Estates Ch 11 Life Insurance in Estate Planning

Question 1

Life insurance is often used in education funding plans.

a. True b. False

Answer 1

True

Question 2

Generally, as an individual gets older, the mortality cost of a term life insurance policy increases.

a. True b. False

Answer 2

True

Question 3

A term life insurance policy is more appropriate for short-term needs than a whole life insurance policy.

a. True b. False

Answer 3

True

Question 4

The insured is the person whose life is covered by the life insurance policy.

a. True b. False

Answer 4

True

Question 5

A cross-purchase agreement will increase the income tax basis of survivors/owners.

a. True b. False

Answer 5

True

Question 6

The number of policies for five equal partners in cross-purchase arrangement to buy-sell is 20.

a. True b. False

Answer 6

True

N ( N-1 )

5 ( 5- 1 ) = 20

Question 7

The owner of a life insurance policy can select the settlement option that will be payable to the beneficiary.

a. True b. False

Answer 7

True

Question 8

If a life insurance policy is determined to be a MEC, any loans against the policy are taxable to the extent that the owner has gain in the policy.

a. True b. False

Answer 8

True

Question 9

IRC Section 1035 allows the owner of a life insurance contract to exchange the contract for another life insurance contract, an endowment contract, or an annuity contract on the same insured without any tax consequences.

a. True b. False

Answer 9

True

Question 10

Accelerated death benefits from a life insurance contract to an insured individual who is chronically or terminally ill may be excluded from gross income.

a. True b. False

Answer 10

True

Question 11

When a life insurance policy is donated to a charity, the donor may deduct the fair market value of the policy as a charitable deduction on their income tax return (subject to income limitations).

a. True b. False

Answer 11

True

Question 12

Life insurance proceeds payable to the estate of a decedent are included in the decedent’s federal gross estate.

a. True b. False

Answer 12

True

Question 13

The owner of a life insurance policy will include the value of the life insurance policy in their federal gross estate if they die before the insured.

a. True b. False

Answer 13

True

Question 14

The three-year rule does not apply to the sale of a life insurance policy.

a. True b. False

Answer 14

True

Question 15

The three-year rule requires inclusion of the death benefit of any life insurance policy transferred within three years of the death of the insured in the insured/owner’s federal gross estate.

a. True b. False

Answer 15

True

Question 16

Irrevocable life insurance trusts are primarily designed to ensure that the death benefit is excluded from the insured’s federal gross estate.

a. True b. False

Answer 16

True

Question 17

Rashad purchased a life insurance policy on his own life and never designated a beneficiary. In this case, the life insurance policy death benefit is:

a. Included in Rashad’s federal gross estate if Rashad dies within three years of the initial premium payment.

b. Included in Rashad’s federal gross estate if Rashad paid the
premiums until his death.

c. Never included in Rashad’s federal gross estate.

d. Always included in Rashad’s federal gross estate.

Answer 17

The correct answer is d.

Because Rashad did not list a beneficiary, the death benefit is payable to Rashad’s estate and will be distributed per Rashad’s will or the intestacy laws of his state of residency.

There is no three-year rule
with regard to the initial premium payment of the life insurance policy as listed in option a

Question 18

Ike and Tina, unrelated business partners, began operating a drug store in southern Florida. They funded a buy/sell agreement with a cross-purchase life insurance arrangement. Tina purchased a life insurance policy with Ike as the insured, and Ike purchased a life insurance policy with Tina as the insured. If Tina dies, which of the following is/are true?

1. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is excluded from Tina’s federal gross estate.
2. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is included in Tina’s federal gross estate if Tina owns 50% or more of the stock of the drug store.
3. The value of the life insurance policy on Ike’s life, owned by Tina, is included in Tina’s federal gross estate.
4. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is included in Tina’s federal gross estate.

a. 1 only.
b. 1 and 3.
c. 2, and 3.
d. 2, 3, and 4.

Answer 18

The correct answer is b.

Option 1 is correct because Tina’s federal gross estate will not include the death benefit of the life insurance policy on her life owned by Ike because Tina does not possess any incidents of ownership in
the policy.

Option 3 is correct because when an individual dies owning a life insurance policy on the life of another person, the value of the life insurance policy will be included in their federal gross estate.

Option 2 is incorrect because Tina’s ownership in the drug store does not change the fact that Tina does not possess any incidents of ownership in the life insurance policy on her life, owned by Ike. The death benefit of a life insurance policy on Tina’s life would only be included in Tina’s federal gross estate if she possessed any incidents of ownership in the life insurance policy.

Option 4 is incorrect because Tina does not possess any incidents of ownership in the policy.

Question 19

Mariah gave a $1,000,000 life insurance policy on her own life to her brother. At the date of the gift, the life insurance policy was valued at $200,000. Which of the following statements regarding the gift of this life insurance policy is correct?

a. If Mariah dies two years after this gift, her federal gross estate will include $200,000.

b. If Mariah dies four years after this gift, her federal gross estate will include $200,000.

c. If Mariah dies two years after this gift, her federal gross estate will include $1,000,000.

d. If Mariah dies four years after this gift, her federal gross estate will include $1,000,000.

Answer 19

The correct answer is c.

The three-year rule (IRC Section 2035) states that if an individual gratuitously transfers ownership of a life insurance policy on their life, or any incident of ownership in a policy on their life within three years of death, the death benefit of the policy is included in their federal gross estate. In this case, only option c provides the correct solution.

If Mariah dies two years after the gift, the gratuitous transfer of the policy falls within the three-year rule and the death benefit is ncluded in Mariah’s federal gross estate.

All of the other options are incorrect.

Question 20

Which of the following statements regarding term life insurance is correct?

a. The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.

b. The cash accumulation account of a term life insurance policy is invested in the bond portfolios of the insurer.

c. The cash accumulation account of a term life insurance policy is invested in individual stocks selected by the insured.

d. The premium of a term life insurance policy will decrease as the pure cost of life insurance increases.

Answer 20

The correct answer is a.

The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. Options b and c are incorrect because a term life insurance policy does not have a cash accumulation account.

