CFP Insurance Flashcards
(101 cards)
1
Q
Define a Modified Endowment Contract (MEC).
A
A MEC is a cash value life insurance policy failing the 7-pay test, altering the taxation of cash distributions (loans/withdrawals).
2
Q
What triggers the 7-pay test for MECs?
A
At policy inception
Upon material policy changes (e.g., increased death benefit, additional flexible premiums)
3
Q
What taxation method applies to MEC distributions?
A
LIFO (Last In First Out): gains withdrawn first and taxable as ordinary income.
4
Q
Penalty applied on MEC distributions before age 59½?
A
10% early withdrawal penalty applies to taxable gains.
5
Q
How does MEC status affect death benefits?
A
No impact—death benefits remain income-tax-free.
6
Q
Define a Viatical Settlement.
A
Sale of life insurance policy by a terminally/chronically ill person to a third-party for immediate cash.
7
Q
Who qualifies as terminally ill for Viatical?
A
Physician-certified life expectancy of ≤24 months.
8
Q
Who qualifies as chronically ill for Viatical?
A
Unable to perform ≥2 ADLs for ≥90 days.
9
Q
Viatical Settlement ‘cooling-off’ period?
A
15-day period allowing the seller (viator) to rescind the contract.
10
Q
Tax consequences for insured receiving Viatical proceeds?
A
Terminally ill: proceeds tax-free.
Chronically ill: proceeds tax-free only if used for LTC expenses.
11
Q
What triggers a buy-sell agreement?
A
Death
Disability
Retirement of business partner
12
Q
Cross-Purchase Agreement advantages?
A
Tax-free death benefit to survivor
Basis step-up for survivor
Ideal for fewer partners
13
Q
Cross-Purchase Agreement disadvantages?
A
Costly if large age differences
Complex with many partners
14
Q
Entity Purchase (Redemption) Agreement advantages?
A
Easier for multiple partners
Premiums paid by business, simplicity in management
15
Q
Entity Purchase disadvantages?
A
No step-up in basis
Larger capital gain exposure when selling business
16
Q
Formula for cross-purchase policies required?
A
Number of policies = n × (n - 1), where n = number of partners.
17
Q
Taxation on Non-qualified Annuity distributions?
A
Gains taxed as ordinary income
10% penalty if before age 59½ (exceptions apply)
18
Q
What is the exclusion ratio in annuitization?
A
Investment in contract ÷ (Annual payment × Life expectancy), determining taxable portion of annuity payments.
19
Q
Withdrawals from annuities purchased after 8/14/1982?
A
LIFO method (earnings first, taxable).
20
Q
Withdrawal taxation from annuities purchased before 8/14/1982?
A
FIFO method (basis first, tax-free recovery initially).
21
Q
Purpose of Section 1035 exchanges?
A
Allows tax-free transfer between similar contracts, deferring taxation.
22
Q
Allowed 1035 exchanges?
A
Life insurance → Life insurance/Annuity/LTCi
Annuity → Annuity/LTCi
Endowment → Annuity/LTCi
23
Q
Disallowed 1035 exchanges?
A
Annuity → Life insurance or Endowment
LTCi → Life insurance or Annuity
24
Q
Characteristics of Term Life insurance?
A
Low initial premium
Temporary coverage
No cash value
25
Level term insurance defined?
Constant death benefit with premiums fixed initially; rise at renewal.
26
Whole Life insurance characteristics?
Fixed premiums
## Footnote
Guaranteed death benefit
Builds cash value
27
Universal Life Option A vs Option B?
Option A: Level death benefit
## Footnote
Option B: Increasing death benefit (face amount + cash value)
28
Most favorable disability definition?
Own-occupation: inability to perform insured’s own job.
29
Hybrid disability definition?
Modified Own-Occupation: 'Own occ' initially then 'Any occ.'
30
Social Security Disability requirements?
Total disability lasting ≥12 months or fatal.
31
Risk avoidance example?
Choosing not to participate in dangerous activities.
32
Risk transfer example?
Purchasing life insurance to shift financial risk.
33
Risk retention example?
Opting for higher insurance deductibles.
34
High severity, low-frequency risks strategy?
Risk Transfer (Insurance).
35
HSA Triple Tax Benefit?
Pre-tax contributions
## Footnote
Tax-free earnings growth
Tax-free qualified withdrawals
36
'Last month rule' for HSA contributions?
Eligible on December 1, full-year contribution allowed.
37
COBRA coverage duration for termination?
18 months (29 months if disabled).
38
COBRA qualifying events extending to 36 months?
Death, divorce, Medicare enrollment, dependent child age-out.
