Life: Federal Tax Considerations For Life Insurance And Annuities

Question 1

Earned income

Answer 1

Salary, wages, or commission, but not income from investments, unemployment benefits, and similar

Question 2

First in, first out (FIFO)

Answer 2

The principle under which it is assumed that the funds paid into the policy first will be paid out first

Question 3

Last in, first out (FIFO)

Answer 3

The policy under which the funds paid into the policy last will be paid out first

Question 4

Policy endowment

Answer 4

Maturity date

Question 5

Policy proceeds

Answer 5

In life insurance, the death benefit

Question 6

Rollover

Answer 6

Withdrawal of the money from one qualified retirement plan and placing it into another plan

Question 7

Surrender

Answer 7

Early termination of a policy by the policyowner

Question 8

Tax deferred

Answer 8

Taxes on deductibles or gains are paid at a future date

Question 9

Vesting

Answer 9

The right of a participant in a retirement plan to retain part or all of the benefits

Question 10

Modified Endowment Contract (MEC)

Answer 10

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

Question 11

7-pay test

Answer 11

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

Question 12

The following are taxation rules that apply to MEC’s cash value

Answer 12

• 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

Question 13

The exclusion ration

Answer 13

Used to determine the annuity amounts to be excluded from taxes

Question 14

Corporate annuities have different tax implications than individual annuities

Answer 14

• 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

Question 15

The following taxation rules apply to contributions made to traditional IRA plans

Answer 15

• contributions must be made in cash (check, money order, etc.)
• excess contributions are taxed at 6%
• tax-deferred earnings are not taxed until withdrawn

Question 16

There are certain conditions under which the 10% penalty for early withdrawals would not apply

Answer 16

• 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

Question 17

Spouses who are the sole beneficiary of an IRA can do the following:

Answer 17

• 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

Question 18

Traditional IRAs

Answer 18

• 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

Question 19

Roth IRAs

Answer 19

• 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

Question 20

Rollover

Answer 20

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

Question 21

Direct rollover

Question 22

Direct rollover

Answer 22

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

Question 23

Transfer (or direct transfer)

Answer 23

A tax-free transfer of funds from one retirement program to a traditional IRA

Question 24

Transfer for value

Answer 24

The life insurance policy is sold to another party prior to the insured’s death