Part 4 - Life Insurance in Personal and Business Planning

Question 1

Marital trust

Answer 1

Commonly a testamentary trust established to receive property equal in value to the taxable estate less the marital deduction amount

Question 2

Net payment cost indices

Answer 2

Cost comparison method required by the NAIC life insurance disclosure model regulation intended to inform a prospective life insurance buyer of the estimated average annual net payment or outlay per $1000 of insurance over a select time period (Ordinarily 10 and 20 years) taking into consideration only the policy’s premiums and illustrated dividends, if any, and adjusting them for the time value of money.

Question 3

Pension maximization strategy

Answer 3

Election by a retiree of a single life income option in lieu of a joint and survivor income option, using the income difference to purchase life insurance on the annuitant’s life for the benefit of the survivor.

Question 4

Policy summary

Answer 4

Document required to be provided to prospective life insurance buyers by the NAIC life insurance disclosure model regulation, intended to help prospective purchasers understand the specific policy being considered for purchase and which contains illustrated and guaranteed policy values along with other policy information

Question 5

Qualified terminable interest property

Answer 5

Under federal tax law, property qualifying for the marital deduction but for which the surviving spouse’s interest terminates on death

Question 6

Retirement tail risk

Answer 6

Possibility of having insufficient resources at retirement to cover an individual’s entire life span

Question 7

Special power of appointment

Answer 7

Right to dispose of property to anyone except the person holding the power

Question 8

Surrender cost indices

Answer 8

Cost comparison method required by the NAIC life insurance disclosure model regulation intended to inform a prospective life insurance buyer of the estimated average annual net cost per $1000 of insurance over selective time periods (Ordinarily 10 and 20 years) taking into consideration the policies premiums, illustrated dividends or other nonguaranteed policy values (if any), and cash surrender values and adjusting these values for the time value of money

Question 9

Tenancy by the entirety

Answer 9

Joint interest property between spouses in which a decedent’s interest passes automatically to the surviving spouse

Question 10

Tenancy in common

Answer 10

Joint interest property in which each person owns his or her share outright which share passes to the person’s heirs

Question 11

Tentative tax base

Answer 11

Under federal tax law, sum of adjusted taxable gifts and the adjusted gross estate

Question 12

Trigger point

Answer 12

State designated in a formal buy/sell agreement at which a disabled owner’s business interest must be purchased

Question 13

Unified credit

Answer 13

Under federal tax law, tax credit that can be applied to offset estate and gift taxes (for deaths occurring in 2011 and 2012, the credit was $1,730,800)

Question 14

Wealth replacement trust

Answer 14

Irrevocable life insurance trust designed to provide a death benefit to beneficiaries roughly equivalent in value to property transferred by the donor/grantor to a charitable remainder trust or others

Question 15

IRC Subsection 7702

Answer 15

Contains a definition of life insurance for purposes of determining whether a policy qualifies for certain aspects of favorable tax treatment.

Failure of a policy to meet the definition generally results in a policy being treated as a combination of term insurance and a taxable side fund.

Policies must meet one of two tests to qualify as life insurance for income tax purposes:
1) Cash value accumulation test
2) Guideline premium and cash value corridor tests
Which ever is chosen, the test must be met for the entire life for the contract

Question 16

Incidence of ownership

Answer 16

Include the right to change the beneficiary, the right to surrender or otherwise terminate the policy, the right to assign the policy, the right to obtain a policy loan, and, in general, the ability to exercise any important right of the policy

Question 17

8 risks individuals face

Answer 17

1) Wage
2) Mortality
3) Health
4) Savings
5) Care
6) Longevity
7) Inflation
8) Investment

Note, the first six risks are specific to individuals. The last two risks are environmental and apply to all individuals.

Remember, risk can be avoided, treated (reduced or controlled), or transferred through insurance

Question 18

4 types of advance directives

Answer 18

• Living will
• Medical power of attorney
• Durable power of attorney
• Do not resuscitate (DNR) order

Question 19

Living will

Answer 19

Advance directive setting forth an individual’s wishes as to the use of life-sustaining measures in case of terminal illness, prolonged coma, or serious incapacitation.

