Taxation of Life Insurance Annuities

Question 1

Income tax treatment of life insurance and annuities comes down to 2 questions:

Answer 1

1. Is the premium tax-deductible or not?
2. Are distributions from insurance products taxable or not?

Question 2

Premiums made for individual life insurance are _____ tax-deductible

Answer 2

NOT

Question 3

Interest earnings credited to life insurance cash values are tax-_________, ____ taxable as long as they remain inside the policy

Answer 3

Deferred; not

Question 4

When a life insurance policy is surrendered, any ______ in the cash value is taxable

Answer 4

Gain

Question 5

Full surrenders:
Gain=

Answer 5

Cash value – premium paid

Question 6

Cost basis

Answer 6

Sum of all premiums paid

Question 7

Withdrawals (partial surrenders) (are/are not) taxable to the extent of any gain

Answer 7

Are

Question 8

Withdrawals are taxed on a _________ basis

Answer 8

First-in-first-out (FIFO); money withdrawn is considered to come from the premiums paid FIRST and cost basis withdrawals are not taxable

Question 9

The death benefit is _______ by a withdrawal of cash value

Answer 9

Reduced

Question 10

When a withdrawal exceeds the cost basis, the excess (is/is not) taxable

Answer 10

Is

Question 11

_____ ______ of a life insurance policy is used as collateral for a policy loan

Answer 11

Cash value

Question 12

Policy loans reduce:

Answer 12

The cash value and policy death benefit. However can be repaid

Question 13

Generally, policy loans (are/are not) taxable to the policyowner

Answer 13

Are not

Question 14

The interest paid on policy loans (is/is not) tax-deductible

Answer 14

Is not

Question 15

Dividends (are/are not) taxable

Answer 15

Are not

Question 16

For tax purposes, dividends are considered to be:

Answer 16

A returns of a portion of the premium paid for the policy

Question 17

While dividends are not taxable, if they are left to:

Answer 17

Accumulate at interest, the interest IS taxable

Question 18

When the entire death benefit is paid in a “lump-sum” to a named beneficiary it (is/is not) taxable as income

Answer 18

Is not

Question 19

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

Answer 19

Is not; are

Question 20

An advance of death benefits

Answer 20

Accelerated death benefits

Question 21

Qualified events for accelerated death benefits

Answer 21

-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

Question 22

Accelerated benefits (are/are not) tax exempt

Answer 22

Are

Question 23

Business life insurance premiums for the following purposes are not tax deductible to the business:

Answer 23

-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

Question 24

Premiums paid for executive bonus plans (are/are not) tax deductible to the business as employee compensation

Answer 24

Are

Question 25

Premiums paid for executive bonus policies (are/are not) taxable income to the employee

Answer 25

Are

Question 26

Group life insurance premiums paid by the employer (are/are not) tax-deductible as a business expense provided under an employer group benefit plan

Answer 26

Are

Question 27

With contributory life insurance plans, the employee portion of the group life premium (is/is not) tax-deductible

Answer 27

Is not

Question 28

Premiums paid by employer for group life insurance coverage above $50,000 (is/is not) taxable as income to the employee

Answer 28

Is

Question 29

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

Answer 29

Modified endowment contract (MEC)

Question 30

To determine if a contract is a MEC:

Answer 30

A premium limit is set and is referred to as a seven-pay limit or MEC limit

Question 31

The seven-pay or MEC limit is based on:

Answer 31

The annual premium that would pay up the policy after the payment of seven level premiums

Question 32

Seven-pay test or MEC test

Answer 32

The cumulative amount paid at any time in the first 7 years cannot exceed the cumulative MEC limit applicable in that policy year

Question 33

Annuity premiums (are/are not) tax deductible

Answer 33

Are not; unless the contract is held in a qualified retirement plan

Question 34

Similar to life insurance, interest earnings credited to individual annuities (are/are not) tax-deferred

Answer 34

Are

Question 35

Earnings on annuities owned by corporations (are/are not) taxable when they are credited

Answer 35

Are

Question 36

Distributions received from an annuity during the accumulation period receive the same tax treatment as a:

Answer 36

Modified endowment contract

Question 37

Annuity withdrawals:

Answer 37

-interest out first -income tax on interest -10% penalty on interest if younger than 59 1/2 (penalty waived for disability, death, or annuitization)

Question 38

If an annuity owner withdrawals money from an annuity in a lump sum, they face severe

Answer 38

Tax penalties on their savings

Question 39

Used to determine the non taxable portion of each monthly annuity withdrawal payment

Answer 39

Exclusion ratio

Question 40

The exclusion ratio is applied to each annuity payment to find:

Answer 40

The portion that is excludable from gross income. The remainder is taxable at ordinary income rates

Question 41

Exclusion ratio=

Answer 41

Premiums paid in / TOTAL of expected payments over annuitants life expectancy

Question 42

Lump sum annuity death distribution

Answer 42

The beneficiary can take proceeds all at once. The gain (total value minus cost basis) is taxable

Question 43

Five year withdrawal annuity death distribution

Answer 43

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

Question 44

Annuity payout death distribution option

Answer 44

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

Question 45

Spousal option annuity distribution at death

Answer 45

If the beneficiary is the owner’s spouse, ownership may be transferred to spouse without any tax consequences

Question 46

Section 1035 exchange

Answer 46

-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

Question 47

Life insurance death benefits are counted as value in a deceased insured’s estate if:

Answer 47

-payable to the insured’s estate -insured owns the policy at time of death -insured transferred ownership within three years of death

Question 48

Annuities are included in gross estate if:

Answer 48

-death occurs during accumulation- entire value including cost is included -death occurs during annuitizatioin- present value of future payments is included