Unit 10 Taxation of Life Insurance Annuities Flashcards
True or false: Premiums paid for individual life insurance are NOT tax-deductible
True
____ credited to life insurance CASH VALUES are tax-deferred. They are not taxable as long as they remain inside the policy.
Interest Earnings
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.
Cost Basis
____ 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 These are taxed on a first-in-first-out (FIFO) basis; money withdrawn is considered to come from the premiums paid (cost basis) FIRST and cost basis withdrawals are NOT taxable.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.
Withdrawals
Are policy loans taxable to the policyowner?
No, generally they are not.
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.
Taxable Gain
Interest
Are dividends taxable?
No
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.
Cost Basis
Accumulate
True or false: death benefits are not taxable as income if paid in a lump sum.
True
True or false: Interest is on annuity death benefits is not taxable.
False
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.
Death Benefit
True or false: Accelerated death benefits are tax exempt
True
Business life insurance premiums for the following purposes are not tax-deductible to the business:
- ____ life insurance policies
- Life insurance policies funding ____ agreements
- 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.
- Key person
- Buy-sell agreements
- Benefits
Employee Compensation
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 ____.
False
NOT Tax-deductible
Group Life Insurance: Premiums paid by the employer for insurance above $____ is taxable income to the employee.
$50,000
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.
Modified Endowment Contracts
Tax-free death benefits
Tax-deferred cash value accumulation
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
Seven-pay limit
Seven-level annual premiums
Seven-pay test
Seven years
True or false: once and MEC always and MEC
True
Annuity premiums are not ____ unless the contract is held in a qualified retirement plan.
Tax-deductible
Similar to life insurance, interest earnings credited to individual annuities are ____. They become taxable when they are paid out.
Tax-deferred
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 ____.
- Last-in-first-out (LIFO) taxation
- 10% , disabled
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:
- They are payable to the ____
- 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.
- The deceased assigned or transferred ownership of the policy to another person within ____ years of death
Estate Taxes
- Estate
- Incidents of Ownership
- 3 Years of Death
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.
Accumulation period
Annuity period
