Life Insurance and Annuities Flashcards
What is a peril?
Cause of a financial loss
What is a hazard
Condition that increases the probability that a loss will occur
What are the three hazards?
Physical hazard
Moral hazard
Morale hazard
What is a physical hazard?
Physical characteristics of the person or property that increase the chance of loss
Example oily rags left near a furnace or high blood pressure
What is moral hazard?
Chance of loss from dishonesty
What is morale hazard?
Indifference to loss which creates carelessness and increases the chance of loss
What is loss in insurance?
Disappearance or reduction in value
What are the four classifications of risk?
Financial and non-financial risk
Static and dynamic risk
Fundamental and particular risk
Pure and speculative risk
What is financial risk?
Risk that may cause financial loss
What is non-financial risk?
Risk that does not cause financial loss, example, pain, and suffering
What is static risk?
Risk that is always present
Occurs regularly and our insurable
Examples, natural disaster, earthquake, death, or flood
What is dynamic risks?
Result of the economy changing
Insurance does not cover these risks
What is fundamental risk?
Risk that affects a large group of people
What is particular risk?
Individual in nature, or affects a small group of people
What is pure risk?
Involves only the chance of loss or no loss and is insurable
What are the four forms of pure risk?
Personal risk
Property risk
Liability risk
Risk for failure of others
What is personal risk?
Loss of income or assets, resulting from the loss of ability to earn income, caused by a disability, death or sickness
What is property risk?
Direct or indirect loss to the property itself from theft or destruction
What is liability risk?
Intentional or unintentional injury to property or others
What is risk from the failure of others?
Failure to meet or follow through on an obligation example breach of contract
What is speculative risk?
Chance of both loss or gain example gambling is not insurable
An insurance contract must contain the following five elements
Offer and acceptance
Consideration
Legal object
Legal capacity
Legal form
What does indemnity mean with an insurance contract?
Insured may recover from the insurance company only to the extent of the actual financial loss
What are the unique characteristics of insurance contracts?
Contract of indemnity
Personal contract, meaning, non-transferable
Contract of adhesion, take it, or leave it
Contract of utmost, good faith
Unilateral contract , only insurer makes legally enforceable promises
Conditional contract , premium must be paid and a covered loss must occur
Aleatory contract, outcome affected by chance dollars collected by the parties may not be equal
Subrogation, if the insured pays the insured for a loss caused by a third party, the insured is required to assign his right to recover from the third-party to the insurer
The owner of the life insurance policy can be reasigned or transfer the policy, true or false
True
What is a single life annuity?
The beneficiary receives a specified amount of money periodically tell the beneficiary dies at which time annuity payments cease
Highest periodic payment
What is a life annuity with period certain?
Beneficiary is paid a specified amount of money periodically for life
Payments are guaranteed for a certain number of periods
If beneficiary died before the specified period ends payments continue to the beneficiaries estate or to a contingent beneficiary until the guaranteed period ends
What is a life annuity with refund?
Beneficiary is paid income periodically for life. Death benefit has not been recovered at the time of the beneficiaries death, which is toll amount, payment received, does not equal or exceeds the basis of the annuity. the remainder up to the basis of the annuity is paid to the contingent beneficiary, either in installments, or in a lump sum
What is a joint and survivor annuity?
Provides payments to two payees, at the death of the first payee. A payment may or may not be decreased to the second payee, but will cease on the death of the second payee.
Are dividends taxable income in an insurance policy?
Dividends are not taxable income until the amount received in dividends, exceeds the policies cost basis, which is usually the amount of premium paid less any distributions
What are the types of life insurance?
Annual Renewable Term
Whole Life
Variable Life
Universal Life A and B
Variable Universal Life A and B
Types of Term Insurance?
Annual Renewable Term: level face amount, exponentially increasing annual premiums
Level term, level face amount premiums remained fixed (five, 10, 15, 20, 25, or 30 years)
Decreasing term, level premiums, decreasing face amount, historically used for mortgage protection.
What are the characteristics of whole life insurance?
Provides lifetime protection
Cash value accumulation
Policies may be participating
Appropriate for people who have long-term insurance need or desire, a cash savings investment feature
Whole life insurance
What are the policy types?
Whole life (ordinary, or straight)
Limited pay life
Graded premium whole life
Modified premium whole life
Whole life insurance
What is whole life ordinary or straight?