Option d is incorrect because the premium of a term life insurance policy increases as the pure cost of life insurance increases.

Question 21

Neil was diagnosed as chronically ill and was in need of additional funds to pay for increased medical expenses so he sold his $100,000 life insurance policy, which had a cash value of $30,000, to a licensed viatical settlement provider for $55,000 in cash.
If the viatical company paid a total of $10,000 in premiums between the time they purchased the policy and the time of Neil’s death, what amount of the death benefit is taxable income to the viatical company?

a. $0.
b. $35,000.
c. $45,000.
d. $100,000

Answer 21

The correct answer is b.
From the viewpoint of the viatical settlement provider, the transfer of the life insurance policy is a transfer for valuable consideration. If a life insurance policy is transferred for valuable consideration, the
death benefit in excess of the transferee’s adjusted basis will be subject to income tax. The viatical company paid Neil $55,000, plus paid an additional $10,000 in premiums, for a total cost basis of
$65,000. The difference between the $100,000 death benefit received and their $65,000 cost basis ($100,000 - $65,000 = $35,000) is taxed as ordinary income. From Neil’s perspective, the $55,000 he
received in exchange for the policy is tax free (if used to pay qualified medical expenses) because he is chronically ill and sold the policy to a licensed viatical settlement company.

Question 22

In which of the following situations would the death benefit of a life insurance policy be taxable, partially or wholly?

Sissy, as designated beneficiary, received the $80,000 death benefit of Bud’s life insurance policy. Bud had purchased the policy for $35,000 from his employer when he retired in 2007.

Gilley’s, Inc., received the $100,000 death benefit of Mickey’s life insurance policy. In 2005, Mickey, the owner of 50% of the stock of Gilley’s, Inc. sold the policy to Gilley’s for $12,000 as part of an entity-type buy-sell agreement.

Weakam, Ullo, and Evans, LLP, received the $1,000,000 death benefit of a life insurance policy on Randy Evans, one of the managing partners. Randy had sold the policy to Weakam, Ullo, and Evans, LLP in 2002 when the business was just starting out as part of an entity-type buy-sell agreement.

Harley sold a $100,000 death benefit life insurance policy to Dusty for $35,000 as part of cross-purchase buy-sell agreement.Harley and Dusty were the only two shareholders of Cupper Corporation and each owned a policy on the other.

Answer 22

Harley sold a $100,000 death benefit life insurance policy to Dusty for $35,000 as part of cross-purchase buy-sell agreement.Harley and Dusty were the only two shareholders of Cupper Corporation and each owned a policy on the other.
Rationale

If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee’s adjusted basis will be subject to income tax.

An exception exists for any transfer of the life insurance policy for valuable consideration to the insured, a partner of the insured, a partnership in which the insured is a partner, a corporation in which the insured is a shareholder or officer, or a transferee who takes the transferor’s basis in the contract.

Option a is an example of a transfer to the insured.

Option b is an example of a transfer to a corporation in which the insured is a shareholder.

Option c is an example of a transfer to a partnership in which the insured is a partner. Option d does not fit any of the exceptions. The life insurance policy is transferred to Dusty, not Cupper Corporation

Question 23

Myles is the owner of a paid-up whole life insurance policy on his own life. All of the following statements are correct except:

Myles has title of the whole life insurance contract.

Myles can borrow against the cash value of the whole life insurance policy.

The death benefit of the whole life insurance policy will be included in Myles’s federal gross estate.

If Myles gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy’s interpolated terminal reserve plus any unearned premium.

Answer 23

If Myles gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy’s interpolated terminal reserve plus any unearned premium.
Rationale

Because it is a paid-up whole life insurance policy, the value for gift tax purposes is the replacement cost of the policy. All of the other statements are true.

Question 24

As part of his employee benefit package, Hugo’s employer provided him with a $50,000 term life insurance policy. Hugo named his wife, Nina, as the sole beneficiary of the life insurance policy. Which of the following statements is true with regard to this life insurance policy?

Because the term insurance policy is part of a group term life insurance policy, the death benefit payable to Nina is considered taxable income.

At Hugo’s death, the death benefit payable to Nina will be included in Hugo’s federal gross estate.

Hugo cannot change the beneficiary of the life insurance policy without Nina’s prior written approval.

If Nina dies before Hugo, her federal gross estate will include the life insurance policy death benefit.

Answer 24

At Hugo’s death, the death benefit payable to Nina will be included in Hugo’s federal gross estate.

Rationale

The death benefit of the life insurance policy will be included in Hugo’s federal gross estate because Hugo was the owner of the life insurance policy and had the right to change the designated beneficiary of the policy.

Option a is incorrect because the death benefit payable from a policy issued under a group term life insurance policy is treated just like the death benefit payable from any other life insurance policy. As long as the policy has not been transferred for valuable consideration, the beneficiary will receive the death benefit without any income tax ramifications.
Option c is incorrect because the owner of the policy can change the beneficiary designation without any authorization from the current beneficiary.
Option d is incorrect because the beneficiary of a life insurance policy does not have any right to the death benefit until the insured has died. In this case, Nina, the beneficiary, has died before the insured on the policy, Hugo, so Nina will not include any amount related to the life insurance policy in her federal gross estate.

Question 25

Many individuals who have been diagnosed with terminal illnesses sell their life insurance policies to viatical settlement providers. Which of the following statements is true regarding the transfer of a policy from an individual with a terminal illness to a viatical settlement provider?

If the individual dies within three years of the transfer, the full proceeds of the insurance policy are included in their federal gross estate.

The individual is subject to capital gain taxes on the difference between their adjusted basis in the life insurance policy and the amount paid to them by the viatical settlement provider.

Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax.

If the individual lives for more than one year after the transfer, the individual will be subject to income tax on the payment from the viatical provider.

Answer 25

Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax.

Rationale

The IRC (Section 101(g)) excludes amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill from the individual’s gross income.

There is no requirement that the individual die within a certain period of time.

