Income Taxation of Life Insurance Flashcards
True or False
Life Insurance premiums are NEVER tax deductible
False; they USUALLY aren’t tax deductible. A deduction may be available if premium is paid as part of compensation for Group Term coverage or Life Insurance as part of a qualified.
True or False
No taxes are due for appreciation of cash value within a life insurance policy UNLESS it’s surrendered and cash value exceeds net premiums paid.
True
True or False
Dividends of a Life Insurance policy are taxable
False; they are however taxable when
cumulative dividends paid to policy owner > cumulative premiums paid by policy owner.
Death benefits are almost always
a. free from taxation
OR
b. taxed
a. free from taxation
However, if you have $1mil policy and elect to have installment payments of $120k per year for 10 years, that extra $200k is taxable
True or False
If the owner of a life insurance policy is also the insured, then upon the owner’s death, the full face amount of the policy is included in the owner’s taxable estate.
True
True or False
The withdrawal of the cash value from a cash value policy will be taxable only to the extent that the total value in the policy exceeds the policy’s basis.
True
What is “Modified Endowment Contract?” (MEC)
- A classification of life insurance that is a contract that fails to meet certain premium limitation tests.
What are MEC limits for?
MEC limits are designed to keep premiums lower so gov can get taxes
(context: life insurance policies were becoming overly used tax deferred savings accounts)
True or False
Once a life insurance policy becomes a MEC, the death benefit will cease to be income tax free
False
What is “Valuable Consideration?”
Includes: Cash, other assets, or a promise to pay
What is the “Transfer for Value Rule?”
if any interest in a life insurance policy is transferred for *valuable consideration, then the death benefit may be subject to ordinary income taxes.
*basically a payment
What does a 1035 Exchange do?
It permits a tax-free exchange of an old life insurance policy for a new policy
(must be between “like” accounts)
True or False
An annuity for a life insurance or endowment policy is a taxable exchange under the 1035 exchange rule
True
How do you determine “Cost Basis” of a policy?
Total premiums paid
- total dividends received
- cumulative previous non-taxable withdrawals
= COST BASIS
