CFP 1: Insurance & Investments Flashcards
How do you calculate the amount of Life Insurance needed? What two things do you have to do in addition to Paul’s calculation?
Take annual income, ÷ by rate of return. Add one year of income for the first year.
If you’re given a rate of inflation, subtract it from the rate of return; don’t bother calculating a real rate of return.
What is AM Best?
The most detailed insurance company evaluator. It’s ratings range from A++ to F.
Name HO-2, 3,4,5,6, and 8
HO-2 = Broad Peril HO-3 = Mostly Open Peril, broad for personal property HO-4= Renter's HO-5 = All Open Peril, also called H0 3/15 HO-6 = Condo's. Can have coverage against assessments HO-8 = Older homes, Basic Peril only.
Name Parts A, B, C, D, E, F, & I of Homeowners Ins.
Part A; Dwelling + attached structures (land is not insurable) Part B: Other structures (10% of A) Part C: Personal property (50% of A) Part D: Loss of use (30% of A) Part E: Medical payments Part F: Personal Liability Part I: Deductible
Name the Exclusions from Open Peril (Hint: Open WIFI)
Ordinance of law Power failure Earth Movement Nuclear accident/Negligence War Intentional Flood I should learn this =)
What are the two cost calculations insurance companies use, and which do they usually pay?
Replacement Cost and Cash Value Method. They pay the greater of the two.
How do you calculate replacement cost of a house for insurance purposes?
Replacement cost of house x co-insurance % (usually 80, sometimes 90). This is the amount you should carry.
Divide by 80%
Multiply by amount of loss.
Subtract deductible.
How do you calculate the cash value of a home?
Multiply replacement cost by factor of depreciation.
Subtract deductible.
Is Worker’s Comp taxable? Is Group Disability?
Worker’s Comp is not taxable. Group Disability is usually paid by the employer, thus the benefits are taxable.
Who is eligible for Medicare? (2)
People over 65.
Disabled people who have rec’d SS benefits for 2 years.
What does Medicare Part A cover?
Hospital stays, skilled nursing home, home health (not home care) or hospice care.
It doesn’t cover outside the US.
It pays after employer health ins. or worker’s comp.
What does Medicare Part B cover, and how does it work?
Name three things it includes and three things it excludes.
It covers Dr. visits, including for depression, counseling for ETOH, and CBT for cardiovascular disease.
It has a premium, a deductible, and an 80/20 split, with NO STOP LOSS
It excludes dental, visual, hearing, and drugs.
What is Medicare Part D?
It’s run by private companies approved by the govt.
Companies must provide a 50% discount.
It covers medications.
What are Medigap policies? What do they pay for?
Private insurance that covers deductibles and co-pays of Parts A and B.
It works like an HMO, so isn’t very flexible.
You must enroll in Medicare parts A and B to purchase.
What are the 3 types of disability insurance? Which one does CFP recommend?
Own Occupation (the one CFP recommends)
Any Occupation (that your training qualifies you for)
Split, which gives you a period of Own, followed by a period of any.
SS also has a “total disability” which means you can’t work at all, and likely won’t work again.
When are disability benefits taxable?
Hint: 3 answers. One for section 162, one for “salary continutation”, and one for S-corps.
If the ER pays the premium as a bonus (section 162), the benefit is tax free
If the employer pays the premium as a “salary continuation”, the benefit is taxable.
If an S-corp pays the premium to a partner or a > 2% ownerthe payments are deductible, and the benefits are tax free.
Does Medicare pay for LT care?
Does it pay for skilled nursing care? (If so, how?)
Does Alzheimer’s qualify for skilled nursing care under Medicare?
Medicare DOES NOT PAY FOR LONG-TERM CARE.
Medicare pays for skilled nursing care in 3 tiers
- Days 1-20 paid in full
- Days 21-100 require a co-pay of $185/day
- After 100 days, medicare doesn’t pay.
Note: For Medicare to pay, your condition must be expected to improve, so Alzheimer’s doesn’t qualify.
What are the only 3 ways you can pay for LT care?
LT care insurance
Your own assets
Medicaid
What is Whole Life insurance?
A cash value life insurance with a fixed death benefit. You can pay in a few installments or over many years. Must pass the 7-pay test, or it’s a MEC.
What is Term life insurance? What are Level Term and Decreasing Term?
Term is usually the cheapest for younger people, and the best for changing circumstances.
- Level Term keeps the premium constant over the term of the policy by pre-paying some of the later premium.
- Decreasing Term keeps the premium constant by reducing the death benefit as the insured gets older.
What are Universal A and B Life Insurance?
What is Variable Universal?
Universal A pays face value, and the company retains some of the cash value.
Universal B pays face value + cash value.