Option a is incorrect because the three-year rule (Section 2035) only applies to gratuitous transfers of life insurance. In this case, the life insurance policy was sold to the viatical settlement provider, and thus would not be subject to the three-year rule.

Question 26

Four years ago, Rhett gave a life insurance policy with a $750,000 death benefit to his daughter, Marcelle. At the time of the gift, the value of the life insurance policy was $65,000, and Rhett paid $10,000 in federal gift tax.
Rhett unexpectedly died this year. What amount will be included in Rhett’s federal gross estate related to this life insurance policy?

$0.
$10,000.
$65,000.
$750,000.

Answer 26

0.

Rationale

Because Rhett died more than three years after the gratuitous transfer of the life insurance policy, Rhett’s federal gross estate would not include any amount related to this life insurance policy.

Question 27

The owner of a whole life insurance policy would like to exchange their life insurance policy for an annuity on their life. Currently, the value of the life insurance policy is $150,000, excluding a $50,000 loan the owner has against the life insurance policy, and the owner’s adjusted basis in the policy is $65,000. Which of the following statements is true?

If the owner exchanges the life insurance policy for an annuity, the owner must recognize a $135,000 capital gain on the exchange.

The owner’s basis in the annuity after the exchange will be $115,000.

The exchange will be considered a transfer for valuable consideration.

Each annuity payment that the owner receives from the annuity will be treated first as a tax free return of basis, then as taxable earnings once the basis has been fully recovered.

Answer 27

The owner’s basis in the annuity after the exchange will be $115,000.
Rationale

In an exchange of a life insurance policy for an annuity, the owner of the life insurance policy must recognize gain to the extent they receive boot in the exchange. Outstanding loans against the life insurance policy are considered boot. In this problem, the owner has potential gain of $135,000 ($150,000 + $50,000 - $65,000), and must recognize gain to the extent they had a loan outstanding, or $50,000. Normally, the owner’s adjusted basis in the life insurance policy will be carried over to the annuity, but if the owner recognizes any gain on the exchange or pays additional expenses, they will increase their adjusted basis in the annuity by the gain recognized or the expenses paid. Because the owner had to recognize gain on the loan, they will increase their adjusted basis by this recognized gain of $50,000. After the exchange, the owner’s adjusted basis in the annuity is $115,000, the adjusted basis in the life insurance policy increased by the amount of gain recognized on the transaction ($65,000 + $50,000). Option c is incorrect as an exchange is not considered a transfer for valuable consideration. Option d is incorrect because each payment received from the annuity will be partially a return of basis and partially taxable interest income.

Question 28

Which of the following statements regarding universal life insurance policies is true?

As long as the premium of a universal life insurance policy is paid, the insurer guarantees that the life insurance policy will remain in force.

A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost.

Funds within the cash accumulation account of a universal life insurance policy cannot be withdrawn from the policy.

A universal life insurance policy allows the insured to select the cash accumulation account investments.

Answer 28

A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost.
Rationale

A universal life insurance policy is similar to a term life insurance policy but with a cash accumulation account attached to it. In the initial years of the policy, the premium paid is in excess of the pure cost of the insurance, and the excess is deposited into the cash accumulation account. In the later years of the life insurance policy, the pure cost of the insurance will increase, but the insured will continue to pay the same premium (assuming a planned level premium).
Funds within the cash accumulation account will pay any difference between the pure cost of the insurance and the premium paid by the owner.
However, if the cash accumulation account does not have the funds to pay the difference, the life insurance contract will lapse. Only a whole life insurance policy will remain in force at all times when the pure cost of the insurance is in excess of the premium paid. Option a is incorrect because the universal life insurance policy will lapse if the policy premium is not paid and the cash accumulation account does not have the funds necessary to pay the mortality and expense fees. Even if the policy premium is paid, the universal life insurance policy will also lapse if the cash accumulation account does not have the funds to pay the excess pure insurance cost (in which case the premium amount must be increased in order to avoid a policy lapse). Option c is incorrect because withdrawals are permitted from the cash accumulation account of a universal life policy. Option d is incorrect because the insured does not select the investments for the cash accumulation account.

Question 29

Talia selected her son as the beneficiary of a whole life insurance policy on her life. Which of the following statements concerning this beneficiary designation is incorrect?

Talia could have chosen her son and her daughter as co-beneficiaries.

If Talia lists her nephew as the contingent beneficiary of the whole life insurance policy, her nephew will collect the death benefit if her son dies before Talia.

If Talia entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime.

At Talia’s death, her son will receive the death benefit of the life insurance policy.

Answer 29

If Talia entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime.

Rationale

If Talia had entered an irrevocable beneficiary designation, she continues to be the owner of the life insurance policy, but she will need her son’s permission to amend the beneficiary designation.

All of the other statements are true.

Question 30

Watson, LLP. has four equal partners. All four partners are interested in entering into a buy-sell arrangement.
How many life insurance policies would be purchased to properly fund a cross-purchase agreement?

4 policies.
6 policies.
8 policies.
12 policies.

Answer 30

12 policies.

Rationale

Each owner would need to purchase a life insurance policy on each of the other owners. Therefore, 12 policies would be purchased in total or 4(4-1) = 12.

Question 31

Winona, age 60, purchased a single premium life insurance policy on her life 15 years ago for $65,000. The current value of the policy is $155,000. Which of the following statements regarding Winona’s life insurance policy is true?

If Winona takes a loan of $130,000 against the cash surrender value of the life insurance policy, she will have a long-term capital gain of $65,000.

If Winona takes a loan of $65,000 against the cash surrender value of the life insurance policy, she will not have any taxable gain.

If Winona takes a loan of $75,000 against the cash surrender value of the life insurance policy, she will recognize $10,000 of long-term capital gain.

If Winona takes a loan of $145,000 against the cash surrender value of the life insurance policy, she will recognize $90,000 of taxable gain.