39
ADLs triggering LTC benefits?
Bathing, Eating, Dressing, Transferring, Continence, Toileting.
40
Partnership LTC insurance?
Protects assets when LTC exhausted and applying for Medicaid.
41
LTC elimination period defined?
Waiting period before benefits begin; affects premium cost.
42
Employer-paid disability benefit taxation?
Fully taxable income to the employee.
43
Employee-paid after-tax disability benefit taxation?
Benefits received tax-free.
44
Principle of Indemnity?
Restore financial position pre-loss; no profit allowed.
45
Subrogation defined?
Insurer’s right to recoup loss payments from responsible third party.
46
Insurable Interest?
Financial interest in insured risk, required at policy inception.
47
Definition of LIFO taxation?
Withdrawals taxed gains-first, applicable in MEC and newer annuities.
48
FIFO taxation?
Withdrawals basis-first, older annuities prior to 8/14/1982.
49
Primary disadvantage of Entity Buy-Sell?
No step-up in tax basis for surviving owners.
50
Key CFP exam tip for insurance taxation?
Identify how premium is paid—employer vs employee; affects taxation significantly.
51
What is the contestability period in life insurance?
Typically two years from policy inception, during which insurer can challenge the validity due to misrepresentation
## Footnote
The contestability period allows insurers to investigate claims made within this timeframe to ensure accurate underwriting.
52
What is a suicide clause in life insurance?
Excludes coverage if suicide occurs within a specific timeframe (usually two years after policy issue); premiums refunded but no death benefit
## Footnote
This clause is designed to prevent individuals from purchasing life insurance with the intent to commit suicide shortly thereafter.
53
What is waiver of premium rider?
Pays premiums if insured becomes totally disabled, keeping policy active without cost during disability
## Footnote
This rider provides financial relief by ensuring the policy remains in force even if the insured cannot make payments due to a qualifying disability.
54
Are life insurance policy loans taxable?
Generally not taxable, provided the policy remains active and not classified as a MEC
## Footnote
MEC stands for Modified Endowment Contract, which has different tax implications.
55
What is the taxation of employer-paid group life premiums exceeding $50,000?
Premiums for coverage above $50,000 are taxable income to the employee (imputed income)
## Footnote
This taxation rule is important for employees to understand regarding their taxable income and benefits.
56
Define residual disability benefits.
Pays partial benefits proportional to loss of income due to partial disability, facilitating return to work
## Footnote
This benefit helps individuals transition back to work while still recovering and losing some income.
57
Define presumptive disability.
Automatically qualifies as total disability if the insured loses sight, hearing, speech, or limb functionality
## Footnote
This definition simplifies claims for individuals with severe impairments, ensuring they receive benefits without extensive proof.
58
What is the coordination of benefits (COB) provision?
Determines payment order if covered by multiple health insurance plans, preventing over-insurance
## Footnote
COB ensures that the total benefits paid do not exceed the total expenses incurred.
59
Why is an inflation protection rider important in LTC policies?
Protects policy benefits against rising LTC costs, a key recommendation for younger applicants
## Footnote
As long-term care costs can increase significantly over time, this rider helps maintain the value of benefits.
60
Define open-perils coverage.
Covers all perils unless explicitly excluded
## Footnote
This type of coverage provides broader protection compared to named-perils coverage.
61
Define named-perils coverage.
Only covers explicitly listed perils
## Footnote
This coverage is more restrictive and only applies to specific risks mentioned in the policy.
62
What is the coinsurance clause in homeowners insurance?
Requires insured to carry coverage of at least a certain percentage (usually 80%) of replacement cost; penalty applied if underinsured at loss
## Footnote
This clause encourages policyholders to insure their properties adequately to avoid financial penalties.
63
What are umbrella policy underlying coverage requirements?
Specified minimum liability coverage in underlying policies (homeowners, auto) required before umbrella activates
## Footnote
Umbrella policies provide additional liability coverage beyond standard limits, but only if the underlying policies meet certain thresholds.
64
What is the principle of adhesion in insurance contracts?
Contracts drafted by insurer, ambiguity interpreted in favor of the insured
## Footnote
This principle protects consumers by resolving uncertainties in favor of the party that did not draft the contract.
65
What is the principle of aleatory contract in insurance?
Unequal exchange of value; insured's premium smaller than potential benefit payout
## Footnote
This principle highlights the inherent risk involved in insurance contracts.
66
What is unilateral contract in insurance?
Only one party (insurer) makes legally enforceable promise; insured can stop paying premiums without legal consequences (policy lapses)
## Footnote
This means the insurer is obligated to pay claims as long as the insured pays premiums.