Question 20

Medical power of attorney

Answer 20

Advance directive designating an individual, referred to as the individual’s healthcare agent or proxy, to make medical decisions for the person if he or she is unable to do so

Question 21

Durable power of attorney

Answer 21

Advance directive designating an individual to make financial and other decisions for a person who becomes incapacitated or is declared incompetent to conduct his or her own affairs; survives the person’s incapacity, unlike some non-durable powers

Question 22

Do not resuscitate (DNR) order

Answer 22

Advance directive requesting no cardiopulmonary resuscitation intervention if one’s heart stops or one stops breathing

Question 23

LLC

Answer 23

Form of business combining features of partnerships and corporations, whose governance and owners rights are defined more by the operating agreement of its members than by statute, featuring limited liability and flexibility in the tax status of participants.

Disregarded for federal tax purposes, and it elects to be taxed as any of the traditional entity forms: proprietorship, partnership, traditional corporation, or Subchapter S corporation.

Question 24

Substantial risk of forfeiture

Answer 24

Condition under which deferred income is not considered constructively received because 1) it is either subject to the claims of the employer’s creditors or 2) if the employees rights are non-forfeitable, the deferred compensation agreement was entered into before the compensation was earned and the employer’s promise to pay is unsecured.

Question 25

Rabbi trust

Answer 25

Assets remains subject to the claims of the employer’s general creditors if the employer becomes insolvent, but, in the absence of such claims, assets must be used to solely provide deferred compensation benefits

Question 26

Constructive receipt

Answer 26

Income deemed received by taxpayer irrespective of whether it is taken in cash

Question 27

Secular trust

Answer 27

Assets are not subject to the claims of the employer’s general creditors

Question 28

Collateral assignment approach

Answer 28

Split dollar life insurance plan under which the insured employee applies for the policy and is primarily responsible for premium payments, with the policy collaterally assigned to the employer to secure amounts it advanced to the employee for premiums.

Question 29

Endorsement approach

Answer 29

Split dollar life insurance plan under which insurance on the employee’s life is applied for and owned by the employer, which is primarily responsible for premium payments

Question 30

Section 303 stock redemption plan

Answer 30

IRC provision permitting an income-tax-free redemption of shares of stock by qualifying estates in an amount up to federal and state death taxes due, funeral expenses, and estate administration expenses

Question 31

Wait-and-see buy/sell agreement

Answer 31

Arrangement under which shareholders in the corporation postpone the decision between a cross purchase and stock redemption agreement until the death of a stockholder

Question 32

Cross purchase buy/sell agreement

Answer 32

Arrangement under which each owner of an interest in a business obligates his or her estate to sell, and the other owners are obligated to purchase, any owner’s interest at his or her death

Question 33

Adjusted gross estate

Answer 33

Under federal tax law, gross estate less allowable deductions except bequests to the surviving spouse and to charities

Question 34

Advance directives

Answer 34

Legal document that provides one’s family and physicians with written instructions regarding one’s preferences for medical treatment in the face of serious medical conditions

Question 35

Alternate valuation date

Answer 35

Under federal tax law, option to use the fair market value of the estate property at a date six months after death

Question 36

Ambulatory instrument

Answer 36

One taking affect only at death

Question 37

Testator

Answer 37

Person making a will

Question 38

Codicil

Answer 38

Amendment that adds provisions or amends a part of a will but doesn’t replace the will

Question 39

Business overhead expense insurance

Answer 39

Type of disability income insurance that covers the monthly expense of a business owner or professional in private practice if he or she is disabled

Question 40

Charitable remainder trust

Answer 40

Irrevocable trust funded with a split interest gift by a grantor, which 1) pays an income to a named non-charitable beneficiary for life or specified term of up to 20 years and 2), at the end of the term, pays the remaining assets to the charitable beneficiary.