Premiums are level and are paid for life face amount of insurance remains constant for life
Benefits, those who have lower risk tolerances
Insurance company guarantees a minimum cash value, build up at each age and assumes the investment risk
Cash value is invested in the insurance companies general account
Whole life insurance
What is limited pay life?
Amount of protection remains constant for life premiums paid for a specific term, after which no further premiums are paid
Whole life insurance
What is graded premium whole life?
Low first year premium, increases each year early policy years, and then levels off usually within the first 5 to 10 years
Whole life insurance
What is modified premium whole life?
Premiums are lower for the first 3 to 5 years, and then increase to a higher level premium
Whole life insurance
What is variable life?
Premium is fixed face amount may vary with no guarantee of cash value
Choose from a wide variety of investment options
Death benefit may go up in value, but cannot fall below a guaranteed minimum face amount, consist of two parts minimum an excess amount created by favorable investment returns
Suitable only for clients with a higher risk tolerance
Whole life insurance
What is current assumption whole life?
Interest sensitive policy in which the insurers current investment experience under non-participating painting policies is credited to cash values
What is universal life insurance?
A flexible premium
Adjustable death benefit
Unbundled life insurance contract
Policyholder may raise policy, death benefits (subject to insurability), policy, cash values and pure insurance cost are unbundled, cash value accumulation is determined by current interest rates
Universal life insurance
What is the difference between universal life A and B?
Universal Life A, known as option, one or a level death benefit, death benefit is simply the face amount of the policy
Universal life B, known as option to or increasing death benefit. Death benefit is the face amount of the policy plus the cash value.
Universal life insurance
Who is typically not suitable for universal life insurance?
Individuals on fixed, incomes, or individuals who cannot manage the flexibility of the policy
What is variable universal life insurance?
Combines many features of universal and variable life insurance
Are universal life product with investment options for cash value, and no minimum guaranteed rate of return or interest
Death benefits are not guaranteed cash value can decline to zero
Suitable for individuals with higher risk tolerance, and those with investment experience
I also come on with the options of A and B
A - level death benefit
B - increasing death benefit, benefit is the face amount of the policy plus the cash value
What is a First to Die life insurance coverage?
Provides a death benefit when the first insured dies
Cost less than two separate policies
May be cost effective in a business application, characterized by several key employees in contrast to purchasing multiple policies at the same face value
What is a survivorship (second to die policy?
Provides death benefits when the second or last insured dies
Used for estate, planning, or spouses, intend to make substantial use of the marital deduction
Usually cost effective because of combined life expectancy
What are the three methods for calculating life insurance needs?
Capital retention method
Human life value method
Financial needs analysis method
Calculating life insurance needs
What is the capital retention method?
Method of determining the amount of life insurance needed that uses interest only to furnish the continued support of the family
Calculated as follows
Annual income needed (salary minus Social Security benefits)
Annual income needed divided by rate of return equals amount of life insurance needed then add the annual amount of income needed because this amount will be needed in the first year
This method does not take into account inflation
Calculating life insurance needs
What is a human life value method?
Replace an individuals economic value
Considers the income of the individual through the remaining work, life expectancy, including raises. Then applying a discount rate to this total to determine present value.
Calculating life insurance needs
What is the financial needs analysis method?
Examines all recurring expenses to dependent survivors and any unusual expenditures that may result from the death of the insured
What are annuities?
Are insurance based products that can be used to for retirement on a tax advantage basis
Provide a periodic payments for a specified period or for someone’s lifetime
Can be annuitized if the owner elects to convert the money to an annuity into a stream of periodic income payments
What is the difference between an immediate or a deferred annuity?
Immediate annuity - purchased with a single premium income benefits begin immediately
Deferred annuity - annuitization until some point in the future, chosen by the owner
What are the three premium payment methods for an annuity?
Single premium deferred annuity (SPDA)
Flexible premium deferred annuity (FPDA)
Single premium immediate annuity (SPIA)
Annuities
What is a single premium deferred annuity? (SPDA)
Lump sum premium within an annuity. Deferred until some point in the future, premium earns interest that accrues tax deferred
Annuities
What is a flexible, premium deferred annuity (FPDA)?
Allows periodic, non-fixed contributions, earnings, accumulate free from current income tax, and are then distributed at some point in the future
Annuities
What is a single premium immediate annuity (SPIA)?
Annuity payments to the annuitant begin one payment interval, following the premium payment
What is twisting?
Practice of using misrepresentation to induce a policy owner with one company to forfeit or surrender a life insurance or annuity policy for the purpose of taking out a policy with another company
How are life insurance death benefits taxed to individual beneficiaries?
