Income Taxation of Life Insurance

Question 1

True or False

Life Insurance premiums are NEVER tax deductible

Answer 1

False; they USUALLY aren’t tax deductible. A deduction may be available if premium is paid as part of compensation for Group Term coverage or Life Insurance as part of a qualified.

Question 2

True or False

No taxes are due for appreciation of cash value within a life insurance policy UNLESS it’s surrendered and cash value exceeds net premiums paid.

Answer 2

True

Question 3

True or False

Dividends of a Life Insurance policy are taxable

Answer 3

False; they are however taxable when

cumulative dividends paid to policy owner > cumulative premiums paid by policy owner.

Question 4

Death benefits are almost always

a. free from taxation

OR

b. taxed

Answer 4

a. free from taxation

However, if you have $1mil policy and elect to have installment payments of $120k per year for 10 years, that extra $200k is taxable

Question 5

True or False

If the owner of a life insurance policy is also the insured, then upon the owner’s death, the full face amount of the policy is included in the owner’s taxable estate.

Answer 5

True

Question 6

True or False

The withdrawal of the cash value from a cash value policy will be taxable only to the extent that the total value in the policy exceeds the policy’s basis.

Answer 6

True

Question 7

What is “Modified Endowment Contract?” (MEC)

Answer 7

• A classification of life insurance that is a contract that fails to meet certain premium limitation tests.

Question 8

What are MEC limits for?

Answer 8

MEC limits are designed to keep premiums lower so gov can get taxes

(context: life insurance policies were becoming overly used tax deferred savings accounts)

Question 9

True or False

Once a life insurance policy becomes a MEC, the death benefit will cease to be income tax free

Answer 9

False

Question 10

What is “Valuable Consideration?”

Answer 10

Includes: Cash, other assets, or a promise to pay

Question 11

What is the “Transfer for Value Rule?”

Answer 11

if any interest in a life insurance policy is transferred for *valuable consideration, then the death benefit may be subject to ordinary income taxes.

*basically a payment

Question 12

What does a 1035 Exchange do?

Answer 12

It permits a tax-free exchange of an old life insurance policy for a new policy

(must be between “like” accounts)

Question 13

True or False

An annuity for a life insurance or endowment policy is a taxable exchange under the 1035 exchange rule

Answer 13

True

Question 14

How do you determine “Cost Basis” of a policy?

Answer 14

Total premiums paid
- total dividends received
- cumulative previous non-taxable withdrawals
= COST BASIS

Question 15

How do you determine the “Surrender Value” of a policy?

Answer 15

Cash proceeds at surrender
+ policy loan balance
= Surrender Value