Universal life is flexible regarding adjusting the premium, the death benefit, and using the cash value to pay premiums or for additional insurance.
Variable Universal allows the owner to invest the cash value in the stock market.
For the CFP Exam, who is Whole Life best suited for? Variable? Universal? FTD Variable Universal? What is the point of STD LI policies?
Whole Life is for someone who wants to be forced to save, or who has little risk tolerance.
Variable is for someone who has investment knowledge, or has high risk tolerance.
Universal is for someone who can afford a premium presently, but might need to cut back because they have low job security.
STD LI policies are there to create liquidity at death.
Variable Universal FTD is the policy for cross purchase agreements
What is the difference between insurance contract provisions and riders?
Contract provisions don’t require additional premiums, riders do.
What is a Guaranteed Purchase or Guaranteed Insurability rider?
It’s a rider that allows you to purchase additional insurance at regular intervals without providing evidence of insurability.
What are Viatical Settlements of LI?
If you’re terminally ill, you can sell your policy to a viatical company (or use an accelerated benefits rider if you have one) to access your LI benefit tax free. Any unused benefit becomes part of your estate.
If you’re chronically (but not terminally ill) you can use your viatical settlement to pay for LT care.
What are Life Settlements of LI? How are they taxed?
Hint: Part is tax free, part is OI, and part is LTCG.
A Life Settlement is a way to access your LI death benefit even if you’re not terminally or chronologically ill. It’s taxed as follows:
- Premiums paid are returned tax free.
- Any amount between premium paid and cash surrender value is taxed as OI.
- Any amount between cash surrender value and net proceeds is taxed as LTCG.
What is the Uniform Simultaneous Death Act? Why is a Survivorship clause potentially better?
The USDA states that any persons that die with 120 hours of each other are said to pre-decease each other as regards their estates. This prevents double estate taxation when a married couple dies.
A survivorship clause does the same thing in a trust or will and can be up to six months.
What makes a MEC? How are they taxed?
Any LI policy that fails the 7-pay test is a MEC. It’s then treated as a deferred annuity for tax purposes.
- Distributions are taxed LIFO.
- 10% penalty if withdrawn before 59.5
To whom can one transfer LI? (4)
To whom can’t one? (2)
LI policies can be transferred to:
- The insured
- The insured’s partner in a partnership.
- To a corporation where the insured is a partner or officer.
- To one’s ex in a divorce.
LI can’t be transferred to:
- A family member of insured.
- A partner of the insured in a corporation.
T. or F.: 1940 featured both an investment adviser’s act, and an investment company act.
True. Read those questions carefully.
Are investment advisers regulated through the SEC or FINRA?
They are regulated by the SEC, but through FINRA.
What is the difference between CD’s and Money Market accounts?
What is a Money Market Mutual Fund?
CD’s and Money Market accounts are the same thing.
Money Market Mutual Funds are a collection of high-quality short-term securities.
Are death benefits from a MEC taxable?
No. It’s LI after all.
Are key employee insurance premiums deductible?
No.
What are Split Dollar Plans? What are the two types?
Split Dollar Plans are key employee insurance.
Type 1: Endorsement
- Company owns policy and pays premiums.
- At death, company receives the greater of premiums paid or cash value of policy.
- EE’s beneficiary receives remainder of proceeds.
- Advantage ER because they rec. the cash value of the policy above premiums paid.
Type 2: Collateral Assignment
- Employee owns the policy but assigns to the ER the value of the premiums paid from the death benefit. Assigning means giving up the power to change the beneficiary.
- Company loans premium amt. to EE in exchange for assignment.
- Advantage EE because they receive amount of $ value in excess of premium.
- This is common for EE’s who are stock holders.
What is Business Overhead Insurance? When is or isn’t it deductible/taxable?
It covers overhead expenses if owner is disabled.
Doesn’t cover owner’s salary.
Premiums are deductible and benefits taxable for a sole proprietor.
Premiums not deductible and benefits not taxable for a corporation.
How does a Pure Life Annuity work? Is it included in gross estate? What is the risk?
It makes payments only for the lifetime of the beneficiary. No inclusion in gross estate because it’s over. It risks a loss of family wealth if you die quickly.
What is a Period Certain Annuity? What is a Refund Annuity?
A Period Certain Annuity guarantees a certain amount of payments. If you die early it goes into your estate. Payouts are < Pure life annuity, but the risk to family wealth is reduced.
A refund annuity guarantees a refund of your basis if you didn’t live long enough to get it all back in payments.
- Payments are still < Pure Life.
- May provide liquidity for estate tax.
- Risks double taxation.
What is a Joint and Survivor Annuity? What is a Joint Life Annuity?
J+S pays until the death of the STD spouse.
