Life Federal Tax Considerations Flashcards
Material Change
An increase or decrease in the face value (death benefit) of a policy. There so that tax laws cannot be taken advantage of.
MEC Loans
Policy loans are taxable from MECs (policies where premiums are paid for for less than 7 years) and there is an additional 10% tax on loans if the person is under 59 1/2 years old. If a person contributes more money than is allowed in the first 7 years of policy, it is considered an MEC.
MECs remain MECs forever
Accumulate-at-interest dividend option
Interest on dividend is taxable in the year in which it’s earned, whether it is left in the account or paid to policy owner. Dividends are returns of overcharged premium and they are not taxable, but the interest on the dividend is taxable.
Roth IRA
Made with after-tax dollars and distributions are income tax free after 59.5. If taken before, distributions are subject to 10% tax. Exceptions can be made where money can be taken out income tax free before 59.5 if the person is 1. disabled 2. paying for college 3. buying a first time home.
Death benefits
Death benefits to a beneficiary on a LI policy are income tax free (except for the amount of interest since the person died).
How are annuities taxed?
Annuities are taxed based on the exclusion ration - only interest earned is taxed but the basis earned is not taxed.
Qualified annuities: Distributions are taxed as ordinary income since they were paid for with pre-tax dollars.
Non-qualified: Only the gains are taxed as ordinary income and the rest are tax-free.
Loans from annuities however are taxed as ordinary income and if taken out before 59.5, will take a 10% penalty.
MECs
MECs are life insurance policies that violate tax laws because too much premium has been paid on them in the first 7 years. Policies undergo the seven pay test from the IRS to determine if you have paid too much premium in the first 7 years. Distributions including loans are taxable. as LIFO (everything is taxed).
LIFO
Entire withdrawal/distribution is taxed (not just gains). This happens when withdrawals are made during the accumulation phase of an annuity as well as when loans are taken from MECs.
Taxation of cash value
Cash value less than premiums that have been paid are not taxed. Cash values left in the policy are also not taxed.
What age must you begin taking money for a traditional IRA, Roth IRA, and annuity?
You must begin taking money from a traditional IRA and annuity at 70.5 (both pre-tax), but there are no minimum ages for Roth IRAs.
Taxation of surrendered life insurance
Only gains from cash value are taxable; the rest is tax free.
Group Life Insurance Taxation
Premiums are deductible to the employer, but not deductible to the employee. The entire death benefit is tax free.
When can premature withdrawals (before 59.5) on an IRA not be subject to 10% penalty
Pay for medical bills more than 10% of income
