of the employer’s contributions can be used to purchase a whole life policy
50%
In regards to life insurance in qualified plans, no more than ____% of the employer’s contributions can be used to purchase a life policy other than whole life
25%
for defined benefit plans no more than ___ times the monthly benefit can be covered by the death benefit
100 times
example: Monthly benefit is $2,000….death benefit can be no more than $200k
The 4 R’s associated with nonqualified deferred compensation plans
recruit
retain
reward
retire
true or false?
non qualified deferred compensation plans do not need to meet discriminatory testing
True
Under nonqualified deferred compensation plans, when can an employer realize a tax deduction?
Not until the year where the income is taxable to the employee
True or FAsle?
S corps and parthnerships cannot take full advantage of nonqualified deferred comp plans
True
occurs within nonqualified deferred comp plans if the executive has access to funds or if the funds are securely set aside for the executive
constructive receipt
True or False?
Funds under construtive receipt do not have to be reported as taxable income
False
True or false?
a substantial risk of forfeiture allows for the nonqualified deferred comp plan to be tax deferred
True
Which of the following qualifies as a substantial risk of forfeiture, resulting in no current income tax?
- an unsecured promise to pay
- a rabbi trust
- a secular trust
1 and 2 only
a trust set up to hold property for funding a deferred comp plan
Rabbi Trust
a trust for the exclusive benefit of the employee
Secular trust
True or false?
secular trusts are irrevocable
true
True or false?
Rabbi trusts are subject to creditors
True
true or false?
secular trusts are subject to creditors
FAlse
a nonqualified retirement plan for key company employees, such as executives, that provides benefits above and beyond those covered in other retirement plans such as IRA, 401(k) or nonqualified deferred compensation NQDC plans.
SERP Plans
Supplemental Executive Retirement Plan
type of plan that has a salary continuation design that provides a specified deferred amount payable in the future without reducing current income
SERP Plans
true or false?
under a SERP plan an employer receives a tax deduction only when the benefits are paid to the executive
True
a nonqualified deferred compensation (NQDC) plan that provides supplemental retirement income benefits to employees whose benefits under the employer’s qualified retirement plan are limited by the application of Internal Revenue Code (IRC)
Excess Benefit Plan
When is income on a nonqualified stock option realized?
at exercise
when you exercise a nonqualified stock option how is your basis in the stock determined?
basis = exercise price plus the ordinary income you realize from exercising the option
how much income will Brewster include in his wages if he receives 10,000 NQSO at $10 per share and exercises them when the market price is $25 per share
$150,000
How much gain does Brewster have if he receives 10,000 in NQSO at $10 per share and exercises them when the market price is $25, he then sells them several years later for $100 per share
$750,000 in gain - long term
True or false?
the employee will realize ordinary income when the transferee exercises the NQSO that were transferred from the employee to the other entity
True
Which date is used to determine when NQSO are considered gifts?
the latter of the transfer date or vested date
True or FAlse?
If an employee transfers NQSO to a charity, the employee will still realize compensation income when the charity exercises them
true
true or false?
the expiration date for ISOs can be greater than 10 years from the grant date
false
True or false?
while living, an employee can transfer ISOs to another party
false
when must ISOs be be exercised by?
within 3 months from retirement/termination date
how long do you need to hold ISOs for favorable tax treatment?
2 years from grant date, 1 year from exercise date
true or false?
when you exercise ISO you realize compensation income
false
is there payroll tax on ISO that are sold within 1 year of exercise
No, but it is included as compensation income
In regards to ISO, how do you calculate an employee’s adjusted basis for regular tax
the exercise price x # of shares
In regards to ISO, how do calcualte the basis for AMT
it equals # shares x fmv of stock
If there is a non qualified disposition with an ISO, is it possible to have a capital loss?
no
Calculate the cost of the following cashless exercise NQSO: and how many shares would have to be sold to satisfy the cashless transfer
Three years ago, Tina was granted a nonqualified stock option to purchase 100 shares of employer stock at $20 per share. She exercised the option when the FMV of the stock was $30, assume her marginal rate is 28%
exercise cost = 20 x 100 = 2,000
tax cost = 30 - 20 x 100 x 28% = $280
total cost = $2,280
shares to be sold = $2,280 / 30 = 76
Under an Employee Stock Purchase Plan, what is the mimum grant price allowed?
85% of the FMV on the date of grant or
85% of FMV on the date of exercise
how long does an employee have to hold shares under a ESPP to receive favorable tax treatment
2 years from grant and 1 year from exercise
Through his company’s ESPP, David receives an option to purchase 1,000 shares of XYZ stock at $20 per share, when the FMV of the stock was $22 per share. He exercises the options when the market price is $25 per share. 5 years later, Dave sells the shares for $100. What are the tax consequences?
