Chapter 15 Federal Tax Considerations For Life Insurance And Annuities

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| By Vivian Tayor
Vivian Tayor, Insurance & Finance
Vivian, with over a decade of financial and insurance leadership, founded Celevi CE, an elite continuing education organization, aiming to empower industry experts with trust and respect.
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Chapter 15 Federal Tax Considerations For Life Insurance And Annuities - Quiz

Welcome to a helpful quiz on federal tax considerations for life insurance and annuities, where you’ll be able to learn all about the topic with questions on modified endowment contracts, policyholders, tax deduction and more with several examples to work with. What do you know so far?


Questions and Answers
  • 1. 

    If there is a material change in a Modified Endowment Contract:  

    • A.

      MEC reverts to a Life insurance policy

    • B.

      The required premium will increase

    • C.

      The insurer must notify the Department of Insurance

    • D.

      A new 7-pay test is required

    Correct Answer
    D. A new 7-pay test is required
    Explanation
    If there is a material change in a Modified Endowment Contract, a new 7-pay test is required. This means that the policyholder will need to undergo a new test to determine if the premiums paid within the first 7 years of the policy exceed certain limits set by the IRS. This test is necessary to ensure that the policy retains its tax advantages. If the premiums paid within the first 7 years exceed these limits, the policy will lose its tax-favored status and be treated as a taxable investment.

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  • 2. 

     The Federal government allows employers to take a tax deduction for premium contributions they make to a group medical expense plan if:

    • A.

      The contributions to the plan exceed 10% of the company’s gross income

    • B.

      If the contributions represent responsible business expenses

    • C.

      The medical benefits received by the employees are taxable

    • D.

      They are contributing 100% of the plan costs

    Correct Answer
    B. If the contributions represent responsible business expenses
    Explanation
    Employers are allowed to take a tax deduction for premium contributions to a group medical expense plan if the contributions represent responsible business expenses. This means that the contributions must be considered necessary and reasonable expenses related to the operation of the business. This requirement ensures that employers are not taking advantage of the tax deduction for personal or unrelated expenses. By meeting this criterion, employers can reduce their taxable income by deducting the premium contributions made to the group medical expense plan.

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  • 3. 

    Medical expense premiums paid by the individual policyholder are deductible as a medical expense, to the extent that when added to all other unreimbursed medical expenses, the total exceeds ____ of the taxpayer’s adjusted gross income

    • A.

      0.7%

    • B.

      7.5%

    • C.

      0.6%

    • D.

      0.5%

    Correct Answer
    B. 7.5%
    Explanation
    Medical expense premiums paid by an individual policyholder are deductible as a medical expense. However, the deduction is limited to the extent that when added to all other unreimbursed medical expenses, the total exceeds a certain percentage of the taxpayer's adjusted gross income. In this case, the correct answer is 7.5%, meaning that the total of all unreimbursed medical expenses, including medical expense premiums, must exceed 7.5% of the taxpayer's adjusted gross income in order for the deduction to apply.

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  • 4. 

     Which of the following is not a 401(k) arrangement?  

    • A.

      Pure salary

    • B.

      Bonus plan

    • C.

      Thrift plan

    • D.

      Sheltered plan

    Correct Answer
    D. Sheltered plan
    Explanation
    A sheltered plan is not a 401(k) arrangement. A 401(k) arrangement refers to a retirement savings plan offered by employers, where employees can contribute a portion of their salary to a tax-advantaged investment account. Pure salary, bonus plan, and thrift plan are all types of 401(k) arrangements commonly offered by employers. However, a sheltered plan is not a recognized type of 401(k) arrangement.

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  • 5. 

    Bob had $500,000 of life insurance at work; he has an additional $40,000 life insurance policy the company purchased on all employees.  His wife is the primary beneficiary and their four children are contingent beneficiaries.  Upon Bob's death, what are the tax consequences to his beneficiaries?

    • A.

      All premiums paid may be deducted from the face valuebefore taxation.

    • B.

      The $40,000 will be taxed since the premium was tax deductible by the employer

    • C.

      The $540,000 lump sum proceeds will be received income tax free.

    • D.

      The contingent beneficiaries must pay income taxes on all proceeds they recieve.