Question 41

Closely held corporation

Answer 41

Business typically owned and managed by a small number of investors and whose ownership interest has no ready market

Question 42

Community property

Answer 42

Joint interest property under which all property acquired during marriage is property of the marriage community

Question 43

Contingent deferred annuity

Answer 43

Life insurer issued guaranteed lifetime withdrawal benefit attached to a mutual fund or managed investment account (Also called stand alone living benefit)

Question 44

Corpus

Answer 44

Property held in trust

Question 45

Credit shelter trust

Answer 45

(Also called: bypass trust or non-marital trust) Testamentary trust holding property equal in value to the marital deduction amount

Question 46

Economizing problem

Answer 46

Condition of unlimited wants and limited resources

Question 47

Entity buy/sell agreement

Answer 47

Arrangement under which an owner of an interest in a business obligates his or her estate to sell and a business entity obligates itself to purchase that interest on the owner’s death

Question 48

Estate conservation (i.e. estate liquidity)

Answer 48

Term used to describe the use of life insurance death proceeds to cover some or all of one’s estate obligations, the most relevant of which typically are estate taxes

Question 49

Federal estate taxes owed

Answer 49

Under federal tax law, net amount owed to the government after applying applicable credits against the tentative federal estate tax

Question 50

General power of appointment

Answer 50

Right to dispose of property not owned by the person holding the power, including giving it to him or herself

Question 51

Guideline premium and cash value corridor tests

Answer 51

Guideline premium test- Greater of the guideline level premium and the guideline single premium as defined in IRC section 7702. One of the two prongs of the guideline premium/cash value or a method of qualification used for determining whether a life insurance policy qualifies for favorable tax treatment. (Other prong) Promised benefits at all times must be at least equal to certain percentage multiples of the policy’s cash value. Typically used with unbundled life policies.

Question 52

Income replacement ratio

Answer 52

Gross earned income after retirement divided by gross income before retirement

Question 53

Inter vivos / living trust

Answer 53

One created during life

Question 54

Testamentary trust

Answer 54

One created through decedent’s will

Question 55

Intestate

Answer 55

Condition of dying without a valid will or having made a complete disposition of property and debt

Question 56

Intentionally defective irrevocable trust

Answer 56

Deferred sale arrangement between a grantor and an irrevocable trust that allows the grantor to make transfers of appreciated income producing property to junior generations free of gift tax

Question 57

Irrevocable life-insurance trust

Answer 57

Living trust created to own and be beneficiary of life insurance that is not part of the grantors’s gross estate yet with proceeds typically available to provide estate liquidity

Question 58

Joint interest property

Answer 58

Property owned jointly by two persons

Question 59

Joint tenancy with right of survivorship

Answer 59

Joint interest property in which a decedent’s interest passes automatically to survivor owners

Question 60

Key person insurance (I.e. Key employee or key man)

Answer 60

Life insurance purchased to indemnify a business for a decrease in earnings brought about by the death of a key person

Question 61

Employer owned life insurance

Answer 61

Under the IRC, life insurance on an employee’s life payable to his or her employer; unless certain conditions* are met, benefits in excess of the employer’s basis are taxable as ordinary income. *Conditions: 1) insureds are former directors or highly compensated employees. 2) Life insurance death proceeds are paid to the insured’s heirs (or a trust for the heirs) or used by the employer to redeem stock owned by the insured in the employer

Question 62

Transfer for value rule

Answer 62

IRC section 101(a)(2) which provides that death proceeds under a life insurance policy are included in gross income to the extent of the excess of gross policy death proceeds over the policy’s cost basis if the policy or any interest in it was transferred to another person for a valuable consideration

Question 63

Seven-pay test

Answer 63

Determines whether a life insurance policy is a modified endowment contract (MEC), which it is if cumulative amounts paid under contract at any time during the first 7 contract years exceeds the cumulative amount that would have been paid had the policy’s annual premium equaled the net level premium for a seven-pay life policy of the same type, using certain required assumptions

Question 64

Modified endowment contract

Answer 64

Life insurance policy entered into after June 20, 1988 that meets the IRC section 7702 definition of life insurance but that fails to meet the seven-pay test and therefore is not entitled to favorable income tax treatment of distributions.

Question 65

Cash value corridor limitation

Answer 65

One of the two prongs of the guideline premium/cash value corridor test method of qualification under IRC section 7702 used for determining whether a life insurance policy qualifies for favorable income tax treatment; promised benefits at all times must be at least equal to certain percentage multiples of the policy’s cash value. Typically used with unbundled policies.