They are not included in gross income
How are partial withdraws from life insurance treated tax wise?
received tax free up to basis
How are policy loans taxed from life insurance?
Tax free
How do you determine the basis of a life insurance contract?
Investment in the contract (basis) = premiums paid - dividends received - outstanding loans or withdrawals.
How do you determine the gain on a life insurance policy at surrender?
Gain at surrender (taxed as ordinary income) = cash surrender value - investment in the contract
Life insurance dividends
How are dividend distributions treated?
Are not taxable, considered a return of premium reduces the policy owners investment in the contract (basis)
Life insurance dividends
What if dividends distributed exceed premiums?
Excess amount of dividends received above the policy owners basis is taxed as ordinary income
Life insurance dividends
How are dividends taxed if the policy owner chooses to leave the dividends with the insurance company?
Any interest earned on the dividends is taxed as ordinary income in a year earned
1035 exchange
What all can a life insurance policy be exchanged for?
Life insurance policy, endowment policy, annuity contract, qualified long-term care insurance policy
1035 exchange
What can an annuity contract be exchange for?
Another annuity contract, qualified long-term care insurance policy
You cannot exchange an annuity contract for a life insurance policy and be tax free
1035 exchange
What can you exchange a qualified long-term care insurance policy for?
Another qualified, long-term care insurance policy
What are the five instances where the transfer of a policy will cause the death benefit to retain it’s tax free status
Transfers to
The insured, a partner of the insured, a partnership, in which the insured is a partner, a corporation in which the insured is an officer or shareholder, and a transferee, whose basis in the policy is determined by reference to the transfers basis
Income taxation of life insurance
Lump sum death benefits?
Excludable from gross income
Income taxation of life insurance
Interest only payments on death benefits?
Interest payments are taxable as ordinary income in the year earned
Income taxation of life insurance
Installment payments of death benefits?
Beneficiary receives, installment payments, principal portion is tax free interest, portion of installment payments, accruing after the date of insured’s death is taxable to the beneficiary as ordinary income
Income taxation of life insurance
Life insurance proceeds, received as an annuity?
Each payment has a return of basis component in an interest component
Use the exclusion ratio
Federal estate taxation of life insurance benefits
Life insurance, death benefits
Avoid probate if there is a named beneficiary
Federal state taxation of life insurance benefits
What are the situation’s that will cause the death proceeds from a life insurance policy to be included in the decedents insured’s gross estate?
Decedent gifted the policy within three years of the decedent’s death
Proceeds are payable to the estate, executor of the estate, creditors of the estate
Decedent insured, retained incidence of ownership in the life insurance policy at death, incidence of ownership are the right to assign the policy, right to change the beneficiary, right to change policy provisions
Federal taxation of life insurance
If decedent owns the policy and proceeds are payable to the spouse?
Proceeds are included in the decedents gross estate, but unlimited marital deduction can be utilized, proceeds can then be deducted from decedents gross estate and removed from estate taxation
What is a Viatical Settlement?
Selling your insurance policy, if you are terminally ill or chronically ill
Viatical Settlement
What is required and what are the tax consequences?
Insured is expected to die within 24 months certified by doctor proceeds not subject to income tax
Chronically ill must also be certified by a doctor and gains from the sale of the policy must be used for the insured‘s long-term care
Third parties who purchase the policies do not qualify for tax relief
How are the withdraws from an annuity treated for tax consequences?
Last in first out, so withdraws are presumed to come from earnings first and are taxed to the extent of earnings
How are taxes treated with withdrawals from a fixed annuity?
Each payment is considered a partial return of tax free basis and taxable income by use of the exclusion ratio.
What is the fixed annuity exclusion ratio?
Fixed Annuity Exclusion Ratio = investment in the contract / expected return of all payments
Fixed annuity
What happens to payments from a fixed annuity if the individual lives beyond life expectancy, or dies before life expectancy?
Payments beyond life expectancy are fully taxable
Dies before life, expectancy, uncovered basis is deductible on the final income tax return as a miscellaneous itemized deduction, not subject to the 2% floor of AGI
How are taxes treated with withdrawals from a variable annuity?
All payments in excess of the exclusion amount are taxable payments beyond projected life expectancy are fully taxable
Variable annuity
How do you determine the exclusion amount with a Variable annuity?
Variable annuity, exclusion amount = investment in the contract / annuitants life
Note: this will give you the yearly amount you will need to divide by 12 the final number to get the monthly payment exclusion
