Unit 10 Taxation of Life Insurance and Annuities

Question 1

premiums

Answer 1

not tax-deductible

Question 2

tax-deferred

Answer 2

not taxable as long as interest earning remain inside the policy
-interest owned on cash values is not taxed while in the policy. policyowner is taxed if gain is withdrawn

Question 3

full surrenders

Answer 3

any gain is taxable

Question 4

gain

Answer 4

cash value minus premiums paid (cost basis: sum of premiums paid)

Question 5

withdrawals/ partial surrenders

Answer 5

taxed only if the withdrawal exceeds the premiums paid
only the gain (if any) 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 a 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 (individual or business)
-interest is taxable
-if paid over time, part of the payment is not taxed and part is taxed

Question 9

accelerated death benefits

Answer 9

an advancement of death benefits. in cases of critical illness, terminal illness, 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 above $50,000 is taxable income to the employee

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+10% penalty on interest if it is withdrawn before age 59.5, unless the insured is disabled

Question 13

annuities

Answer 13

premiums are not tax deductible

Question 14

accumulations

Answer 14

-interest during accumulation is not taxed in the contract
-taxable when paid out

Question 15

withdrawls

Answer 15

-interest out first
-income tax on interest
-10% penalty on interest if the contract owner is younger than 59.5. penalty waived for disability, death, or annuitization

(same treatment as a MEC)

Question 16

annuity payments after annuitization

Answer 16

-taxed according to the exclusion ratio (used to determine the nontaxable portion of each monthly payment)

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

Question 17

distributions at death

Answer 17

-lump sum (all of gain is taxable)
-five-year withdrawal (interest out first, no 10% penalty)
-annuity payments (taxed according to the exclusion ration)
-if the spouse is the beneficiary, transfer ownership to the spouse with no tax consequences

Question 18

section 103 exchange

Answer 18

tax code allowing movement of cash values from one contract to another
-life to life is not taxable
-annuity to annuity is not taxable
-life to annuity is not taxable
-annuity to life does not qualify
-annuity gains are taxable

Question 19

estate taxes

Answer 19

-taxes are due on transfer of wealth
-taxes are a percentage of the estate’s value
-life insurance death benefits are included in the insured’s gross estate if: they are payable to the insured’s estate, the insured owns the policy at the time of death, the insured transferred ownership within three years of death

Question 20

estate taxes for annuities

Answer 20

-tax treatment depends on when the death occurs
-if during the accumulation, entire value including cost is included in the estate
-if during the annuitization, present value of future payments is included in the estate