Taxation of Life Insurance Annuities Flashcards
Income tax treatment of life insurance and annuities comes down to 2 questions:
- Is the premium tax-deductible or not?
- Are distributions from insurance products taxable or not?
Premiums made for individual life insurance are _____ tax-deductible
NOT
Interest earnings credited to life insurance cash values are tax-_________, ____ taxable as long as they remain inside the policy
Deferred; not
When a life insurance policy is surrendered, any ______ in the cash value is taxable
Gain
Full surrenders:
Gain=
Cash value – premium paid
Cost basis
Sum of all premiums paid
Withdrawals (partial surrenders) (are/are not) taxable to the extent of any gain
Are
Withdrawals are taxed on a _________ basis
First-in-first-out (FIFO); money withdrawn is considered to come from the premiums paid FIRST and cost basis withdrawals are not taxable
The death benefit is _______ by a withdrawal of cash value
Reduced
When a withdrawal exceeds the cost basis, the excess (is/is not) taxable
Is
_____ ______ of a life insurance policy is used as collateral for a policy loan
Cash value
Policy loans reduce:
The cash value and policy death benefit. However can be repaid
Generally, policy loans (are/are not) taxable to the policyowner
Are not
The interest paid on policy loans (is/is not) tax-deductible
Is not
Dividends (are/are not) taxable
Are not
For tax purposes, dividends are considered to be:
A returns of a portion of the premium paid for the policy
While dividends are not taxable, if they are left to:
Accumulate at interest, the interest IS taxable
When the entire death benefit is paid in a “lump-sum” to a named beneficiary it (is/is not) taxable as income
Is not
If the death benefit payment is made under other settlement options- not a “lump-sum”- the original death benefit (is/is not) taxable, any interest earned on the proceeds (are/are not) taxable as originally income when paid to the beneficiary
Is not; are
An advance of death benefits
Accelerated death benefits
Qualified events for accelerated death benefits
-terminal illnesses expecting to end in death within 24 months
-acute illness,
-emergency organ transplants
-permanent confinement to nursing homes
-long-term care (if ADLs can no longer be performed
Accelerated benefits (are/are not) tax exempt
Are
Business life insurance premiums for the following purposes are not tax deductible to the business:
-key person life insurance policies
-life insurance policies funding buy-sell agreements
-life insurance policies that will reimburse the company for benefits paid under deferred compensation arrangements
Premiums paid for executive bonus plans (are/are not) tax deductible to the business as employee compensation
Are
Premiums paid for executive bonus policies (are/are not) taxable income to the employee
Are
Group life insurance premiums paid by the employer (are/are not) tax-deductible as a business expense provided under an employer group benefit plan
Are
With contributory life insurance plans, the employee portion of the group life premium (is/is not) tax-deductible
Is not
Premiums paid by employer for group life insurance coverage above $50,000 (is/is not) taxable as income to the employee
Is
This law prescribes a test that is interested to differentiate between policies that are purchased primarily for certain tax advantages, versus policies that are purchased primarily for death protection
Modified endowment contract (MEC)
To determine if a contract is a MEC:
A premium limit is set and is referred to as a seven-pay limit or MEC limit
The seven-pay or MEC limit is based on:
The annual premium that would pay up the policy after the payment of seven level premiums
Seven-pay test or MEC test
The cumulative amount paid at any time in the first 7 years cannot exceed the cumulative MEC limit applicable in that policy year
Annuity premiums (are/are not) tax deductible
Are not; unless the contract is held in a qualified retirement plan
Similar to life insurance, interest earnings credited to individual annuities (are/are not) tax-deferred
Are
Earnings on annuities owned by corporations (are/are not) taxable when they are credited
Are
Distributions received from an annuity during the accumulation period receive the same tax treatment as a:
Modified endowment contract
Annuity withdrawals:
-interest out first
-income tax on interest
-10% penalty on interest if younger than 59 1/2 (penalty waived for disability, death, or annuitization)
If an annuity owner withdrawals money from an annuity in a lump sum, they face severe
Tax penalties on their savings
Used to determine the non taxable portion of each monthly annuity withdrawal payment
Exclusion ratio
The exclusion ratio is applied to each annuity payment to find:
The portion that is excludable from gross income. The remainder is taxable at ordinary income rates
Exclusion ratio=
Premiums paid in / TOTAL of expected payments over annuitants life expectancy
Lump sum annuity death distribution
The beneficiary can take proceeds all at once. The gain (total value minus cost basis) is taxable
Five year withdrawal annuity death distribution
The beneficiary must withdraw all proceeds within 5 years. These withdrawals are taxed the same as withdrawals during the owner’s life. The gain is taxable and all the gain must be taken out before any non-taxable cost basis
Annuity payout death distribution option
Beneficiary must select within one year from the date of the owner’s death. The payments are taxed as annuity payments- part taxable gain and part non-taxable cost-basis, with the non-taxable amount determined using the exclusion ratio
Spousal option annuity distribution at death
If the beneficiary is the owner’s spouse, ownership may be transferred to spouse without any tax consequences
Section 1035 exchange
-applies to life insurance and annuities
-move cash values from one to another
-life to life- non taxable
-annuity to annuity- not taxable
-annuity to life does not qualify
Life insurance death benefits are counted as value in a deceased insured’s estate if:
-payable to the insured’s estate
-insured owns the policy at time of death
-insured transferred ownership within three years of death
Annuities are included in gross estate if:
-death occurs during accumulation- entire value including cost is included
-death occurs during annuitizatioin- present value of future payments is included
