Insurance/Annuities

Question 1

What is a deferred annuity?

Answer 1

Payments to annuitant begin at some future date

Usually a retirement annuity that accumulates interest until retirement age

Can be purchased in lump sum or periodic installment premiums

Question 2

What is a flexible premium deferred annuity (FPDA)?

Answer 2

Allowed insured to vary premiums paid

Retirement income is a function of premiums paid

Question 3

What is a single premium deferred annuity (SPDA)?

Answer 3

Lump sum payment of premium

Earnings accumulate tax free until distributed

Proceeds from a life insurance policy can be used to purchase a single premium annuity

Question 4

What is an equity indexed annuity?

Answer 4

Form of fixed annuity - linked to an index

Immediate - benefit linked to an index
Deferred - credited interest rate is linked to an index

Index is most often the S&P500

Question 5

What are aspects of equity indexed annuities?

Answer 5

• limits downside risk of index
• Index term: typically 1-10 years, interest credited at end of term
• Participation rate: percentage of index increase that affects credited interest, can vary or be guaranteed
• Cap rate (not all): maximum rate of credited interest
• Floor crediting rate (not all): typically 0%, no losses allocated to contact

Question 6

What are the indexing methods for equity indexed annuities?

Answer 6

Annual Reset/Ratcheting: index linked rate calculated each year (beginning vs end if year), interest added each year and protected from future decreases, generally has lower participation rate and may use averaging over time

High Watermark: compares highest anniversary index to initial index, beneficial if index declines near the end, interest only credited at the end, may have low participation rate or use cap rate

Point to Point: compares index at end of term (topically 6-7 years) to beginning of term, paying interest at end, may have higher participation rate

Question 7

Are death benefits from life insurance taxed?

Answer 7

Generally excludable from taxable income; exception is the transfer for value rule

Question 7

Are death benefits from life insurance taxed?

Answer 7

Generally excludable from taxable income; exception is the transfer for value rule

Question 8

How are life insurance dividends taxed?

Answer 8

• dividends earned on cash value are but taxable until withdrawn
• Cash value not taxable if withdrawn at death

Question 9

How are loans against life insurance taxed?

Answer 9

Tax free, exception is modified endowment contract or MEC

Question 10

Is the exchange of a life insurance policy to another or for an annuity a taxable event?

Answer 10

No

Exchanging an annuity for life insurance does create a taxable event.

Question 11

How are annuity withdrawals taxed typically?

Answer 11

Return if principal until all accumulated premiums have been distributed then taxed as ordinary income

Question 12

What is a MEC? What does it affect? What is the impact?

Answer 12

• An annuity that fails the 7 Pay Test, when cumulative premiums paid exceed the premiums due for the time period being considered
• MEC status only affects withdrawals and loans, not taxation of proceeds at death
• 10% penalty if withdrawn before age 59 1/2,, withdrawals and loans are taxed on a LIFO basis, considered a taxable distribution to the extent of any gain in the contract

Question 13

If an annuity is surrendered prior to death how are the following handled, lump sum, interest-only, installment payments.

Answer 13

Lump sum: amount above premiums paid is ordinary income

Interest-only: interest is taxable as ordinary income

Installment: portion is a return of principal and interest. Interest portion is taxed as ordinary income.

Question 14

What is the transfer for value rule?

Answer 14

If a life insurance policy is transferred for value then the death benefits are taxable to the transferee to the extent proceeds exceed basis..

Question 15

What are the exceptions to the transfer for value rule?

Answer 15

Transferred to the insured.
Transferred to a business partner of the insured.
Transferred to a partnership of the insured.
transferred to a corporation and which ensured is a shareholder or officer.
Transfer the results in carryover basis from transferor to transferee

Question 16

Under the transfer for value rule how will the proceeds be treated?

Answer 16

Terminally or chronically ill = tax free receipt

Not terminally or chronically ill (life settlement) = tax-free return of basis, ordinary income on cash surrender value over basis, and capital gains on the remainder

CSV - premiums paid = ordinary income
Cash surrender value

Question 17

How are group life insurance premiums taxed for the employer and the employee?

Answer 17

Premiums paid by an employer are deductible by the employer

the first $50,000 of coverage is not taxable to an employee

an employee must impute taxable income for benefits in excess of $50,000; the imputed income is a function of age and amount of benefits per $1,000 in excess coverage

Question 18

How is taxable income on an annuity calculated using the exclusion/inclusion ratio for life insurance proceeds or annuity payments?

Answer 18

Step one: total payments = monthly payment X 12 months X life expectancy

Step 2: exclusion ratio = basis/total payments

Step 3: amount excluded from monthly income = exclusion ratio X monthly payments

Question 19

How are life insurance death benefits paid as annuities handled from a tax perspective?

Answer 19

They retain the exclusion ratio indefinitely

the beneficiary of an annuity from a life insurance settlement is not permitted to recover any basis left at death

Question 20

What are the Activities of Daily Living (ADLs)?

Answer 20

Eating, toileting, transferring, bathing, dressing, and continence

Question 21

Describe viatical settlements and accelerated benefits:

Answer 21

some life insurance companies allow insureds who are terminally or chronically ill to receive an accelerated death benefit under the contract.

essentially the owner surrenders the life insurance contract in return for a payment that is less than the death benefit (and greater than the cash value) and the proceeds are typically used to pay for the medical care of the insured

Question 22

What is the definition of a chronically ill individual?

Answer 22

A person who is not terminally ill that has been certified by a licensed healthcare provider as being unable to perform, without assistance, at least two activities of daily living for at least 90 days, or a person with a similar level of disability.

Question 23

What is the definition of a terminally ill individual?

Answer 23

A person who has been certified by a licensed healthcare provider is having a condition or illness that can reasonably be expected to result in death within 24 months

Question 24

How are amounts received under a life insurance viatical settlements treated for chronically ill versus terminally ill?

Answer 24

Terminally ill excluded from gross income. chronically ill the non-taxable portion is limited to the amount incurred by the payee (that are not reimbursed by insurance) for qualified long-term care services provided for the insured.

Question 25

What is the year that affects how the taxation of withdrawals from annuities is taxed?

Answer 25

Annuities after 1982 and premature withdrawals receive LIFO tax treatment

Annuities prior to 1982 receive FIFO treatment