$2,000 ordinary income
$78,000 capital gain
how do you determine the income component of stocks exercised under a ESPP?
the lesser of fmv on date of grant - option price
or the fmv on date of disposition - option price
how is phantom stock taxed to the employee?
at retirement or other termination event the vested value is received as cash and taxed as ordianry income
similar to phantom stock, except it gives the right to the monetary equivalent of the increase in the value of shares of stock over a specified time period
stock appreciation rights
states that an employee who receives restricted stock may elect to recognize the income immediately rather than waiting until there is no longer a substantial risk of forfeiture
Section 83b election
how long does an employee have to make an 83b election?
30 days after receiving the restricted stock
when is restricted stock taxed?
when there is no longer a substantial risk of forfeiture:
when it is vested
meeting performance goals
What are the tax consequences of the following transaction assuming no section 83b election:
Mark has restricted stock of 1,000 shares worth $10 at time of grant. Mark is required to work for the company for 5 years otherwise the restricted stock is forfeited. Mark works for 7 years. The stock was $40 by end of year 5. Mark then sells the restricted stock at $45
Mark realizes $30,000 in compensation income at year 5
Mark has a long term capital gain of $5,000 in year 7
If 83b was elected:
Mark has $10,000 in compensation in year 1
Mark has long term capital gain of $35,000 in year 7
True or false? an employee is taxed when they convert junior class shares into common class shares
False
True or false? an employee is not taxed on the date the junior class shares are issued
True
a plan in which employee may, within limits, choose the form of employee benefits from a selection of benefit provided by the empolyer
cafeteria plan
true or false?
cafeteria plans must include a cash option
true
True or false?
cafeteria plans are not complex
false
true or false?
cafeteria plans are expensive to administer
true
are cafeteria plan subject to discriminatory testing?
Yes
Employers who employed on average ___ or fewer employees during the preceding two years are allowed to use SIMPLE cafeteria plan
100
eligible employers who start a SIMPLE cafeteria plan can maintain the plan until they exceed ____ employees during the preceding year
200
can scholarships or fellowships be provided under a cafeteria plan?
no
can dependent care services be provided under a cafeteria plan?
yes
can employee discounts be provided under a cafeteria plan?
no
can non qualified or qualified deferred comp be included in a cafeteria plan?
no
can group life insurance be provided under a cafeteria plan?
yes
can a HSA be included in a cafeteria plan?
Yes
can accident and health benefits be included in cafeteria plans?
yes
can long term care insurance be included in cafeteria plans?
no
how many hours are required for an employee to be eligible under a SIMPLE cafeteria plan?
1,000
can someone under 21 years old take part in a SIMPLE cafeteria plan?
No
how many years of service are required to participate in a SIMPLE cafeteria plan?
1 year
a cafeteria plan in which employees can be reimbursed for qualified expenses
flexible spending account
what are the two types of FSA’s?
health FSA
dependent care assistance fsa
maximum amount allowed to be reimbursed for health/medical expenses under a FSA for 2017 is ___
$2,600
what is the maximum annual salary reduction for dependent care expenses under a FSA for 2017?
$5,000
what is the maximum salary reduction if an employee uses a health FSA and dependent care FSA for 2017?
$7,600
are contributions to FSA’s subject to payroll taxes?
no
are FSA’s use it or lose it? or do they allow carry over?
use it or lose it
true or false?
long term care insurance and over the counter drugs are eligible for reimbursement under a FSA
false, besides for insulin
Calculate the total tax savings from the below FSA assuming all expenses are qualified:
employer uses $2,000 of FSA for qualified expenses avoiding the following taxes: 15% fed 4% state 1.45% medicare 6.2% SSI
total savings = 26.65% x 2,000 = $533
are prepaid legal services included in the employees gross income?
Yes
are prepaid legal services tax deductible to the employer?
Yes
true or false?
an employee does not have to include child and dependent care services under $5,000 in their gross income if provided by the employer
True
True or False?
dues paid to a private health club/gym by the employer are taxable to the employee as wage compensation
True
is qualified employer provided educational assistance at undergrad and graduate levels included in an employee’s gross income?
no, maxed at $5,250 though
benefits that are so small that accounting for them would be impractical and therefore are excluded from an employee’s gross income
de minimis fringe benefits
example of de minimis fringe benefits
company computer or copy machine
a type of welfare benefit plan into which employers make deposits that will be used to provide future employee benefits
Voluntary Employees’ Beneficiary Association (VEBA)
in what year are VEBA contributions deductible to the employer
in the year they are made
can life insurance benefits be included in a VEBA?
yes
can commuter expense coverage be covered in a VEBA?
no
can vacation be included in a VEBA?
yes
can job training benefits be included in a VEBA?
yes
true or false?
