Tax Treatment of Life Insurance and Annuities

Question 1

Is there a tax consequence to taking out a loan against a policy’s cash value?

Answer 1

No, there are no tax consequences.

Question 2

Are life insurance death benefits included in the value of the deceased insured’s estate?

Answer 2

Yes

Question 3

True or False: Premiums paid for individual life insurance are not deductible.

Answer 3

True

Question 4

Dividends are paid by a ________ company.

Answer 4

mutual

Question 5

What is the effect of an outstanding loan if the insured dies?

Answer 5

The death benefit will be reduced by the loan amount and any interest owed.

Question 6

If classified as a MEC, distributions from the policy will be considered ____________________.

Answer 6

taxable as income.

Question 7

What occurs when the insured dies and his policy has an outstanding loan?

Answer 7

The loan amount and any interest owed will be subtracted from the death benefit.

Question 8

Which annuity is funded with after-tax dollars-­- qualified or nonqualified?

Answer 8

A nonqualified annuity

Question 9

The death benefit provided by a qualified annuity is __________ to the beneficiary.

Answer 9

taxable

Question 10

List some of the taxable distributions from a MEC.

Answer 10

Cash value surrender, dividends received, and policy loans

Question 11

When paid to a beneficiary, is the death benefit from a MEC-classified policy taxable?

Answer 11

No. The death benefit is paid on a tax-free basis.

Question 12

In a qualified annuity, how is the payout taxed?

Answer 12

The entire payout is taxed as ordinary income since the annuity was funded with pre-tax dollars.

Question 13

Estate taxes comprise both _______ and _________ taxes.

Answer 13

state and federal taxes.

Question 14

What rule states that property must be sold within 3 years prior to death to eliminate inclusion in a person’s estate?

Answer 14

The transfer of value rule

Question 15

Premature distributions from an MEC will be subject to __________ and a ____% IRS penalty.

Answer 15

Premature distributions from an MEC will be subject to TAXATION and a 10% IRS penalty.

Question 16

Ann invests $15,000 in a nonqualified annuity. At age 64, she withdraws all $22,000. What’s her basis and what’s taxed?

Answer 16

Ann’s basis is $15,000. The annuity is funded after-tax and the $7,000 of earnings would be taxed as ordinary income.

Question 17

Name four items that may be included in a person’s estate.

Answer 17

Real and personal property, life death benefits, annuity values, retirement funds, and ownership rights in real property

Question 18

Does the cash value of a MEC grow on a tax-deferred basis?

Answer 18

Yes. As long as money remains inside the contract, MEC cash value grows tax-deferred. However, withdrawals are taxable.

Question 19

The cost basis of a cash value contract consists of premiums paid for the ____ policy, but not ______.

Answer 19

The cost basis of a cash value contract consists of premiums paid for the BASE policy, but not RIDERS.

Question 20

A qualified annuity allows for ________ contributions and the annuity value grows on a _____________ basis.

Answer 20

A qualified annuity allows for PRE-TAX contributions and the annuity value grows on a TAX-DEFERRED basis.

Question 21

True or False: Dividends are treated as a return of overpaid premium, and are not taxable when returned to policyowners.

Answer 21

True

Question 22

The cash value of a whole life contract usually begins to show a value sometime in the ______ year following issue.

Answer 22

third

Question 23

If no beneficiary is listed or alive upon an insured’s death, a death benefit will be payable to the insured’s ________.

Answer 23

estate.

Question 24

A negative tax consequence may be created when the cash value policy is ______________.

Answer 24

surrendered.

Question 25

What is the dollar limit that may be contributed annually to a nonqualified annuity?

Answer 25

There is no contribution limit.

Question 26

The cash value grows within a contract on a ______________ basis.

Answer 26

tax-deferred basis.

Question 27

True or False: Distributions from a MEC are taxed on a first-in/first-out (FIFO) basis.

Answer 27

False.

Distributions from a MEC are taxed on a last-in/first-out (LIFO) basis.

Question 28

Identify the acronym: MEC

Answer 28

Modified Endowment Contract

Question 29

Describe a Modified Endowment Contract.

Answer 29

A life insurance policy in which the premiums paid are not in proportion to the death benefit provided.

Question 30

The death benefit received by a beneficiary is received ___________.

Answer 30

tax-free.

Question 31

In an MEC policy, premiums paid during the first __ years of the policy exceed what’s needed to fund a __-pay life plan?

Answer 31

In an MEC policy, premiums paid during the first 7 years of the policy exceed what’s needed to fund a 7-pay life plan?

