CFP - Insurance Flashcards
Viatical and life settlements
Ex. Viatical settlement - Company paid dying person $250k for their $500k policy and paid and additional $10k premium. What amount is taxable to the company and what about is taxable to the dying person?
Ex. What happens if the terminally ill person miraculously heals?
Ex. Mr. Golden bought a $1 million life insurance policy 10 years ago. He has paid $150,000 in premiums over 10 years. The current cash value is $175,000. The cost of the insurance over 10 years was $10,000. Mr. Golden has no use for the policy anymore. A life settlement company has offered him $400,000 in cash to buy the policy. If he sells the policy, what will be the taxable event to him? Hint: Remember the trick to life settlements.
Ex. $500k - basis ($250k + $10k) = $240k at ord. income rates for the company
-$0 taxable to the dying person
Ex. The person who sold their contract is not affected, but the viatical companies return will suffer if the terminally ill person continues to live longer.
Viatical settlement = terminally ill
Life settlement = not terminally ill, usually over 65, and sale taxed at LTCG
General life surrender = Normally ord. income and possibly 10% penalty
Ex.
-$25,000 taxed as ordinary income The income is characterized as ordinary income to the extent the cash value exceeds the premiums paid ($175,000 - 150,000) or $25,000
The cost of insurance affects the premiums paid . $150,000 - 10,000 = $140,000 basis. Mr. Golden will have to recognize income of $260,000 (400,000 - 140,000). The income is characterized as ordinary income to the extent the cash value exceeds the premiums paid ($175,000 - 150,000) or $25,000. The balance will be treated as capital gains $260,000 - 25,000 or $235,000. HINT: With this type of question always back into the answer.
Roadmap - Settlement options, nonforfeiture options, dividend options
Property loss calculation
Roadmap - Level of covered perils for different home owners policies + HO-15 Rider
HO-7 - Mobile home
Because a HO-15 endorsement provides increased limits on property and higher sublimits on jewelry and furs, the items shown would be covered without additional endorsement. For example, under a HO 15 endorsement coverage for collectible coins carries a $5,000 limit.
Roadmap - Torts, types of liability, negligences
Homeowners insurance coverages (A-D)
Key to remember
-A (abode)
-B (buildings)
-C (contents) - boats and trailers are limited to $1000, animals, birds, fish, motorized land vehicles, and aircraft not included
-D (dditional + demnity) - covers temporary housing
-E (enemies) - comprehensive liability insurance
-F (first aid) - medical payments to others
Client purchased a $1 million umbrella policy requiring $300,000 liability on their HO-3. They only have $100,000 of liability. If there is $1 million loss, what benefit will the umbrella policy pay?
$700,000. $200,000 gap the client will be responsible for.
Medicare (1. part a, b, d 2. provisions/costs 3. when to enroll 4. claiming on tax return 5. Medigap)
- Parts
- Part A - Free + hospital coverage; a flat deductible for hospital visits. 1-60 days = Medicare pays all but flat deductible amount. Day 61 and on, patient responsible for daily co-payment
- Part B - Costs + doctors & tests
- Medicare usually pays 80% of doctor visits after deductible (no-stop loss)
- Part D - Drugs and must have A and/or B to get D. Most Part D plans have a coverage gap/donut hole creating a temp limit on what the drug plan will cover for prescriptions - Medicare for skilled care - Pays all of first 20 days, partial for next 80, over 100, nothing is covered
-Also covers hospital for 3 days - Medicare special enrollment period is the 8 month period following the last month your group health coverage and following the month employment ends, whichever comes first. Generally, enroll in Medicare 3 months before 65.
- Self employed = 100% deductible above line | Others can deduct on Sch. A assuming health costs are above 7.5% of AGI
- Regardless of pre-existing conditions, once covered under Medicare, you can obtain Medigap insurance during open enrollment period (6 months starting on the first day of first month where person’s 65+ AND enrolled in Medicare Part B)
REMEMBER- Enrolling in Medicare part A or B precludes you from investing in an HSA anymore!
