Unit 10: Taxation of Life Insurance and Annuities

Question 1

premiums

Answer 1

not tax deductible

Question 2

interest earn on cash values

Answer 2

• tax deferred
• not taxed while in the policy
• policyowner is taxed in gain is withdrawn

GAIN —–> INTEREST

Question 3

full surrenders

Answer 3

any gain is taxable

Question 4

gain

Answer 4

cash value - premiums paid

Question 5

partial surrenders

Answer 5

• taxed only if the withdrawal exceeds the premiums paid

- only the gain is taxed

Question 6

cash value loans

Answer 6

not taxed while the policy is in force

taxed if the policy is surrendered and there is gain

interest paid on loans is not tax deductible

Question 7

dividends

Answer 7

not taxed
considered to be a return of premium
interest earned is taxed

Question 8

death benefits

Answer 8

not taxed if paid in a lump sum to a named beneficiary

interest is taxable

if paid over time, part of the payment is not taxed and part is taxed

Question 9

accelerated benefits

Answer 9

• critically ill
• terminally ill
• death
• not taxed

Question 10

taxation of business life policies

Answer 10

premiums are not tax deductible, except for an executive bonus
death benefits are not taxable
premiums for executive bonus policies are taxable income to the employee

Question 11

taxation of group life insurance

Answer 11

premiums paid by employer are tax deductible
premiums paid by employee are NOT tax deductible
death benefits to a named beneficiary are not taxable
premiums paid by employer for insurance about 50k is taxable income to the employees

Question 12

modified endowment contract (MEC)

Answer 12

seven-pay limit - too much premium paid in the first seven years of the policy

• flexible premium universal life
• single premium whole life

interest on cash values is not taxed while in the policy

withdrawals or loans are taxed

• interest out first
• 10% penalty on interest if withdrawn before the age of 59 1/2 unless insured is disabled

Once a MEC always a MEC

Question 13

annuities

Answer 13

premiums not tax deductible

Question 14

accumulations

Answer 14

taxable when paid out

interest during accumulation not taxed in the contract

Question 15

withdrawals

Answer 15

same treatment as a MEC

interest out first

income taxed on interest

10% penalty on interest if younger than 59 1/2
-penalty waived for disability death or annuitization

Question 16

annuity payments

Answer 16

taxed according to the exclusion ratio

premiums paid in divided total of expected payments over the annuitant’s life expectancy = percent of the payment not taxed

in the annuitant lives beyond their life expectancy 100% of the payment becomes taxable

Question 17

distributions at death

Answer 17

tax treatment varies depending on how the money is paid out.

lump sum - all of gain is taxable

five year withdrawal - interest out first - no 10% penalty

annuity payments - taxed according to the exclusion ratio

if the spouse is the beneficiary - transfer ownership to the spouse

Question 18

section 1035 exchange

Answer 18

L to L = no penalty (life to life)

A to A = no penalty (annuity to annuity)

L to A = no penalty (life to annuity)

A to L = GAINS TAXED (annuity to life)

Question 19

life insurance proceeds

Answer 19

taxes are a % of the estates value

taxes due on transfer of wealth

life insurance death benefits are included as insured’s gross estate if:

• payable to the insureds estate
• insured owns the policy at time of death
• insured transferred ownership within three years of death

Question 20

annuities

Answer 20

tax treatment depends on when death occurs

annuities are included in gross estate if:

• death occurs during accumulation - entire value include cost is included
• death occurs during annuitization - present value of future payments is included