67
What is the taxation of benefits from employer-paid health insurance?
Benefits generally tax-free; premiums deductible by employer and not taxable to employee
## Footnote
This tax treatment incentivizes employers to provide health insurance to employees.
68
What is the COBRA premium payment limit?
Cannot exceed 102% of total premium (employer and employee contributions combined)
## Footnote
COBRA allows individuals to maintain their health insurance after leaving employment, but at a cost.
69
What are Medicare Parts A, B, C, and D?
A: Hospital insurance (inpatient care)
B: Medical insurance (doctor visits, outpatient)
C: Medicare Advantage (private Medicare)
D: Prescription drug coverage
## Footnote
Each part provides different types of coverage to address various healthcare needs.
70
Define adverse selection in insurance.
Tendency of higher-risk individuals to purchase coverage more often, potentially causing insurer losses if not controlled via underwriting
## Footnote
Insurers must balance risk and premiums to ensure profitability.
71
What is the purpose of state guaranty funds in insurance?
Protect policyholders against insurer insolvency by providing coverage continuation or claim payment up to state-defined limits
## Footnote
These funds ensure that consumers are not left without coverage if an insurer fails.
72
What is a key exam tip regarding MEC vs non-MEC policies?
Clearly distinguish MEC vs non-MEC policies, especially LIFO vs FIFO taxation
## Footnote
Understanding the implications of MEC classification is crucial for tax planning.
73
What are the COBRA durations for coverage?
18/29/36 months scenarios
## Footnote
The duration of COBRA coverage depends on the qualifying event and specific circumstances.
74
What is a key tax nuance to remember regarding premiums paid by employer vs employee?
Identify taxation nuances clearly (premiums paid by employer vs employee)
## Footnote
This is important for understanding personal tax liabilities associated with health benefits.
75
What should you remember about life insurance death benefits?
Typically tax-free
## Footnote
This tax treatment is a significant advantage of life insurance policies.
76
What is a key consideration for policies issued before and after 8/14/1982?
Watch for policies issued before and after 8/14/1982 (FIFO vs LIFO taxation in annuities)
## Footnote
The date of issue affects the tax treatment of annuities significantly.
77
Which of the following contracts can be exchanged tax-free under a Section 1035 exchange?
Annuity for long-term care insurance
78
The primary advantage of using a Section 1035 exchange when replacing a life insurance policy is to:
Defer taxation of gains
79
COBRA coverage generally applies to employers who had how many employees in the prior year?
20 or more
80
COBRA coverage typically provides continuation coverage for what type of insurance?
Group health insurance
81
Where are the cash value subaccounts in a Variable Universal Life policy held?
Separate accounts protected from creditors
82
Which life insurance option allows flexible premium payments and provides investment choices with greater risk?
Variable Universal Life
83
Proceeds from a viatical settlement are tax-free when the insured is:
Terminally or chronically ill
84
A 'chronically ill' individual for viatical settlements typically must meet which condition?
Unable to perform 2 of 6 activities of daily living
85
A MEC status impacts which taxation aspect of life insurance policies?
Taxation of withdrawals and loans from cash value
86
A Variable Universal Life policy classified as a MEC will still provide:
Tax-free death benefits
87
Which life insurance product provides coverage for a specified term only?
Term Life
88
Which life insurance product initially offers the lowest death benefit relative to the premium?
Whole Life
89
Which policy offers flexibility to adjust premium and death benefit?
Universal Life
90
Which policy transfers investment risk to the policyholder?
Variable Life
91
The Extended Term nonforfeiture option will provide coverage:
At the original face amount, but for a limited period
92
Whole life insurance premiums are:
Guaranteed for life
93
Which type of insurance is best suited for temporary needs, such as mortgage protection?
Term Life
94
Which policy type typically accumulates a cash value on a tax-deferred basis?
Whole Life
95
When does a life insurance policy become a Modified Endowment Contract (MEC)?
When it exceeds allowable premium payments under the 7-pay test
96
Which nonforfeiture option reduces the face amount but maintains lifetime coverage?
Reduced Paid-Up
97
A deferred annuity may be exchanged tax-free under Section 1035 into which of the following?
Long-term care insurance
98
How long does COBRA continuation coverage typically last upon termination of employment?
18 months
99
What happens to withdrawals from a MEC during the owner's lifetime?
Withdrawals are taxed as ordinary income, interest-first
100
How do outstanding loans impact the death benefit in a Variable Universal Life policy under option B?
They reduce the death benefit
101
Which professional certifies the insured as terminally or chronically ill for a viatical settlement?
Licensed physician
