CH 7 Federal Tax Considerations for Life Insurance and Anuuities

Question 1

TERM: Earned Income

Answer 1

Salary, wages, or commissions; but not income from investments, unemployment benefits, and similar

Question 2

TERM: Gross Income

Answer 2

A person’s income before taxes or other deductables

Question 3

TERM: FIFO (First In, First Out)

Answer 3

Principle under which it is assumed that the funds paid into the policy first will be paid out first.

Question 4

TERM: LIFO (Last In, First Out)

Answer 4

Principle applied to asset management in life insurance products, under which it is assumed that the funds paid into the policy last will be paid out first.

Question 5

TERM: Nonprofit Organization

Answer 5

An organization that uses its surplus to fulfill its purpose instead of distributing the surplus to its owners or members.

Question 6

TERM: Policy Endowment

Answer 6

Maturity date.

Question 7

TERM: Policy Proceeds

Answer 7

In life insurance, the death benefit.

Question 8

TERM: Pretax Contribution

Answer 8

Contribution made before federal and/or state taxes are deducted from earnings.

Question 9

TERM: Rollover

Answer 9

Withdrawal of the money from one qualified plan and placing it into another plan.

Question 10

TERM: Surrender

Answer 10

Early termination of a policy by the policyowner.

Question 11

Permanent Life Features

Answer 11

Premiums
cash value exceeding premiums paid
Policy loans
Policy dividends
Dividend interest
Lump-sum death benefit

Question 12

Tax Treatment

Answer 12

Non tax deductible
Taxable at surrender
Not income taxable
Taxable in the year earned
Not income taxable

Question 13

According to the taxation rules of life insurance policies, how are cash value increases taxed?

Answer 13

Cash value growth is tax deferred.

Question 14

When would life insurance policy proceeds be included in the insured’s taxable estate?

Answer 14

When there is an incident of ownership at the time of death.

Question 15

What is the main purpose of the 7-pay test?

Answer 15

To determine if a life insurance policy is a Modified Endowment Contract.

Question 16

Why are dividends in life insurance policies not taxable?

Answer 16

They are not considered income for tax purposes; they are a return of unused premium.

Question 17

Upon surrender of a life insurance policy, what portion of the cash value will be taxed?

Answer 17

Only the portion in excess of the premium paid.

Question 18

Is the death benefit of a life insurance policy taxed to the beneficiary if it’s received as a lump sum?

Answer 18

No, lump sum benefits are received tax free.

Question 19

What is the general taxation rule for death benefits payable to the beneficiary of a life insurance policy?

Answer 19

Death benefits are generally not subject to income taxes.

Question 20

If the beneficiary of a life insurance policy receives death benefit payments that consist of principal and interest, which portion, if any, will be taxed?

Answer 20

Interest only.

Question 21

What portion of a nonqualified annuity payment would be taxed?

Answer 21

Interest earned on principal.

Question 22

What is the name for an overfunded life insurance policy?

Answer 22

A Modified Endowment Contract (MEC).

Question 23

In a direct rollover, how is the money transferred from one retirement plan to a new one?

Answer 23

From trustee to trustee.

Question 24

If a life insurance policy develops cash value faster than a seven-pay whole life contract, it becomes a/an

A) Nonqualified annuity
B) Modified endowment contract
C) Accelerated benefit policy
D) Endowment

Answer 24

Modified endowment contract

Question 25

Death benefits payable to a beneficiary under a life insurance policy are generally

A) Exempt from income taxation if under $10,000
B) Exempt from income taxation if over $10,000
C) Not subject to income taxation by the Federal Government
D) Subject to income taxation by the Federal Government

Answer 25

Not subject to income taxation by the Federal Government.

Question 26

Which of the following terms is used to name the nontaxed return of unused premiums?

A) Dividend
B) Premium return
C) Interest
D) Surrender

Answer 26

Dividend.

Question 27

When the owner of a $250,000 life insurance policy died, the beneficiary decided to leave the proceeds of the policy with the insurance company and select the interest settlement option. At the time of withdrawal the interest paid was $11,000, the beneficiary would be required to pay income tax on

A) $11,000
B) None, because the beneficiary has not received the death benefit
C) $261,000
D) $239,000

Answer 27

$11,000

Question 28

If an immediate annuity is purchased with the face amount at death or with the cash value at surrender, this would be considered a

A) Roll over
B) Settlement option
C) Non-taxable exchange
D) Nonforfeiture option

Answer 28

Settlement option

Question 29

Which of the following describes the taxation of an annuity when money is withdrawn during the accumulation phase?

A) Withdrawn amounts are taxed on a first in, first out basis
B) Taxes are deferred on withdrawn amounts, but a flat penalty is charged
C) Taxes are deferred on withdrawn amounts
D) Withdrawn amounts are taxed on a last in, first out basis

Answer 29

Withdrawn amounts are taxed on a last in, first out basis

Question 30

Who can make a fully deductible contribution to a traditional IRA?

A) Anybody; all IRA contributions are fully deductible regardless of income level
B) Someone making contributions to an educational IRA
C) A person whose contributions are funded by a return on investment
D) An individual not covered by an employer-sponsored plan who has earned income

Answer 30

An individual not covered by an employer-sponsored plan who has earned income.

Question 31

In life insurance policies, cash value increases

A) Grow tax deferred
B) Are income taxable immediately
C) Are taxed annually
D) Are only taxed when the owner reaches age 65

Answer 31

Grow tax deferred.

Question 32

Which of the following is true regarding taxation of dividends in participating policies?

A) Dividends are taxable only after a certain amount is accumulated annually
B) Dividends are taxable in some life insurance policies and nontaxable in others
C) Dividends are considered income for tax purposes
D) Dividends are not taxable

Answer 32

Dividends are not taxable.

Question 33

Which of the following best describes taxation during the accumulation period of an annuity?

A) The annuity is subject to both state and federal taxation
B) The growth is subject to immediate taxation
C) Taxes are deferred
D) The annuity is subject to state taxes only

Answer 33

Taxes are deferred.

Question 34

The advantage of qualified plans to employers is

A) Tax-free earnings
B) No lump-sum payments
C) Taxable contributions
D) Tax-deductible contributions

Answer 34

Tax-deductible contributions.

Question 35

What method is used to determine the taxable portion of each annuity payment?

A) The exclusion ratio
B) The excise ratio
C) The annuity to age ration
D) The marginal tax formula

Answer 35

The exclusion ratio.

Question 36

If $100,000 of life insurance proceeds were used in a settlement option, which paid $13,000 per year for ten years, which of the following would be taxable annually?

A) $10,000
B) $7,000
C) $3,000
D) $13,000

Answer 36

$13,000

If $100,000 of life insurance proceeds were used in a settlement option paying $13,000 per year for ten years, $10,000 per year would be income tax free as principal and $3,000 per year would be income taxable as interest.

Question 37

J transferred his life insurance policy to his son two years before his death. Which of the following is true?

A) The unpaid premiums on the policy will be deducted from J’s taxable estate
B) Because the policy has been transferred, it will not be included in J’s taxable estate
C) The entire face value of the policy will be included in J’s taxable estate
D) The interest portion of the policy will be included in J’s taxable estate

Answer 37

The entire face value of the policy will be included in J’s taxable estate.

Question 38

What part of the Internal Revenue Code allows an owner of a life insurance policy or annuity to exchange or replace their current contract with another contract without creating adverse tax consequences?

A) Section 457 Deferred Compensation Plan
B) Section 1035 Policy Exchange
C) Modified Endowment Exchange
D) 401(k) Plan

Answer 38

Section 1035 Policy Exchange