Chapter 10 Flashcards

1
Q

What two questions relate to tax treatment regarding annuities?

A
  1. Is the premium tax-deductible or not?

2. Are distributions from insurance product taxable or not

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2
Q

Are premiums paid for individual life insurance tax deductible?

A

No

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3
Q

how are interest payments credited to life insurance treated?

A

They are tax-deferred

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4
Q

When a life insurance policy is surrendered, how are gains taxed?

A

The gains are taxable (Gain = Cash value - policy’s cost basis)

So cash value accumulations are tax deferred, but not necessarily tax-free

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5
Q

How are withdrawal’s (partial surrenders) taxed?

A

They are taxable to the extent of any gain

-THey are taxed on a FIFO basis (meaning, the assumption is that anything withdrawn is considered to come from the premiums paid (cost basis) FIRST and cost basis withdrawals are not taxable

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6
Q

Any money received from a policy, other than the death benefit, does what to the death benefit?

A

It reduces the cost basis

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7
Q

Are policy loans taxable?

A

No - even if the amount exceed’s the policy’s cost - the basis. The amount of the loan never becomes taxable even when the insured dies

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8
Q

If a policy is surrendered or it lapses while there is a policy loan outstanding, any portion of the loan amount that exceeds the policy’s cost basis is what?

A

A taxable gain

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9
Q

Is interest paid on a policy loan tax-deductible?

A

No

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10
Q

Are dividends from policies taxable?

A

No (assumed to be return of a portion of premiums)

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11
Q

Do dividends reduce the cost basis?

A

Yes (recall, they are a return on principal - which is why they are not taxable)

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12
Q

While dividends are not taxable, if they are left to accumulate interest, is the interest taxable?

A

Yes

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13
Q

When the entire death benefit amount “lump sum” is paid to a named beneficiary, is it taxable?

A

No - it is not taxable in that case. Whether the policy is owned by an individual or a business

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14
Q

If a death benefit payment is made under other settlement options, not a “lump-sum”, how is it treated for tax purposes?

A
  1. The original death benefit is not taxable

2. Interest earned on the proceeds are taxable as ordinary income when paid to the beneficiary

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15
Q

What are accelerated death benefits?

A

An advance of death benefits - written certification from a physician is required, diagnosing a qualifying even that will substantially decrease the insured’s life span

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16
Q

What do “qualifying events” include?

A

Terminal illnesses expecting to end in death within 24 months, acute illness, emergency organ transplants, permanent confinement to nursing homes, and long-term care (if activities of daily living can no longer be performed). Part or all of the death benefit may be us

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17
Q

With qualifying events, can part or all of the death benefit be used?

A

Yes

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18
Q

Are accelerated death benefits tax exempt?

A

Yes

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19
Q

What three types of business life insurance are not tax deductible to the business?

A
  1. Key person life insurance policies
  2. Life Insurance policies funding buy-sell agreements
  3. Life insurance policies that will reimburse the company for benefits paid under deferred compensation plans
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20
Q

Why are key person, buy-sell agreements, and life insurance policies that will reimburse the company for benefits paid under deferred compensation plans not tax deductible for businesses?

A

Because the business receives financial benefits from owning these policies

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21
Q

Are premiums paid by the company for executive bonuses tax deductible?

A

Yes (as such, the amount of premium paid is also considered taxable income to the employee)

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22
Q

With contributory group plans, is the employee portion of the group life insurance premium tax deductible?

A

No

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23
Q

Group life insurance premiums paid by the employer are tax-deductible as a business expense provided under an employer group benefit plan

A

Note

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24
Q

With group life insurance plans, is the premium for the first $50,000 of coverage taxable to the employee?

A

No - the premium for the first $50,000 of coverage is not taxable to the employee

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25
Q

With group life insurance plans, is the premium additional coverage above $50,000 taxable as income to the employee?

A

Yes

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26
Q

What is the “modified endowment contract”?

A

A modified endowment contract, or a MEC, is a special type of life insurance under federal income tax law. Specifically, 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 protection

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27
Q

MECs are still life insurance and offer tax-free death benefits and tax deferred 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 implications due to the contracts MEC status

A

Note

28
Q

To determine if a contract is an MEC, what occurs?

A

A premium limit is set and is referred to as a seven-pay limit or MEC limit. Based on the annual premium that would pay up the policy after the payment of several level annual premiums

29
Q

What is the MEC test?

A

Under the MEC test, the cumulative amount paid at any time in the first 7 years cannot exceed the cumulative MEC limit applicable in that policy year

30
Q

If you fail the MEC test (cumulative premiums are higher than they should be), what is the policy classified as?

A

An MEC

31
Q

If you over-contribute premium, resulting in MEC status, what can you do to avoid having a policy become a MEC?

A

The insurer may refund excess premiums within 60 days to avoid having a policy become a MEC

32
Q

What is the MEC test known as?

A

The modified pay limit

33
Q

Withdrawals OR loans from MECs are taxed - t/f? LIFO or FIFO

A

True - on a LIFO basis (meaning, interest is taxed first)

34
Q

With MECs, does a penalty exist for interest withdrawn before age 59.5? How much?

A

Yes (10% penalty)

35
Q

Are annuity premiums tax-deductible?

A

No - unless the contract is held in a qualified retirement account

36
Q

How is interest credited to annuity accounts treated?

A

it is tax-deferred. They become taxable when they are paid out

37
Q

When does interest credited to an annuity become taxable?