Disability insurance provision
Most important = Disability definition
Next important = COLA
REMEMBER Brett’s surgeon –> radiologist example - Own occ allows you to still collect disability if you change careers, even if you make more than you did before; any or modified own, you don’t get the benefit because now you make more than you did before
Disability insurance taxability for Partnership & S Corp 2% or greater shareholders
Owner of S Corp = tax-free benefit
-S Corp owns the policy + deducts it; they then bonus it back to the owners so it’s tax free
REMEMBER - Owner of S Corp = Tax-free benefits
Long-term care insurance (deductibility)
After 1996, premiums paid and unreimbursed for qualified LTC are deductible
-For W-2 employees, on Sch A (remember 7.5% of AGI floor) - Deduction also limited to a ceiling based on age
-For self-employed, deduct up to allowed amount on 1040 (don’t worry about the 7.5% hoop)
Types of life insurance + suitability
Endowments are no longer issued - likely wrong answer
Universal option B - Cash value + DB included in estate
Ex.
-Fear of carrier failure - choose something variable (because of separate accounts)
-Need for single purpose like paying off debt - choose term
-Need as a saving vehicle - choose whole life
Life insurance provisions (6 w/ focus *reinstatement + conversion)
-Incontestable: After 2 years, validity of contract can’t be questioned
-Suicide clause: Person commits within 2 years, company only returns premiums
-Grace period
-APL provision
-Reinstatement: You can reinstate policy within period after premium default WITH proof of insurability
-Conversion: Don’t have to prove evidence of insurability
Life insurance premium waivers for disability
Whole - Disability = Full premium waiver (death benefit remains enforce)
Universal/Variable Universal = Two options (but can’t be both)
1. Disability income benefit pays either the charges for mortality and admin
2. Full amount of premium
Life insurance surrender
Ex. Client surrenders policy with $50k cash value, $35k premiums billed, $15k dividends to reduce premiums.
1. How much is surrender value?
2. What is the taxability?
- $50,000
- $30,000 ord. income = cash value - basis
-basis = $35k billed - $15k dividends that reduce the premiums
Life insurance loans (back in pre-study 7-2) at policy surrender and at death
Value received at the time of surrender = cash value - loan
Tax situation at ord. income = cash value - basis/net premiums paid (taking into account dividends that reduce premiums)
-if the listed cash value says NET, add the loan back to the cash value
If the person dies with a loan on their life insurance policy, it’s subtracted from the death benefit before paying out heirs
MEC taxation on withdrawals
Ex. A client owns a life insurance policy classified as a MEC the client has taken out a policy loan of $300,000. The basis in the contract is $400,000 and the policy cash value is $600,000. what is the taxable income from the policy loan?
Withdrawal from MEC is LIFO + 10% penalty (under 59.5) | Non-MEC is FIFO with NO 10% penalty
Ex. $200,000
Roadmap - Buy-sell agreements
Buy-sell without funding via: Naked promise or installment sale
Buy-sell with funding via: Life insurance
-Stock redemption
-Cross purchase
Transfer for value exceptions summarized + transfer for value taxability
If the policy is going to the insured or a business owned by the insured, no ord. income & transfer for value not triggered
Transfer for value rules make the policies death benefits income taxable to the beneficiary to the extent that it exceeds basis (like a vatical). The three year rule doesn’t apply when a sale/transfer for value occurs.
Annuities (QLAC + annuity taxation)
Ex. Client age 55 purchased a single premium annuity for $100,000, held the contract for 5 years, surrender charges have terminated, and the annuity has earned 7% per year. If he surrenders it, what is the tax impact?
Qualified longevity annuity contract (QLAC) - Fund with IRA or retirement plan dollars w/ goal of keeping person from outliving their savings; may also reduce RMDs + longer you delay payment, the larger the payments will be
Ex. $40,255 subject to ordinary income +10% penalty.
- Client purchased annuity for $100,000 and they annuitize contract using a 20 year single life expectancy if the annuity pays $1,000 per month how much of the monthly benefit is included in taxable income?
- What’s tax treatment if annuity is held by a trust or non-person?