- Payments are reduced.
- Nothing left for heirs.
- Spouse is taken care of.
Joint Life Annuity is a Pure Life Annuity for one spouse. It’s almost always the wrong answer on the CFP exam.
What is a Single Premium Deferred Annuity?
What is a Variable Annuity?
What is a QLAC?
SPDA– accumulates earnings tax-deferred until payout.
Variable Annuity–invests in mutual funds for accumulation, payout, or both. It’s the answer for an investor with a high risk tolerance who wants to “keep up with the market” or “cope with inflation.”
A QLAC is a deferred, fixed annuity from an IRA or retirement plan. It can defer income tax by reducing RMD’s.
How are annuities taxed?
How are annuities owned by entities taxed?
Normal withdrawals are LIFO. 10% earnings penalty if before 59.5.
Normal annuity payments have an exclusion ratio that represents return of basis. Calculate total payments, ÷ by basis, that is the exclusion ratio. The % that is taxed = 1 - exclusion ratio.
Annuities owned by entities are taxed as OI.
How are Permanent Group Life premiums taxed?
Term Group Life premiums?
Permanent, non-forfeitable insurance is deductible to ER and taxed to EE.
Term Group Life is only taxed if the death benefit > 50k
- The tax is computed by a table amount per 1k of benefit over 50 per month.
7 Other Thoughts about Group Term
- Is it subject to FICA and FUTA?
- How much coverage can EE dependents get w/o it being taxed as income?
- Can it be discriminatory? If not, what consequence?
- Who owns the policy? Who names the beneficiary? Who’s estate does the death benefit go in?
- How does the EE get the db out of their estate?
- Can the EE convert when they quit or retire?
- Group Term benefit is subject to FICA and FUTA
- EE Dependents can get 2k coverage for free but beyond that premium is taxed as income.
- Group Term must be non-discriminatory. If it discriminates, keys must include the full cost of their insurance in their income above the 50k exemption.
- Usually, the ER owns the policy, but the EE names the beneficiary. The death benefit becomes part of the EE’s estate.
- If the EE gives up all rights to the policy for at least 3 yrs (absolute assignment) the DB is no longer part of their estate.
- When an EE quits or retires, they can convert group term to permanent without having to prove insurability.
- 162 is a carve out for key employees wherein the EE owns the policy and the ER pays the premium. Deductible to the ER, taxable to the EE. Portable to the EE.
3 Thoughts on SS Disability Benefits
- How do you qualify?
- When do payments begin?
- When do they impact your disability insurance?
- To qualify, your disability must be expected to last at least 12 months or result in death.
- Payments begin with the 6th full calendar month of disability.
- Payments usually reduce what you’re receiving from your disability insurance.
What is the Flex Spending Max. salary reduction and grace period?
Max salary reduction is $2,750 for 2021. There’s a 2.5-month grace period for the max amount or you can have a rolling balance of $550, but not both.
Flex spending is usually separate accounts for medical and dependent care.
5 Details about Dependent Care FSAs
- What is the max deferral?
- Do both spouses have to work to qualify?
- Does it effect dependent care credit eligibility?
- If expenses are for a child, they must be under what age?
5k max for 2021
Yes, Yes, 13
Can 401k’s be part of Cafeteria Plans?
Yes.
What fringe benefits are tax free to the EE? (9)
Hint: they’re for things the govt. wants to encourage + things that are occasional
- Premiums for health ins. for EE or dependents
- Group life premiums up to $50k death benefit
- ER provided day care
- Company car for business only
- Transit or bus pass up to $270/mo
- Parking up to $270/mo
- Occasional overtime meal, cab fare, theater or sports tickets
- Discounts on company products up to profit margin
- Discounts on services up to 20%
What are Money Market Deposit Accounts?
Commercial accounts that allow up to 6 withdrawals/month. Same account category as CD’s.
What are Money Market Mutual Funds? Are they FDIC insured?
MMF’s are not FDIC insured! They’re short-term debt stuff, t-bills, commercial paper. Typically offered by open-end investment companies.
What are Banker’s Acceptances?
They’re used to guarantee payment to shippers. They are bearer securities, sold at a discount to par.
What are Euro Dollars?
Accounts in dollars in a foreign country.
What are Yankee bonds?
Bonds issued in the US by foreign companies.
What is a bond point worth? What % of interest rate change does it represent?
It’s typically 1% of interest rate change. For a $1,000 bond, it’s worth $10.
What is the yield hierarchy for DISCOUNTED bonds?
Hint: When you see a discount, Call Mom Currently
Yield to call > Yield to maturity > Current yield
What is the yield hierarchy for premium bonds?
Hint: This means interest rates have fallen.
Current yield > Yield to maturity > Yield to call
