Unit 10 Taxation of Life Insurance Annuities

Question 1

True or false: Premiums paid for individual life insurance are NOT tax-deductible

Answer 1

True

Question 2

____ credited to life insurance CASH VALUES are tax-deferred. They are not taxable as long as they remain inside the policy.

Answer 2

Interest Earnings

Question 3

When a life insurance policy is surrendered, any gain in the cash value is taxable. The gain is the cash value minus the policy’s ____; the sum of all premiums paid. So cash value accumulations are tax-deferred, but not necessarily tax-free.

Answer 3

Cost Basis

Question 4

____ are taxable to the extent of any gain. These are taxed on a first-in-first-out (FIFO) basis; money withdrawn is considered to come from the premiums paid (cost basis) FIRST and cost basis withdrawals are NOT taxable. The death benefit is reduced by a withdrawal of cash value.

Answer 4

Withdrawals

Question 5

Are policy loans taxable to the policyowner?

Answer 5

No, generally they are not.

Question 6

If a policy is surrendered or it lapses, under the tax rules for full surrenders, any portion of the loan amount that exceeds the policy’s cost basis is a ____.

The ____ paid on policy loans is NOT tax-deductible.

Answer 6

Taxable Gain

Interest

Question 7

Are dividends taxable?

Answer 7

No

Question 8

For tax purposes, dividends are considered to be a return of a portion of the premium paid for the policy. Since premiums are paid with after-tax dollars, they are not taxed again when they are returned in the form of dividends. However, as a return of premium, dividends also reduce the policy’s ____.

While dividends are not taxable, if they are left to ____ at interest, the interest IS taxable.

Answer 8

Cost Basis

Accumulate

Question 9

True or false: death benefits are not taxable as income if paid in a lump sum.

Answer 9

True

Question 10

True or false: Interest is on annuity death benefits is not taxable.

Answer 10

False

Question 11

If the ____ payment is made under other settlement options - not a lump sum - the original death benefit is not taxable, any interest earned on the proceeds are taxable as ordinary income when paid to the beneficiary.

Answer 11

Death Benefit

Question 12

True or false: Accelerated death benefits are tax exempt

Answer 12

True

Question 13

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

1. ____ life insurance policies
2. Life insurance policies funding ____ agreements
3. Life insurance policies that will reimburse the company for ____ paid under deferred compensation agreements

Premiums paid for executive bonus plans are tax-deductible to the business as ____. As such, the amount of the premium paid is also considered taxable income to the employee.

Answer 13

1. Key person
2. Buy-sell agreements
3. Benefits

Employee Compensation

Question 14

True or false: Group life insurance premiums paid by the employer are not tax-deductible as a business expense provided under an employer group benefit plan.

With contributory plans, the employee portion of the group life insurance premium is ____.

Answer 14

False

NOT Tax-deductible

Question 15

Group Life Insurance: Premiums paid by the employer for insurance above $____ is taxable income to the employee.

Answer 15

$50,000

Question 16

A ____(MEC) is a special type of life insurance under federal income tax law. The law prescribes a test that is intended to differentiate between policies that are purchased primarily for certain tax advantages, versus policies that are purchased primarily for death benefits.

MECs are still life insurance and offer ____ death benefits and ____ cash value accumulation. If a policy becomes a MEC and no distributions are taken from that policy during the insured’s lifetime, they will not experience any adverse tax complications due to the contract’s MEC status.

Answer 16

Modified Endowment Contracts

Tax-free death benefits

Tax-deferred cash value accumulation

Question 17

To determine if a contract is a MEC, a premium limit is set and is referred to as a ____ limit or MEC limit. It is based on the annual premium that would pay up the policy after the payment of ____ annual premiums.

Under what is known as the ____ or MEC test, the cumulative amount paid at any given time in the first ____ years cannot exceed the cumulative MEC limit applicable in that policy year

Answer 17

Seven-pay limit

Seven-level annual premiums

Seven-pay test

Seven years

Question 18

True or false: once and MEC always and MEC

Answer 18

True

Question 19

Annuity premiums are not ____ unless the contract is held in a qualified retirement plan.

Answer 19

Tax-deductible

Question 20

Similar to life insurance, interest earnings credited to individual annuities are ____. They become taxable when they are paid out.

Answer 20

Tax-deferred

Question 21

Distributions received from an annuity during the accumulation period receive the same tax treatment as a MEC.
1. ____ taxation - the entire taxable gain is received before any non-taxable cost basis.
2. If the contract owner is under age 59.5, a ____% penalty tax must be paid in addition to the regular tax due on any taxable amount received. The penalty does not apply if the owner is ____.

Answer 21

1. Last-in-first-out (LIFO) taxation
2. 10% , disabled

Question 22

Life Insurance Proceeds: ____ taxes are owed if an estate’s value exceeds a certain value at the time of the individual’s death. The taxes are a percentage of the estate’s value.

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

1. They are payable to the ____
2. The deceased possessed any ____ in the policy at the time of death - the right to name or change the beneficiary, the right to access cash values, the right to assign ownership of the policy to another party, etc.
3. The deceased assigned or transferred ownership of the policy to another person within ____ years of death

Answer 22

Estate Taxes

1. Estate
2. Incidents of Ownership
3. 3 Years of Death

Question 23

The estate tax treatment of annuities depends on whether death occurs during the accumulation period or during the annuity period.

• If death occurs during the ____ period, the entire value of the annuity - not just the gain, but also the cost basis - is included in the estate.
• If death occurs during the ____ period, the present value of any payments that will continue to a beneficiary or survivor annuitant is included in the estate.

Answer 23

Accumulation period

Annuity period