Answer 31

If Winona takes a loan of $145,000 against the cash surrender value of the life insurance policy, she will recognize $90,000 of taxable gain.
Rationale

Because Winona’s life insurance policy was funded with a single premium payment, the policy is considered a modified endowment contract (MEC). Any loan from a MEC is considered taxable gain, taxed as ordinary income, to the extent there is any gain in the contract. Therefore, option d is correct because Winona takes a $145,000 loan from the contract and has $90,000 ($155,000-$65,000) of gain. Winona must recognize taxable gain as ordinary income to the extent of the gain inherent in the policy before receiving a return of capital. In answer a, if Winona borrowed $130,000, she would also recognize $90,000 of taxable gain, taxed as ordinary income, because gain always comes out first from a MEC (LIFO tax treatment). In option b, Winona would recognize $65,000 of taxable gain, taxed as ordinary income, if she took a loan of $65,000. If Winona borrowed $75,000 as in option c, Winona would have a $75,000 taxable gain, taxed as ordinary income. Note that Winona is not subject to the 10% early distribution penalty because she is over age 59½.

Question 32

Which of the following is not considered an incident of ownership?

The right to change the beneficiary of a life insurance policy.

The insured making cash gifts to the owners of the life insurance policy of the premium amount.

The right to take loans against the cash value of the life insurance policy.

A provision in an ILIT that directs the trust to pay the federal estate taxes of the insured.

Answer 32

The insured making cash gifts to the owners of the life insurance policy of the premium amount.

Rationale

If the insured makes cash gifts to the owners of the life insurance policy equal to the premium amount it is not considered an incident of ownership.

All of the other options would be considered an incident of ownership.

Question 33

Colleen transferred ownership of a whole life insurance policy on her life to an Irrevocable Life Insurance Trust (ILIT) six years ago and retained the right to borrow against the policy. When Colleen dies, the proceeds of the life insurance policy are:

Included in Colleen’s federal gross estate if she has any outstanding loans against the life insurance policy.

Included in Colleen’s federal gross estate if Colleen continued paying the policy premiums after the life insurance policy was transferred to the ILIT.

Never included in Colleen’s federal gross estate.

Always included in Colleen’s federal gross estate.

Answer 33

Always included in Colleen’s federal gross estate.
Rationale

The IRC (Section 2042) states that if a decedent owns a life insurance policy on her own life or possesses any incidents of ownership in the policy on the date of her death, the policy death benefit will be included in her gross estate. The right to borrow against the life insurance policy is considered an incident of ownership which would cause inclusion in Colleen’s federal gross estate.

Because Colleen retained this right, her federal gross estate would include the death benefit of the whole life insurance policy owned by the ILIT.

Option a is incorrect because as long as the decedent has the right to take a loan against the policy, it is considered an incident of ownership. There is no requirement that a loan be outstanding.

Option b is incorrect because paying the premium on a policy transferred to an ILIT does not create the incidents of ownership that would cause inclusion in Colleen’s federal gross estate.

Question 34

Which of the following statement(s) is/are correct regarding buy-sell arrangements?

1. Entity purchase arrangements increase the income tax basis for some surviving owners upon the death of another owner.
2. Cross-purchase arrangements increase the income tax basis for all surviving owners (who are parties to the agreement) upon the death of another owner.

1 only.
2 only.
Both 1 and 2.
Neither 1 nor 2.

Answer 34

2 only.
Rationale

Entity arrangements do not increase the income tax basis of surviving owners.

Question 35

Mariska’s father died last month and she is the listed beneficiary on his insurance policy. Mariska has contacted the insurer and has requested a lump-sum payment of the death benefit of the life insurance policy.
Which of the following statements regarding this lump-sum payment is true?

When Mariska receives the lump-sum payment of the death benefit from the insurer, the payment will be taxable to the extent of any interest earned between the date of death and the payment to Mariska.

Because Mariska has elected a lump-sum payment of the death benefit, she will actually receive a payment less than the face value of the policy.

Had Mariska elected the life annuity, each payment would have been excluded from her gross income.

Mariska could have elected to leave the death benefit on deposit with the insurer and continue the tax-deferred growth of the policy.

Answer 35

When Mariska receives the lump-sum payment of the death benefit from the insurer, the payment will be taxable to the extent of any interest earned between the date of death and the payment to Mariska.

Rationale

When Mariska receives the lump sum death benefit, she will also receive fully taxable interest on the death benefit that accrued from the time of her father’s death to the date the insurer paid Mariska.

Option b is a false statement.

Option c is incorrect because if Mariska had elected the annuity option, a portion of each annuity payment would have been taxable as interest income and the remaining portion of the payment would have excluded from Mariska’s taxable income.

Option d is incorrect because if Mariska had chosen to leave the death benefit on deposit with the insurer, she would have to include the earnings on the death benefit in her taxable income each year.

Question 36

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Caesar gifted the policy to his daughter.
Six months prior to the gift, Caesar had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor.

Caesar died four years after the gift of the life insurance policy.

What amount is included in his federal gross estate related to this whole life insurance policy?

$0.
$250,000.
$500,000.
$500,000 discounted for Caesar’s six month life expectancy.

Answer 36

0.
Rationale

Caesar’s federal gross estate would not include any value related to this life insurance policy because he is not the owner or beneficiary of the life insurance policy at his death, and the gift was made more than three years prior to his death.

An individual’s federal gross estate only includes the death benefit of a life insurance policy on the insured, if the individual is the owner or beneficiary, or if there was a gratuitous transfer of the life insurance within three years of the individual’s death.

Question 37

Selena was recently diagnosed with stage four lung cancer. Her doctors have given her nine months to live. She has many medical expenses and needs money.
If Selena sells a whole life insurance policy, with a $1,000,000 face value and a $250,000 adjusted basis to a viatical settlement provider for $350,000, how much capital gain will Selena have to recognize for income tax purposes on the sale?

$0.
$250,000.
$350,000.
$1,000,000.

Answer 37

$0.
Rationale

The IRC (Section 101(g)) states that amounts received under a life insurance contract on the life of an insured individual who is chronically or terminally ill may be excluded from gross income. Because her doctors expect her to die within 9 months, Selena is considered terminally ill. A terminally ill individual is a person who has been certified by a licensed health care provider as having a condition or illness that can reasonably be expected to result in death within 24 months.

