Federal Tax Considerations for Life Insurance and Annuities

Question 1

How are life insurance death proceeds taxed?

Answer 1

If taken as a lump sum, proceeds are tax free. If other than lump sum, principal is tax free and interest is taxable.

Question 2

How are dividends taxed in participating policies?

Answer 2

Dividends are the return of unsused premiums, so they are not considered income for tax purposes. However, if dividends are left with the insurer to accumulate interest, the interest earned on the dividend account is subject to taxation as ordinary income each year interest is earned.

Question 3

When can life insurance death proceeds be included in the insured’s taxable estate?

Answer 3

(1) If the insured is the owner of the policy at the time of death or possessed any incidents of ownership at the time of death; (2) if the insured’s estate is the designated beneficiary at the time of the insured’s death; and (3) if the insured, as policyowner, assigns or transfers ownership of the policy or makes a gift of the policy within 3 years prior to his or her death.

Question 4

When does a life insurance policy become a Modified Endowment Contract?

Answer 4

Any life insurance policy that fails a 7-pay test is classified as a Modified Endowment Contract (MEC), and loses the standard tax benefits of a life insurance contract.

Question 5

What are the consequences of withdrawing money from a traditional IRA prior to age 59 1/2.

Answer 5

10% penalty on distribution unless it qualifies for an exemption.

Question 6

Which nontaxable exchanges are allowed under the section 1035?

Answer 6

Cash value life insurance to another cash value insurance, endowment or annuity; an endowment to another endowment or annuity, and an annuity to another annuity.

Question 7

Generally, the premium paid for personal life insurance is

Answer 7

Not tax deductible.

Question 8

For personal life insurance, the lump-sum death benefit is received

Answer 8

On a last-in-first-out basis.

Question 9

Which of the following is NOT true regarding policy loans?

Answer 9

Money borrowed from the cash value is taxable.

Question 10

When a beneficiary in a life insurance policy receives payments consisting of both principal and interest portions, what will be taxed as income?

Answer 10

Both principal and interest.

Question 11

Which method is used to determine the taxable portion of each annuity payment?

Answer 11

The exclusion ratio

Question 12

The 10% early withdraw penalty from an IRA can be waived for

Answer 12

Catastrophic medical expenses.

Question 13

A policy cancels his life policy but instructs the insurance company but instructs company to transfer the cash value of the policy to an annuity. This nontaxable transaction is called a

Answer 13

1035 exchange

Question 14

Which of the following taxation principles applies to annuities?

Answer 14

Tax-deferred accumulation

Question 15

In life insurance policies, cash value increases are

Answer 15

Tax deferred.

Question 16

If $100,000 of life insurance proceeds were used in a settlement option which paid $13,000 per year for 10 years, which of the following amounts would be taxable annually?

Answer 16

$3,000.

Question 17

Which of the following terms is used to name the nontaxable return of unused premiums?

Answer 17

Dividend

Question 18

Excess contributions to a Roth IRA are subject to what tax penalty?

Answer 18

6 %

Question 19

Which of the following is true regarding taxation of policy dividends?

Answer 19

Dividends are not taxable.

Question 20

In a direct rollover, how is the money transferred from one plan to the new one?

Answer 20

From the trustee to the new trustee

Question 21

Avoiding tax consequences when transferring assets from one IRA to another can be accomplished by which of the following?

Answer 21

Direct rollover from one plan to the other.