Question 66

Cash value accumulation test

Answer 66

One method of qualification under IRC section 7702 to be met by a life insurance policy for favorable income tax treatment; policy’s cash surrender value cannot at any time exceed the net single premium that would be required to fund future contract benefits provided under the policy. Typically used with bundled whole life policies.

Question 67

General counsel memorandum

Answer 67

US treasury department detailed analysis prepared to explain the reasoning underlying regulation, revenue ruling, or private letter ruling

Question 68

Technical advice memorandums

Answer 68

US treasury department statement prepared after the fact in response to a tax issue, usually in connection with a taxpayer audit

Question 69

Private letter rulings

Answer 69

US treasury department interpretation of a specific fact situation deemed not to be of general interest

Question 70

Revenue rulings

Answer 70

US treasury department interpretation of a specific fact situation deemed to be of general interest

Question 71

Regulations

Answer 71

Government agency’s interpretation for proper implementation of a law

Question 72

Legislative history

Answer 72

Testimony and documents considered by the US Congress during its deliberations in enacting a law

Question 73

Capital retention approach

Answer 73

Method of life insurance need determination that derives a life insurance amount by assuming that interest earned on the life insurance death benefit (capital) alone will be used to meet an income objective, with the insurance death benefit retained and ultimately transferred to the heirs when its income producing role has been fulfilled.

Question 74

Capital liquidation approach

Answer 74

Method of life insurance need determination that derives a life insurance amount by assuming that both the life insurance death benefit (capital) and interest earned thereon are liquidated to meet an income objective.

Question 75

Churning

Answer 75

Systematic and indiscriminate replacement of existing life insurance policies

Question 76

Buyer’s guide

Answer 76

Document required to be provided to prospective life insurance buyers by the NAIC life insurance disclosure model regulation, intended to assist prospective purchasers in deciding how much and what type of life insurance to buy and comparing the costs of similar policies

Question 77

Surrender value solve

Answer 77

Value solve measure that solves for the cash surrender value that a particular premium and death benefit, amount, pattern, and duration will develop

Question 78

Death benefit solve

Answer 78

Value solve measure that solves the death benefit that a particular premium amount, pattern, and duration and, if applicable, attainment of a target cash surrender value by a specified policy year will support

Question 79

Value solve measures

Answer 79

Comparison method commonly used to discern differences in the illustrated performance of life insurance policies, which solves for one element (e.g. premiums, death benefits, or cash values) by setting the remaining elements to identical values

Question 80

Premium solve

Answer 80

Value solve measure the solves for the premium necessary to support a particular death benefit amount, pattern, and duration and, if applicable, attainment of a target cash surrender value by a specified policy year

Question 81

Volatility

Answer 81

Deviation of actual from average values

Question 82

Investment asset risk

Answer 82

Possibility of poor relative investment performance

Question 83

Inflation risk

Answer 83

Possibility that an individual’s cost of living will exceed that anticipated

Question 84

Longevity risk

Answer 84

Possibility of outliving one’s financial resources

Question 85

Care risk

Answer 85

Possibility that an individual will be unable to care for him or herself due to a physical or mental impairment

Question 86

Savings risk

Answer 86

Possibility that unexpected expense, a lack of planning, or carelessness impedes or interrupts and individual’s planned conversion of human capital to investment capital

Question 87

Health risk

Answer 87

Possibility that an individual loses his or her ability to work or incurs medical expense because of illness or injury

Question 88

Wage risk

Answer 88

Possibility that an individual’s earnings from employment decline by more than expected

Question 89

1035 exchange

Answer 89

IRC provision permitting a tax free exchange of certain types of life insurance policies and annuities for others

Question 90

Gross proceeds

Answer 90

Under the IRC, amounts paid on life insurance policy surrender, including the cash value of any paid up additions and the value of dividends accumulated at interest

Question 91

Cost recovery rule

Answer 91

Under the IRC, general rule for taxation of lump sum surrender cash value payments under life insurance and annuity policies under which the amount included in a policyowner’s gross income is the excess of the gross proceeds over the cost basis.