Life: Federal Tax Considerations For Life Insurance And Annuities Flashcards
Earned income
Salary, wages, or commission, but not income from investments, unemployment benefits, and similar
First in, first out (FIFO)
The principle under which it is assumed that the funds paid into the policy first will be paid out first
Last in, first out (FIFO)
The policy under which the funds paid into the policy last will be paid out first
Policy endowment
Maturity date
Policy proceeds
In life insurance, the death benefit
Rollover
Withdrawal of the money from one qualified retirement plan and placing it into another plan
Surrender
Early termination of a policy by the policyowner
Tax deferred
Taxes on deductibles or gains are paid at a future date
Vesting
The right of a participant in a retirement plan to retain part or all of the benefits
Modified Endowment Contract (MEC)
Policies are classified as an MEC when they fail the 7-pay test
Once a policy becomes classified as a MEC, they are always classified as a MEC
7-pay test
A policy fails when the cumulative premiums paid during the first 7 years of the policy exceed the total amount of net level premiums that would be required to pay the policy up using guaranteed mortality costs and interest
- policy becomes classified as a Modified Endowment Contract (MEC), and cannot undo that title
The following are taxation rules that apply to MEC’s cash value
- tax-deferred accumulations
- any distributions are taxable, including withdrawals and policy loans
- distributions are taxed on last in, first out basis — known as “interest-first” rule; and
- distributions before age 59 1/2 are subject to 10% penalty
The exclusion ration
Used to determine the annuity amounts to be excluded from taxes
Corporate annuities have different tax implications than individual annuities
- growth in the annuity is not tax-deferred
- interest income is taxed annually unless the corporation owns a group annuity for its employees, and each employee receives a certificate of participation
The following taxation rules apply to contributions made to traditional IRA plans
- contributions must be made in cash (check, money order, etc.)
- excess contributions are taxed at 6%
- tax-deferred earnings are not taxed until withdrawn
There are certain conditions under which the 10% penalty for early withdrawals would not apply
- participant is age 59 1/2
- participant is totally disabled
- the money is used to make a down payment on a home (not to exceed $10,000, and usually for first time buyers)
- withdrawals are for post-secondary education expenses
- withdrawals are catastrophic medal expenses or death
Spouses who are the sole beneficiary of an IRA can do the following:
- treat the IRA as their own
- base the required minimum distribution (RMD) age on their own current age
- base the required minimum distribution on the decedent’s age at death, reducing the disribution period year by 1
Traditional IRAs
- grows tax deferred
- contributions are tax deductible
- 10% penalty for early nonqualified distributions prior to age 59 1/2
- distributions are taxable
- payouts must begin by age 72
- excess contributions are subject to 6% tax penalty
Roth IRAs
- grows tax free
- contributions are not tax deductible
- qualified distribution required minimum distribution
- distributions are not taxable
- no required minimum age for payouts
- excess contributions are subject to a 6% tax penalty
Rollover
A tax-free distribution of cash from one retirement plan to another
If distribution is made directly to the participant, 20% must be withheld by the payor
Direct rollover
Direct rollover
If the distribution is made directly from the first plan to the trustee or administrator of the new IRA plan the 20% withholding of funds can be avoided
Transfer (or direct transfer)
A tax-free transfer of funds from one retirement program to a traditional IRA
Transfer for value
The life insurance policy is sold to another party prior to the insured’s death