Question 38

Who has the right to surrender a life insurance policy for its cash surrender value?

The insured of the life insurance policy.
The owner of the life insurance policy.
The beneficiary of the life insurance policy.
The insurer of the life insurance policy.

Answer 38

The owner of the life insurance policy.
Rationale

The owner of a life insurance policy is the only party to a life insurance policy who can surrender a life insurance policy for its cash surrender value

Question 39

Walden owned a life insurance policy with his brother, Allen, as the insured. When Walden died, his will specifically bequeathed the policy to his sister, Judith.
Which of the following statements regarding the value of the life insurance policy to include in Walden’s federal gross estate is not true?

If the life insurance policy is a term life insurance policy, the value is the unused premium.

Because Allen is still alive, the value of the policy included in the gross estate is zero.

If the life insurance policy is a whole life policy in pay status, the value is equal to the unearned premium plus the interpolated terminal reserve.

If the life insurance policy is a paid-up or single premium life insurance policy, its value is its replacement cost.

Answer 39

Because Allen is still alive, the value of the policy included in the gross estate is zero.

Rationale

This statement is completely false. There is no such exception. The policy, like all other assets owned by the decedent, will be included in the gross estate, (with very few exceptions). All of the other statements are true.

Question 40

In 2006, Donna, age 30, purchased a regular whole life insurance policy on her life and designated her sister, Robin, as the beneficiary. The policy death benefit is $1,000,000. On January 1, 2024, Donna, on the advice of her CFP® professional, assigned the policy to an ILIT. At the time, the cash value of the policy was $100,000. The named beneficiary of the trust is Robin and the trustee is James.
Which of the following statements regarding the life insurance policy is/are correct?

The gift, which was taxable, is $85,000, after the standard 15 percent discount.

The taxable gift is $100,000.

The value of the policy for gift tax purposes is the interpolated reserve plus the unexpired premium.

The value of the policy for gift tax purposes is replacement value.

Answer 40

The value of the policy for gift tax purposes is the interpolated reserve plus the unexpired premium.

Rationale

This is an in-pay status whole life policy. Premiums are paid to age 100 (or higher, depending on the policy).

Question 41

The owner of a life insurance policy has decided to surrender the life insurance policy to the insurer. Since inception of the life insurance contract, the owner has paid premiums of $100,000 and received cash policy dividends equal to $20,000.
If at the surrender date, the owner receives a cash payment of $140,000 from the insurer, what is his gain/ loss subject to income tax on the life insurance policy?

$0.
$20,000.
$40,000.
$60,000.

Answer 41

$60,000.
Rationale

The owners adjusted basis in the property would be $80,000 - the sum of the premiums paid on the policy less any dividends received (a dividend on a life insurance policy is a return of the policy owner’s adjusted basis). If the insurer pays a cash surrender value of $140,000, the gain on the policy would be $60,000 ($140,000-$80,000).

Question 42

Which of the following is not a valid settlement option for the designated beneficiary of a life insurance policy?

A lump-sum payment of the death benefit.
Individual retirement account rollover.
Life annuity.
Term annuity.

Answer 42

Individual retirement account rollover.

Rationale

A beneficiary of a life insurance policy cannot rollover the death benefit into an IRA.
The designated beneficiary of a life insurance policy can choose to receive the death benefit as a lump sum payment, as an annuity (term or life), or the beneficiary can leave the death benefit on deposit with the insurer.
In some situations, the owner of the life insurance policy will establish an irrevocable settlement option, thereby choosing the beneficiary’s settlement option.

Question 43

Olivia’s dad, Benson, died on August 10 of this year. Six years ago, Benson had gifted ownership of a paid-up $1,000,000 whole life insurance policy on his life with a replacement value of $150,000 and an adjusted basis of $100,000 to Olivia.

If Olivia, as designated beneficiary, receives the death benefit of the life insurance policy this year, how much will be taxable to her?

$0.
$50,000.
$100,000.
$1,000,000

Answer 43

$0.
Rationale

A gift of a life insurance policy is not a transfer for valuable consideration and as such the death benefit, payable by reason of Benson’s death, is not included in Olivia’s taxable income.

Question 44

Which of the following statements is true?

Life insurance policy dividends are taxable as dividend income.

Life insurance policy dividends kept on deposit with the insurer will generate tax-deferred interest income.

If a life insurance policy lapses, any outstanding loans will be required to be repaid to the insurer outside funds immediately at the lapse.

If a life insurance policyowner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured.

Answer 44

If a life insurance policyowner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured.
Rationale

Option d is a correct statement.

Option a is incorrect as policy dividends are return of the policy owner’s adjusted basis. Option b is incorrect as life insurance policy dividends kept on deposit with the insurer will generate taxable interest income to the life insurance policyowner.

Option c is incorrect because the outstanding loan would be off set by the surrender value.

Question 45

Mariah gave a $1,000,000 life insurance policy on her own life to her brother. At the date of the gift, the life insurance policy was valued at $200,000. Which of the following statements regarding the gift of this life insurance policy is correct?

If Mariah dies two years after this gift, her federal gross estate will include $200,000.

If Mariah dies four years after this gift, her federal gross estate will include $200,000.

If Mariah dies two years after this gift, her federal gross estate will include $1,000,000.

If Mariah dies four years after this gift, her federal gross estate will include $1,000,000.

Answer 45

If Mariah dies two years after this gift, her federal gross estate will include $1,000,000.

Rationale

The three-year rule (IRC Section 2035) states that if an individual gratuitously transfers ownership of a life insurance policy on their life, or any incident of ownership in a policy on their life within three years of death, the death benefit of the policy is included in their federal gross estate. In this case, only option c provides the correct solution. If Mariah dies two years after the gift, the gratuitous transfer of the policy falls within the three-year rule and the death benefit is included in Mariah’s federal gross estate. All of the other options are incorrect.

Question 46

Which of the following is not a reason for using life insurance in an estate plan?

The proceeds of the life insurance policy can be used to create liquidity for the decedent’s estate.