A VEBA sits inside an irrevoacble trust
True
can accident/homeowners insurance be included in a VEBA?
no
Can savings, retirement, or deferred comp be included in a VEBA?
no
how long do short-term disability benefits generally last?
2 years
how long do long-term disability benefits generally last?
more than two years or until a certain age, usually 65
what has greater chances of occurrence, generally speaking, death or disability?
disability
true or false?
own occumpation disability is the msot expensive
true
what is the difference between own occupation and modified occupation?
modified states that the insured can not be working to claim benefits
under the social security definition of disability, how long must the disability last
at least 5 months and expected to last at least 12 months or unti ldeath
does disability insurance usually exclude preexisting sicknesses?
yes
disability policy where if the employee returns to work for lesser pay the policy will pay the difference between original pay and the lesser pay
residual policy rider
occurs when an insured is unable to perform one or more important duties of his own but can still perform some duties
partial disability
true or false?
when disability benefits under a policy are lowered by social security disability benefits your premiums will be lower
true
designed to cover the expenses that are usual and necessary in the operation of a business should the owner/insured become disabled
business overhead expense insurance
are premiums deductible under business overhead expense insurance
yes
what is the maximum benefit length under business overhead expense insurance
1-2 years
are benefits under business overhead expense insurance taxable?
yes
under key employee disability insurance, are premiums deductible if the employee is the beneficiary?
yes
under key employee disability insurance, are premiums deductible if the employer is the beneficiary?
no
under key employee disability insurance, are benefits tax free if paid to the employee?
no
under key employee disability, are benefits tax free if paid to the employer?
yes
how long does a policy owner have to wait until they can receive their first disability payment with most policies?
elimination period plus 30 days
health or dissability policies that guarantee the insured the right to renew until a specified age or # of year with no premium increases
noncancelable policies
health or disability policies where a right to renew is guaranteed but the insurance company can increase premiums on a class basis
guaranteed renewable
health or disability polices where the insurance company may terminate the policy if certain conditions are met
conditionally renewable
what is the time limit for incontestability?
two years except for fraud
how long does the insured have to notify the insurance company of a claim they want to file?
20 days
how long does the insured have to provide proof of loss?
90 days from date of loss
disability option you can select that increases the coverage amount as your income increases
guarantied insurability option
disability option you can select that increases your benefit each year by inflation or some other index
cost of living adjustment benefit
what is the difference between hospital reimbursement contract and hospital service contracts
reimbursement contracts pay the insured for the costs they realized during hospital stay, where as service contracts allow the insured to receive actual hospital services for a stated number of days
amounts an insured must pay to receive certain covered services
copayments
what does 80/20 coinsurance mean?
the insured pays 20% of covered expenses after the deductible is reached and before the stop loss limit is reached
the dollar amount of covered benefits to which the coinsurance provision is applied
stop loss limit
the maximum amount the insured must pay including the deductible and coinsurance payment
maximum out of pocket
how much does does Jane’s insurance company pay in the following scenario:
jane becomes ill and has a insurance policy with $250 deductible and 80% coinsurance. She incurrs medical bills of 7,000 and doctor expenses of 3,250
$8,000
how much would mary pay under the following scenario:
mary becomes ill and realizes 6k of medical expense. her policy has a $300 deductible with a 5,000 stop loss limit. coinsurance is 80/20
300 + 20% x 5,000 = $1300
an organization that provides a broad range of health services to a group of subscribers for a fixed periodic payment
Health maintenance organization
hospital and surgical expenses coverage that requires the insurance company to pay the first costs that are insured, without being subject to a deductible
first dollar coverage
can self employed personas deduct health insurance costs?
yes
do HMO’s provide out of network service?
no
do PPO’s provide out of network service?
yes but at higher costs
what are the qualifying events under extended cobra coverage?
death
termination of employment
change in employment status (full time to part time)
divorce or legal separation
child reaching an age where the child is no longer eligible
employee reaches medicare age and spouse/dependents lose coverage as a result
how long does the individual have to select coverage if they want to be covered by COBRA’s extended coverage provision?
within 60 days of qualifying event
how long does the individual have to pay the premium for coverage under COBRA’s extended coverage provision?
45 days
how much can the employer charge for COBRA coverage?
up to 102% of normal group rates