A

When it is paid out

38
Q

Earnings on annuities owned by corporations are taxable when?

A

When they are credited

39
Q

Distributions from an annuity during the accumulation phase receive the same treatment as modified endowment account - t/f?

A

True - LIFO taxation (the entire taxable gain is received before any non-taxable cost basis

40
Q

With annuities, a 10% penalty tax must be paid in addition to the regular tax due on any taxable amount received. When does this penalty not apply?

A

When the individual is disabled

41
Q

What is the “exclusion ratio” for annuities?

A

The exclusion ratio is used to determine the nontaxable portion of each monthly payment. The formula is applied to each annuity payment to find the portion that is excludable from gross income. The remainder is taxed as ordinary income

42
Q

as an example of the “exclusion ratio” - an annuity owner paid $12,000 into a contract and its now worth $19,200. The exclusion ratio is $12,000/$19,200 or 62.5%. If the monthly payment received is $100, the portion that is excluded from gross income is $62.50 or 62.5% of $100. The $37.50 balance of each $100 monthly payment is ordinary income

A

Note

43
Q

After annuitization, is it true that annuity payments are “taxed according to the exclusion ratio”?

A

Yes

44
Q

Premiums Paid in / Total of expected payments over annuitants life expectancy = what?

A

% of payment NOT TAXED

45
Q

If an annuitant lives beyond his/her life expectancy, how much of the payment becomes taxable?

A

100%

46
Q

What are 4 different ways that annuity payments can be made at the death of an annuity owner to the beneficiary?

A
  1. Lump-Sum
  2. Five-Year withdrawal period
  3. Annuity Payout
  4. Spousal Option
47
Q

What is the “lump sum” payout of an annuity to a beneficiary? What is the tax treatment?

A
  1. Beneficiary can take all of the proceeds at once

2. The gain is taxable

48
Q

What is a 5-year withdrawal period? What is the tax treatment?

A

The beneficiary must withdrawal all of the proceeds within 5 years. These withdrawals are taxed the same as withdrawals during the owner’s life. That is, the gain is taxable and all the gain must be taken out before any non-taxable cost basis is withdrawn (Evan - sounds like LIFO)

49
Q

what is an “annuity payout” option for delivery to a beneficiary? What is the tax treatment?

A

The beneficiary may take the proceeds under an annuity payout option. This option must be selected within one year of the owners death.

The payments are taxed as annuity payments - part taxable gain and part non-taxable cost-basis, with the non-taxable amount determined by the exclusion ratio

50
Q

What is the “spousal option” for delivery to a beneficiary? What is the tax treatment?

A

The beneficiary is the owner’s spouse. Ownership may be transferred to the spouse without any tax consequences

51
Q

If death occurs during the annuity period, tax treatment of any continuing payments depends on what?

A

Whether those payments are being made to a:

  1. Survivor Annuitant
  2. Beneficiary
52
Q

If payments are made to a survivor annuitant under a joint and survivor annuity, how are they taxed?

A

They are taxed as they were when made to both annuitants. If the entire cost basis has not yet been paid out, the amount excludable from taxable income remains fixed even if the payments to the survivor annuitant is reduced, such as under a joint and two thirds survivor annuity

53
Q

With a joint and survivor annuity, when do payments become fully taxable?

A

When the entire cost basis has been paid out

54
Q

If payments are made to a beneficiary under an annuity contract, how are those payments taxed?

A

The entire payment becomes non-taxable until the entire cost basis has been paid out (including the portion of cost basis that was paid to the annuitant). At that point, any remaining payments are fully taxable.

55
Q

If the entire cost basis had been paid out to the annuitant prior to death, how would annuity payouts be taxed to a beneficiary?

A

They would be fully taxable

56
Q

A gain in a life insurance contract is considered taxable when the policy is surrendered - t/f?

A

True

57
Q

What does section 1035 of the tax code allow?

A

Individuals to move cash from one contract to another without having any gain taxed at that time

58
Q

To quality for 1035 (transfer cash from one account to another without having any gain taxed at that time) what must be the case?

A

Insured and beneficiary must be the same between the two accounts

59
Q

The 1035 exchange applies to what 2 things?

A
  1. Life Insurance

2. Annuities

60
Q

What movements of cash flows qualify under a 1035 exchange?

A
  1. Life insurance policy to another life insurance policy
  2. Annuity contract to another annuity contract
  3. life insurance policy to an annuity contract
61
Q

Does an annuity to a life insurance contract qualify under a 1035 exchange?

A

No - The surrender of an annuity to move the cash values to a life insurance policy does not qualify as a 1035 exchange.

62
Q

Under an annuity to life transition (which does not qualify under a 1035 exchange), are the annuity gains taxable?

A

Yes

63
Q

When are estate taxes owed?

A

Estate taxes are owed if an estate’s value exceeds a certain value at the time of the individual’s death - and taxes are applied to the estate’s value

64
Q

When are life insurance policies counted as a value in a deceased’s insured estate (and thus subject to estate taxes)?

A
  1. They are payable to the estate
  2. The deceased possessed any incidents of ownership 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 or
  3. The deceased assigned or transferred ownership of the policy to another person with three years of death
65
Q

What is the estate tax treatment of annuities - (1) during the accumulation period?

A

If death occurs during the accumulation period, the entire value of the annuity - not just the gain, but also the cost basis - is included in the estate

66
Q

What is the estate tax treatment of annuities during the annuitization period?

A

the present value of any payments that will continue to a beneficiary or survivor annuitant is included in the estate