The proceeds of the life insurance policy can be used to eliminate any debt for the decedent’s surviving spouse.

The insured can borrow the death benefit from the life insurance policy to fund his retirement.

Expected future education expenses can be funded with the death benefit of the life insurance policy.

Answer 46

The insured can borrow the death benefit from the life insurance policy to fund his retirement.
Rationale

The insured can borrow against the cash surrender value of the life insurance policy to fund his retirement. The insured cannot borrow the death benefit of the life insurance policy. All other statements are reasons for using life insurance in an estate plan.

Question 47

At age 69, Andre, a widower, needs more than his pension and Social Security income to pay his living and medical expenses. His children do not have the resources to help him and he has already liquidated his individual retirement accounts.
Which of the following is true if Andre decides to surrender his whole life insurance policy to the insurer?

Andre would receive the present value (using the actuarial factors according to Andre’s life expectancy) of the life insurance policy death benefit.

Any amount of surrender value paid to Andre would reduce the death benefit payable to the listed beneficiary of the policy dollar-for-dollar.

To surrender the life insurance policy, Andre must receive the approval of the listed beneficiary of the life insurance policy.

The surrender value of the policy would be paid to Andre and the life insurance contract would be canceled.

Answer 47

The surrender value of the policy would be paid to Andre and the life insurance contract would be canceled.
Rationale

If Andre surrenders the life insurance policy to the insured, the insurer will pay Andre the surrender value, the contract will be canceled, and correspondingly there will not be a death benefit payment at Andre’s death. Option a is incorrect because if Andre surrender the life insurance policy, the surrender value is equal to the cash accumulation account less a surrender charge from the insurer. Option b is incorrect because once the policy is surrendered the contract is canceled and no death benefit would be paid to the beneficiary. Option c is incorrect because Andre would not have to receive the approval of the listed beneficiary unless it was stated that he had made an irrevocable beneficiary designation.

Question 48

Laverne is the owner and insured on a $1,000,000 face value life insurance policy in pay status. Laverne’s adjusted basis in the life insurance contract is $250,000.
If Laverne gifts this life insurance policy to her daughter and listed beneficiary, Shirley, which of the following statements is correct?

After the date of the gift, any dividends paid on the life insurance policy will be taxable to Laverne.

Shirley can amend the beneficiary designation of the life insurance policy to include her son, Lenny, as a co-beneficiary.

If Shirley dies before Laverne, Shirley’s probate estate will include the replacement value of the life insurance policy.

If Laverne dies within three years of the gift of the life insurance policy to Shirley, the death benefit will be included in Laverne’s probate estate.

Answer 48

Shirley can amend the beneficiary designation of the life insurance policy to include her son, Lenny, as a co-beneficiary.
Rationale

After Laverne has gifted the life insurance policy to Shirley, Shirley can select the designated beneficiary of the life insurance policy.

Shirley has the right to change the beneficiary selected by Laverne and does not need Laverne’s approval to amend the designation.

Shirley should be aware, however, that naming Lenny as a beneficiary will result in a taxable gift from her to Lenny upon Laverne’s death because there will be three different parties to the policy (the owner, the insured, and the beneficiary (the “unholy trinity”)).

Option a is incorrect because any dividends issued on the life insurance policy will be paid to Shirley and the dividends are nontaxable distributions equal to return of capital.

Option c is incorrect because the value of a life insurance policy in pay status is the sum of the interpolated terminal reserve plus any unearned premium.

Option d is incorrect as the life insurance policy will be included in Laverne’s federal gross estate (not the probate estate) if she dies within three years of the gift of the life insurance policy.

Question 49

Which of the following statements regarding term life insurance is correct?

The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.

The cash accumulation account of a term life insurance policy is invested in the bond portfolios of the insurer.

The cash accumulation account of a term life insurance policy is invested in individual stocks selected by the insured.

The premium of a term life insurance policy will decrease as the pure cost of life insurance increases.

Answer 49

he premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.
Rationale

The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.

Options b and c are incorrect because a term life insurance policy does not have a cash accumulation account.

Option d is incorrect because the premium of a term life insurance policy increases as the pure cost of life insurance increases.

Question 50

Twelve years ago, Sebastian purchased a single premium $1,000,000 life insurance policy on his own life for $150,000 and named his daughter, Holly, as the sole beneficiary. Sebastian gifted ownership of the policy to Holly this year when the value of the life insurance policy was $200,000. Sebastian paid $15,000 of gift tax on the transaction.
At Sebastian’s death, how much of the death benefit that Holly receives will be subject to income tax?

$0.
$785,000.
$800,000.
$1,000,000.

Answer 50

0.
Rationale

Even though the life insurance policy is considered a modified endowment contract, the receipt of the death benefit remains income tax free to the extent the policy had not been transferred for valuable consideration. In this case, the transfer to Holly was a gift, not a transfer for valuable consideration, so the death benefit is not subject to income tax.

Question 51

Neil was diagnosed as chronically ill and was in need of additional funds to pay for increased medical expenses so he sold his $100,000 life insurance policy, which had a cash value of $30,000, to a licensed viatical settlement provider for $55,000 in cash.
If the viatical company paid a total of $10,000 in premiums between the time they purchased the policy and the time of Neil’s death, what amount of the death benefit is taxable income to the viatical company?

$0.
$35,000.
$45,000.
$100,000.

Answer 51

Neil was diagnosed as chronically ill and was in need of additional funds to pay for increased medical expenses so he sold his $100,000 life insurance policy, which had a cash value of $30,000, to a licensed viatical settlement provider for $55,000 in cash. If the viatical company paid a total of $10,000 in premiums between the time they purchased the policy and the time of Neil’s death, what amount of the death benefit is taxable income to the viatical company?
$0.
$35,000.
$45,000.
$100,000.

Question 52

Ike and Tina, unrelated business partners, began operating a drug store in southern Florida. They funded a buy/sell agreement with a cross-purchase life insurance arrangement. Tina purchased a life insurance policy with Ike as the insured, and Ike purchased a life insurance policy with Tina as the insured. If Tina dies, which of the following is/are true?

1. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is excluded from Tina’s federal gross estate.
2. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is included in Tina’s federal gross estate if Tina own’s 50% or more of the stock of the drug store.
3. The value of the life insurance policy on Ike’s life, owned by Tina, is included in Tina’s federal gross estate.
4. The death benefit of the life insurance policy on Tina’s life, owned by Ike, is included in Tina’s federal gross estate

1 only.
1 and 3.
1, 2, and 3.
1, 2, 3, and 4.

Answer 52

1 and 3.
Rationale

Option 1 is correct because Tina’s federal gross estate will not include the death benefit of the life insurance policy on her life owned by Ike because Tina does not possess any incidents of ownership in the policy. Option 3 is correct because when an individual dies owning a life insurance policy on the life of another person, the value of the life insurance policy will be included in their federal gross estate. Option 2 is incorrect because Tina’s ownership in the drug store does not change the fact that Tina does not possess any incidents of ownership in the life insurance policy on her life, owned by Ike. The death benefit of a life insurance policy on Tina’s life would only be included in Tina’s federal gross estate if she possessed any incidents of ownership in the life insurance policy. Option 4 is incorrect because Tina does not possess any incidents of ownership in the policy.

Question 53

Judd, age 71, has been paying the premium on a whole life insurance policy for the past 30 years. The policy has a $1,000,000 death benefit and has built up a cash value of $250,000. Judd’s adjusted basis in the life insurance policy is $200,000. Which of the following statements is not correct?

If the insurer pays Judd a life insurance policy dividend of $3,000, his adjusted basis in the whole life insurance policy will increase to $203,000.

If the insurer pays Judd a life insurance policy dividend of $4,000, his adjusted basis in the whole life insurance policy will decrease to $196,000.

The cash surrender value of Judd’s whole life insurance policy would be equal to the cash value of the policy less any life insurance policy surrender charge still in effect.

Judd can take a loan from the cash value of the life insurance policy without suffering any income tax consequences

Answer 53

if the insurer pays Judd a life insurance policy dividend of $3,000, his adjusted basis in the whole life insurance policy will increase to $203,000.

Rationale

Life insurance policy dividends are a return of the policy owner’s adjusted basis. Any policy dividends received would decrease, not increase, the owner’s adjusted basis. All other options are correct.

Question 54

Travis, 28, and his wife, 26, have recently moved into a new home. They financed $350,000 of the $500,000 purchase price and utilized all of their savings to pay the down payment of $150,000. Travis’s wife, Shanna, stays at home with their 3-year old son, Barker, and is expecting a baby in two months.
Which of the following statements is not correct?

Travis should consider a 30-year term life insurance policy on his life which could fund his children’s educational needs if he should die during the term.

A universal life insurance policy would provide Travis with the insurance protection of a term life insurance policy and would also provide him with a tax-deferred savings mechanism.

A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death.

Travis should consider a whole life insurance policy on his life which could fund his children’s educational needs or pay off the mortgage if he dies while those needs exist, and which could also provide Travis with a source of funds if he lives through his retirement

Answer 54

A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death.

Rationale

A whole life insurance policy is a permanent type of insurance - eliminating a mortgage is a temporary need. Also, whole life insurance at Travis’ age would have the highest premium. All of the other statements are correct.

Question 55

Raphael is the owner of a variable life insurance policy on his life. His wife, Haven, is the designated beneficiary. Which of the following statements is correct?

If Haven dies before Raphael, Haven must include the value of the life insurance policy in her federal gross estate.

At Raphael’s death, the variable life insurance policy death benefit will be paid to Haven.

When the beneficiary of a life insurance policy is the spouse of the insured/owner, the death benefit payable to the spouse is included in the insured’s probate estate.

As beneficiary, Haven can borrow against the death benefit during Raphael’s life.

Answer 55

At Raphael’s death, the variable life insurance policy death benefit will be paid to Haven.

Rationale

As listed beneficiary, Haven will receive the death benefit of the life insurance policy at Raphael’s death.

Option a is incorrect because only the owner of a life insurance policy is required to include the value in their federal gross estate. In this question, Haven is only the beneficiary; she does not have any right to the life insurance policy until Raphael’s death.

Option c is incorrect. A life insurance policy is included in the insured’s probate estate only when the death benefit is payable to the insured (or the insured’s estate) or no designated beneficiary has been selected.

Option d is incorrect because the beneficiary of a life insurance policy cannot borrow against the death benefit.

Question 56

In an attempt to exclude the death benefit of a paid up $500,000 face value whole life insurance policy from his gross estate, Drake gifted the policy to his daughter. Six months prior to the gift, Drake had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor.
What is the gift tax value of the gift of this policy?

The replacement cost of the life insurance policy.

The life insurance policy’s interpolated terminal reserve plus any unearned premium.

$500,000 discounted for Drake’s six month life expectancy.
The cash surrender value of the life insurance policy.

Answer 56

$500,000 discounted for Drake’s six month life expectancy.
Rationale

If a physician has determined that the insured has a physical condition that is terminal, the value of a life insurance policy for gift tax purposes will be the death benefit, discounted for the predicted life expectancy of the insured.

Question 57

Last year, Omar gave a life insurance policy with a $400,000 death benefit to his son, Scout. At the time of the gift, the value of the life insurance policy was $50,000 and Omar had to pay $5,000 in federal gift tax. Omar unexpectedly died this year. What amount will be included in Omar’s federal gross estate related to this life insurance policy?

$5,000.
$400,000.
$405,000.
$455,000

Answer 57

$405,000.
Rationale

Life insurance proceeds on policies gratuitously transferred within three years of death are included in the gross estate of the donor. Gift tax paid within three years of death is included in the federal gross estate as well under the gross-up rule.

Question 58

Cooper is the owner, the insured, and the beneficiary of a whole life insurance policy. Which of the following situations regarding this scenario is incorrect?

When Cooper dies, his federal gross estate will include the death benefit of the life insurance policy.

When Cooper dies, his probate estate will include the death benefit of the life insurance policy.

