CH 7 Federal Tax Considerations for Life Insurance and Anuuities Flashcards
TERM: Earned Income
Salary, wages, or commissions; but not income from investments, unemployment benefits, and similar
TERM: Gross Income
A person’s income before taxes or other deductables
TERM: FIFO (First In, First Out)
Principle under which it is assumed that the funds paid into the policy first will be paid out first.
TERM: LIFO (Last In, First Out)
Principle applied to asset management in life insurance products, under which it is assumed that the funds paid into the policy last will be paid out first.
TERM: Nonprofit Organization
An organization that uses its surplus to fulfill its purpose instead of distributing the surplus to its owners or members.
TERM: Policy Endowment
Maturity date.
TERM: Policy Proceeds
In life insurance, the death benefit.
TERM: Pretax Contribution
Contribution made before federal and/or state taxes are deducted from earnings.
TERM: Rollover
Withdrawal of the money from one qualified plan and placing it into another plan.
TERM: Surrender
Early termination of a policy by the policyowner.
Permanent Life Features
Premiums cash value exceeding premiums paid Policy loans Policy dividends Dividend interest Lump-sum death benefit
Tax Treatment
Non tax deductible Taxable at surrender Not income taxable Taxable in the year earned Not income taxable
According to the taxation rules of life insurance policies, how are cash value increases taxed?
Cash value growth is tax deferred.
When would life insurance policy proceeds be included in the insured’s taxable estate?
When there is an incident of ownership at the time of death.
What is the main purpose of the 7-pay test?
To determine if a life insurance policy is a Modified Endowment Contract.
Why are dividends in life insurance policies not taxable?
They are not considered income for tax purposes; they are a return of unused premium.
Upon surrender of a life insurance policy, what portion of the cash value will be taxed?
Only the portion in excess of the premium paid.
Is the death benefit of a life insurance policy taxed to the beneficiary if it’s received as a lump sum?
No, lump sum benefits are received tax free.
What is the general taxation rule for death benefits payable to the beneficiary of a life insurance policy?
Death benefits are generally not subject to income taxes.
If the beneficiary of a life insurance policy receives death benefit payments that consist of principal and interest, which portion, if any, will be taxed?
Interest only.
What portion of a nonqualified annuity payment would be taxed?
Interest earned on principal.
What is the name for an overfunded life insurance policy?
A Modified Endowment Contract (MEC).
In a direct rollover, how is the money transferred from one retirement plan to a new one?
From trustee to trustee.
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
C) Accelerated benefit policy
D) Endowment
Modified endowment contract
Death benefits payable to a beneficiary under a life insurance policy are generally
A) Exempt from income taxation if under $10,000
B) Exempt from income taxation if over $10,000
C) Not subject to income taxation by the Federal Government
D) Subject to income taxation by the Federal Government
Not subject to income taxation by the Federal Government.
Which of the following terms is used to name the nontaxed return of unused premiums?
A) Dividend
B) Premium return
C) Interest
D) Surrender
Dividend.
When the owner of a $250,000 life insurance policy died, the beneficiary decided to leave the proceeds of the policy with the insurance company and select the interest settlement option. At the time of withdrawal the interest paid was $11,000, the beneficiary would be required to pay income tax on
A) $11,000
B) None, because the beneficiary has not received the death benefit
C) $261,000
D) $239,000
$11,000
If an immediate annuity is purchased with the face amount at death or with the cash value at surrender, this would be considered a
A) Roll over
B) Settlement option
C) Non-taxable exchange
D) Nonforfeiture option
Settlement option
Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase?
A) Withdrawn amounts are taxed on a first in, first out basis
B) Taxes are deferred on withdrawn amounts, but a flat penalty is charged
C) Taxes are deferred on withdrawn amounts
D) Withdrawn amounts are taxed on a last in, first out basis
Withdrawn amounts are taxed on a last in, first out basis
Who can make a fully deductible contribution to a traditional IRA?
A) Anybody; all IRA contributions are fully deductible regardless of income level
B) Someone making contributions to an educational IRA
C) A person whose contributions are funded by a return on investment
D) An individual not covered by an employer-sponsored plan who has earned income
An individual not covered by an employer-sponsored plan who has earned income.
In life insurance policies, cash value increases
A) Grow tax deferred
B) Are income taxable immediately
C) Are taxed annually
D) Are only taxed when the owner reaches age 65
Grow tax deferred.
Which of the following is true regarding taxation of dividends in participating policies?
A) Dividends are taxable only after a certain amount is accumulated annually
B) Dividends are taxable in some life insurance policies and nontaxable in others
C) Dividends are considered income for tax purposes
D) Dividends are not taxable
Dividends are not taxable.
Which of the following best describes taxation during the accumulation period of an annuity?
A) The annuity is subject to both state and federal taxation
B) The growth is subject to immediate taxation
C) Taxes are deferred
D) The annuity is subject to state taxes only
Taxes are deferred.
The advantage of qualified plans to employers is
A) Tax-free earnings
B) No lump-sum payments
C) Taxable contributions
D) Tax-deductible contributions
Tax-deductible contributions.
What method is used to determine the taxable portion of each annuity payment?
A) The exclusion ratio
B) The excise ratio
C) The annuity to age ration
D) The marginal tax formula
The exclusion ratio.
If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for ten years, which of the following would be taxable annually?
A) $10,000
B) $7,000
C) $3,000
D) $13,000
$13,000
If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for ten years, $10,000 per year would be income tax free as principal and $3,000 per year would be income taxable as interest.
J transferred his life insurance policy to his son two years before his death. Which of the following is true?
A) The unpaid premiums on the policy will be deducted from J’s taxable estate
B) Because the policy has been transferred, it will not be included in J’s taxable estate
C) The entire face value of the policy will be included in J’s taxable estate
D) The interest portion of the policy will be included in J’s taxable estate
The entire face value of the policy will be included in J’s taxable estate.
What part of the Internal Revenue Code allows an owner of a life insurance policy or annuity to exchange or replace their current contract with another contract without creating adverse tax consequences?
A) Section 457 Deferred Compensation Plan
B) Section 1035 Policy Exchange
C) Modified Endowment Exchange
D) 401(k) Plan
Section 1035 Policy Exchange