- Basis / payout = tax free %
$583.30 - All ord. income in the year income is accrued; loses ability to defer but ord. income increases basis
Group life insurance
Non-discriminatory - Employee not tax on premium paid by employer if employees coverage doesn’t exceed $50,000. If coverage exceeds $50,000, they’re tax on the overage (but it’s bonus to you, so the death benefit is still tax-free)
Discriminatory – Employee who benefit from the discriminatory don’t get the first $50,000 tax-free. People who don’t benefit from the discriminatory (only $50,000 coverage) still do.
-Keyword: Carve out plan
Flexible spending account (FSA aka Section 125) + HSA + MSA + COBRA
FSA
1. No income tax/FICA/FUTA
2. No LTC
3. Not HSA
4. Use it or lose it by 12/31 for dependent care
-Health FSA can offer a grace period (2.5 months) or carryover ($640), but not both
-Dependent care, FSA reduces the expense, eligible for dependent care credit
Ex. If client incurred $6,000 for dependent care, she can take a dependent care credit of $200 (she can only take $1,000 dependent care credit at 20% because the FSA paid $5,000 of the $6,000 cost
FSA contribution election can’t be changed during a plan year unless qualified status change occurs
HSA - Can be used for some medical premiums (qualified LTC + COBRA)
MSA (medical savings account) - Contributions only by individual (deductible) or employer. Employer contributions are not included in the eligible person’s income. HOWEVER only employer or employee can contribute in same taxable year, not both
COBRA - Can include continued coverage for dental and vision insurance, but not disability
Fringe benefits + VERBA
Contributions are deductible expenses for employers (within limits) EXECPT for deferred comp arrangements + retirement benefit
Split dollar plan (collateral assignment & endorsement methods)
Arrangement where employer and executive share cost/benefits of insurance policy
Endorsement (employee is not a share owner) – employer owns policy and has responsibility for premium payment
-If the employee wants to buy the policy, need to pay the higher of the cash value or premiums paid (no interest). The employer will realize a gain representing the Delta between cash value and premium’s paid.
-At death, employer retains cash value, and employees beneficiaries get death benefit
Collateral assignment (employee is a share owner) – employee owns and assigns the policy
-At death, employer gets premiums, and employee gets cash value (if surrendered) or benes get death benefit (if employee dies)
Health reimbursement arrangement
Solely employer funded and reimburses employees for substantial medical expenses up to a maximum dollar amount per coverage period
Can an employer deduct loan interest paid on life contract covering key persons?
Yes, business may deduct limited amount of interest paid on contract covering a key person to the extent that each loan doesn’t exceed $50,000
Which type of employer group coverage is not tax deductible by the employer?
Code section 125 flexible spending account
Why? FSA solely funded by employee
Client who’s fully injured under Medicare has received 105 consecutive days of skilled nursing care following discharge from a lengthy hospital stay. If the facility charges $300 per day and the daily Medicare co-pay is $185.50 per day how much will Medicare pay for the entire 105 days of skilled nursing care?
$15,160
Remember, Medicare covers first 20 days in full, requires copayment up to 100 days, and provides no coverage after that
Which of the following are amounts received by the owner of a life insurance policy that would be treated as income-first distributions under a MEC contract?
I. Cash dividends
II. Interest accrued on a policy loan (added to the loan balance)
III. Dividends retained by the insurer to purchase “paid-up” additions
IV. Dividends retained by the insurer as principal or interest to pay off a policy loan
I, II, IV
When policy dividends from modified endowment contracts (MECs) are used like cash, they are distributed under FIFO rules such as those applicable to annuity distributions. Cash distributions and dividends used to pay off policy loans are considered to be income first distributions. The interest accruing from a policy loan on a MEC is treated the same way for federal tax purposes. Dividends used to buy paid up (permanent) additions are not treated as income-first distributions. The loan interest was not distributed. It was added to the outstanding loan balance.
Your client, Susan bought a deluxe refrigerator 10 years ago. It cost Susan $1,200 when new. A current model of the same refrigerator would now cost $1,500. The appliance was expected to last 15 years. However, it was destroyed by a grease fire that started in Susan’s kitchen. How much would the insurance carrier pay if Susan’s policy provided for actual cash value coverage?
$500; Actual cash value is the current replacement value of $1,500 less depreciation of 10/15 of the current replacement value of $1,500 ($1,000) or $500.