Cooper’s estate will include the death benefit in its taxable income.

If Cooper designates a new beneficiary before he dies, and the beneficiary is alive at the time of Coopers death, the death benefit will be excluded from his probate estate.

Answer 58

Cooper’s estate will include the death benefit in its taxable income.
Rationale

The IRC (Section 101(a)) provides an income tax exemption for a death benefit paid from a life insurance contract by reason of the death of the insured.

In this case, Cooper’s estate will receive the death benefit, but it will still be excluded from the taxable income of the estate because of the exemption provided by the IRC (Section 101(a)). All of the other statements are correct.

Question 59

Your client was visited by Al State, the local insurance salesman. Al convinced your client he needed to buy a new life insurance policy on your client’s three month old baby’s life. The policy has a $10,000 death benefit. Your client is the owner of the policy, the policy is on child’s life, and your client’s spouse is the beneficiary.
Your client paid his first premium payment then had a heart attack and died. Which of the following statements is correct?

A.The interpolated terminal reserve plus any unearned premium will be included in your client’s gross estate.

B.The death benefit will be included in your client’s gross estate.

C.The replacement cost will be included in your client’s gross estate.

D.The policy will not be included in your client’s gross estate because he is not the beneficiary.

Answer 59

Solution: The correct answer is A.

The interpolated terminal reserve plus any unearned premium will be included in your client’s gross estate.
In this instance, the value is probably zero because only one premium payment had been made

Question 60

Sarah, age 90, would like to spend the few years she has left enjoying her life. She is currently unable to eat and bathe without assistance. She would like to use her life insurance policy to fund the remainder of her life.
Which of the following statements is correct?

A.If Sarah surrenders her policy for accelerated death benefits, she will be subject to income tax on the gain because she is not terminally ill.

B.Sarah could exchange the policy in a 1035 exchange for an annuity without being subject to income tax on the transfer.

C.If Sarah borrows from the policy, then the loan will be considered a taxable distribution.

D.If her son purchases the policy from Sarah at the fair market value, he will receive the insurance proceeds income tax free at Sarah’s death.

Answer 60

Solution: The correct answer is B.

Sarah can exchange the policy for an annuity income tax free. While Sarah is not terminally ill, she is chronically ill because she is unable to perform 2 of the 6 activities of daily living (eating and bathing).

Thus, surrendering her policy for accelerated benefits will not cause her to be subject to income tax.

The loan is not considered a taxable distribution because the policy is not a MEC. If her son purchases the policy then Sarah has transferred the policy for value.

This will cause the policy to be taxed in the son’s income when Sarah dies.

Question 61

George is considering transferring his life insurance policy to an ILIT. Which of the following statements is true?

A.If George included a clause that said, “George can change the beneficiary of the trust at any time to any person other than himself” then the assets would be included in George’s gross estate when he died.

B.If the trust allows the trustee to lend money to the George’s estate at George’s death, then the proceeds of the life insurance policy will be included in George’s gross estate.

C.Transferring the policy to the ILIT will eliminate the chance that the proceeds will be included in George’s gross estate at George’s death.

D.If George continues to pay the trustee an amount needed to pay the premiums on the policy, the proceeds will be included in his gross estate when he dies.

Answer 61

Solution: The correct answer is A.

Retaining the right to determine the ultimate beneficiary will cause inclusion in George’s gross estate.

The trust may be allowed to lend money to George’s estate. Inclusion will occur when the trust is required to lend money. George must survive for three years before the asset will not be included in his gross estate.

George can still pay the premiums on the policy without causing inclusion in his gross estate.

Question 62

Which of the following is a disadvantage of using an entity purchase buy-sell agreement?

A.A sole proprietorship is not ideal for entity purchases because they are more expensive.

B.It requires the business entity to purchase a deceased owner's interest, which can put a strain on the business's cash reserves.

C.If the surviving owners later sell the business, it may increase their taxable gain on the sale.

D.The business cannot deduct the life insurance premiums used to fund the purchase obligation until the death of the insured.

Answer 62

Solution: The correct answer is C.

If an entity buy-sell agreement is used, and the surviving owners plan to sell their business interests after the death of the first owner but prior to their own deaths, the entity buy-sell agreement will increase their taxable gain upon sale of their interests. Of course, this would not be an issue for family businesses that are not sold during the lifetimes of the surviving family members.

Choice A is incorrect. Entity purchase agreements cannot be used for sole proprietorships because the proprietorship legally ceases to exist upon the proprietor’s death.

Choice B is incorrect. Using the death benefit to meet the purchase obligation under the buy-sell agreement does not affect cash holdings or other assets that the company may need for continued business operations, it is the purpose of the agreement.

Choice D is incorrect. The premiums are nondeductible, this is standard.

Question 63

Which of the following statements is true regarding Crummey powers and estate tax implications for ILIT beneficiaries?

A.Beneficiaries who possess Crummey powers have no estate tax exposure regardless of the amount they can withdraw from the trust annually.

B.If the annual amount subject to a beneficiary's Crummey power is limited to the greater of $5,000 or 5% of the trust assets, there will be no estate tax exposure for the beneficiary.

C.Crummey powers always cause estate tax inclusion for beneficiaries unless the trust assets are less than the estate tax exemption amount when the beneficiary dies.

D.Beneficiaries must withdraw the full amount subject to their Crummey power each year, or the entire trust corpus will be included in their taxable estate.

Answer 63

Solution: The correct answer is B.

The Five-and-Five exception prevents estate tax inclusion for beneficiaries if their annual withdrawal power is limited to the greater of $5,000 or 5% of trust assets.

Choice A is incorrect. Beneficiaries can have estate tax exposure from Crummey powers regardless of the withdrawal amount. The Five-and-Five exception prevents inclusion for powers limited as described.

Choice C is incorrect. Crummey powers do not necessarily cause estate inclusion if structured properly using the Five-and-Five exception.

Choice D is incorrect. Beneficiaries are not required to exercise their withdrawal rights over the annual contribution. The lapse of the power triggers the Five-and-Five exception.