Chapter 18 - Taxes And Individual Life

Question 1

Taxes

Answer 1

Individual life insurance premiums are not tax deductible. The growth is tax deferred until age 100. The beneficiary receives the death benefit tax free. If the policy is surrendered or lapses, THE PORTION OF THE CASH SURRENDERED VALUE THAT EXCEEDS PREMIUMS PAID IN WILL BE SUBJECT TO INCOME TAX. SAME THING IF IT ENDOWS AT AGE 100

Question 2

Endowment Life Insurance / Modified Endowment Contracts

Answer 2

Endow means when the cash value = the face value.

Endowment Life: Policy that has an earlier that age 100 endowment age, such as 65. In this case at age 65 the cash is paid to the policy owner and the DEATH BENEFIT COVERAGE ENDS. Help so people don’t have to keep paying premiums until they are 100. Different from limited pay where the policy premiums would stop at the specified age, but the policy doesn’t mature until age 100. The endowment policy is mature at the age specified prior to 100.

Modified Endowment Contracts (MECs)- an endowment life policy which is overfunded in the early years is considered by the IRS to be more like an investment than like life insurance. It may lose the tax deferred status of the cash value account, meaning the growth might be taxed immediately.
-Any loans taken from the MEC may be taxable as income to the extent that the loan exceeds premiums paid. If the owner withdraws money prior to age 59.5, a 10% tax may also be imposed.
- The IRS will use a Cash Accumulation Test or 7 Pay Test, if the premium paid exceeds a 7 pay life policy the IRS will treat it as a MEC. Compares the total premiums you paid in the first 7 years and if the payments exceed what’s needs your policy becomes a MEC.

Question 3

1035 Exchange

Answer 3

IRS Section 1035 allows people to defer taxes when selling something for something similar. Allows you to exchange an insurance policy that you own for a new life insurance policy without paying tax on the investment gains earned.

A life policy for a life policy, unsuitable or long term care policy would not be subject to tax.

Does not work for an annuity for a life policy.