Question 32

How is a nonqualified annuity benefit taxed?

Answer 32

The benefit is taxed on a last-in/first-out (LIFO) basis

Question 33

Interest earned is always _________.

Answer 33

taxable.

Question 34

What is the typical cost basis for a qualified retirement plan?

Answer 34

$0, since qualified plans are typically funded on a pre-tax basis.

Question 35

Joe’s policy has a cash value of $30,000 and his premiums were $28,000. If he surrenders the policy, what is taxable?

Answer 35

The cash value that exceeds premiums paid for the base policy would be taxable. This amounts to $2,000.

Question 36

In a Non-Qualified Annuity, how is the payout taxed?

Answer 36

Only the earnings portion is subject to tax as ordinary income

Question 37

Any interest earned on dividends left to accumulate with interest would be taxable as _________________.

Answer 37

ordinary income.

Question 38

To be excluded from a person’s estate, a piece of property must be sold within ___________.

Answer 38

3 years of death.

Question 39

Distributions from a MEC are considered premature if taken prior to age ______.

Answer 39

59 1/2.

Question 40

What type of annuity may be used as a platform for an IRA?

Answer 40

A qualified annuity

Question 41

True or False: Individual life insurance premiums are generally paid with pre-tax dollars.

Answer 41

False.

Individual life insurance premiums are generally paid with after-tax dollars.

Question 42

Are variable life insurance loans taxable?

Answer 42

No, but interest is charged to the policyholder.

Question 43

A policy is considered a MEC based on the ___-pay test.

Answer 43

7-pay

Question 44

Is the death benefit of an annuity included in a deceased client’s estate?

Answer 44

Yes. It becomes part of the estate and any amount over the cost basis may be taxable to the beneficiary.

Question 45

A nonqualified annuity allows for _________ contributions and the annuity value grows on a ___________ basis.

Answer 45

A nonqualified annuity allows for AFTER-TAX contributions and the annuity value grows on a TAX-DEFERRED basis.

Question 46

What technique may be used to roll assets from one annuity to another without taxation?

Answer 46

A 1035 Exchange

Question 47

Distributions from a qualified plan are taxed at _________________ rates.

Answer 47

ordinary income

Question 48

Which annuity allows for a pre-tax contribution–qualified or nonqualified?

Answer 48

A qualified annuity

Question 49

A client who contributed $100,000 to an annuity dies when it is worth $50,000. What is the death benefit?

Answer 49

$100,000. The death benefit on an annuity is the greater of contributions or the account value at death.

Question 50

A premature distribution penalty of ___% is assessed against annuity withdrawals taken prior to age ______.

Answer 50

A premature distribution penalty of 10% is assessed against annuity withdrawals taken prior to age 59 1/2

Question 51

Are life insurance death benefits taxable?

Answer 51

No. Death benefits are received tax-free.

Question 52

What is another name for all of a deceased’s assets?

Answer 52

The estate

Question 53

How is the death benefit on a life insurance policy taxed?

Answer 53

The death benefit is always received by the beneficiary on a tax-free basis.

Question 54

Joan invests $15,000 in a qualified annuity. At age 64, she withdraws all $22,000. What’s Joan’s basis and what’s taxed?

Answer 54

Her basis is zero since the annuity is qualified (funded pre­tax) and the entire $22,000 is taxed as ordinary income.

Question 55

Upon policy surrender, any cash value in excess of premiums paid will be taxable as __________________.

Answer 55

ordinary income.

Question 56

Are dividend returns on a life insurance policy ever guaranteed?

Answer 56

No

Question 57

_____________ is the equity that grows within a whole life policy.

Answer 57

Cash value

Question 58

The term MEC is a ________________ of a life insurance contract, according to the IRS.

Answer 58

classification

Question 59

What percentage of the benefit received from a qualified annuity is subject to taxation?

Answer 59

100%, since the annuity is funded with pre-tax dollars.

Question 60

What percentage of income from a qualified plan is typically taxable?

Answer 60

100%, since qualified plans are normally funded with pre-tax funds and have a zero-cost basis

Question 61

Can a policy classified as a MEC ever be classified as a “non-MEC” policy?

Answer 61

No, once a MEC, always a MEC.

Question 62

In a nonqualified annuity, how is a single distribution taxed?

Answer 62

Earnings first. In other words, Last-In / First-Out (LIFO)

Question 63

A client who contributed $100,000 to an annuity dies when it is worth $200,000. What is her death benefit?

Answer 63

$200,000. The death benefit on an annuity is the greater of contributions or the account value at death.