    Correct Answer
    C. The $540,000 lump sum proceeds will be received income tax free.
    Explanation
    The $540,000 lump sum proceeds will be received income tax free because life insurance proceeds are generally not subject to income tax.

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  • 6. 

    The payment of an accelerated death benefit is not taxable income if the accelerated death benefit payment is qualified.  The benefit qualifiers are all the following, except:

    • A.

      The ratio of the policycash value before and after the benefit payment must at least be equal to the ratio of the death benefit before and after the benefit payment.

    • B.

      The amount of benefit must at least be equal to the present value of the reduced death benefit remaining afterpayment of the accelerated benefit.

    • C.

      The benefit amount is determined similarlyto that of an annuity, taking into consideration the amount of months remaining for the insured.

    • D.

      The prognosis of a physician must be less than 12 months

    Correct Answer
    D. The prognosis of a physician must be less than 12 months
    Explanation
    The payment of an accelerated death benefit is not taxable income if the accelerated death benefit payment is qualified. The benefit qualifiers include the ratio of the policy cash value before and after the benefit payment being at least equal to the ratio of the death benefit before and after the benefit payment, the amount of benefit being at least equal to the present value of the reduced death benefit remaining after payment of the accelerated benefit, and the benefit amount being determined similarly to that of an annuity, taking into consideration the amount of months remaining for the insured. However, the prognosis of a physician must be less than 12 months for the benefit to be qualified.

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  • 7. 

    What is false regarding the taxation of an annuity if the annuitant should die during distribution?

    • A.

      Interest earned during the accumulation periodis not taxable.

    • B.

      If the annuitant chose the life income option, nothing is included in the gross estate.

    • C.

      If annuity paymentsare to continue to another person upon an annuitant's death, the survivor's proceeds are includedin the gross estate.

    • D.

      If a lump sum goes to a beneficiary, only the amount in excess of the policyowner's investmentis included in the beneficiary's gross income for federal tax purposes.

    Correct Answer
    A. Interest earned during the accumulation periodis not taxable.
    Explanation
    During the accumulation period of an annuity, any interest earned is typically not taxable. This means that the annuitant does not have to pay taxes on the interest that is accumulating in the annuity account. However, it is important to note that once the annuity payments begin, the annuitant may be required to pay taxes on the income received.

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  • 8. 

    The 1035 Exchange states no gain or loss will be recognized on the exchange of contracts by the same insurered.  This is true for each situation described below, except:

    • A.

      An annuity contract is exchanged for another annuity contract

    • B.

      A Whole life Policy is exchanged for a Universal Life Policy

    • C.

      An Endowment Policy is exchanged for another Endowment Policy that provides for payments on or before the original endowment date.

    • D.

      An Endowment Policy is exchanged for a Whole Life policy.

    Correct Answer
    D. An Endowment Policy is exchanged for a Whole Life policy.
    Explanation
    The 1035 Exchange allows for the tax-free exchange of certain insurance contracts. However, in this case, an Endowment Policy is being exchanged for a Whole Life policy. Since these are two different types of policies, the exchange does not meet the requirements of the 1035 Exchange and would therefore result in the recognition of gain or loss.

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  • 9. 

    Which of the following is an advantage of a 403(b) Annuity?

    • A.

      All monies invested and the accumulationof interest is tax- deferred until recieved.

    • B.

      They are profit- sharing plans.

    • C.

      Employees of states, counties and municipalities may reduce thier pay bya specified amount to invest in one or more 403(b) investments.

    • D.

      Distributions are tax exempt.

    Correct Answer
    A. All monies invested and the accumulationof interest is tax- deferred until recieved.
    Explanation
    An advantage of a 403(b) Annuity is that all the money invested and the accumulation of interest is tax-deferred until received. This means that individuals do not have to pay taxes on the money they invest or any interest earned until they start receiving distributions. This can provide a significant advantage as it allows the invested funds to grow without being diminished by taxes, potentially resulting in higher returns over time.

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  • 10. 

    Kacie sucessfully owned and operated a business for 10 years and have decided to plan for her retirement.  She wants a qualified plan to maximize the tax advantages.Her best option is

    • A.

      Simplified Employee pension

    • B.

      HR-10 Plan

    • C.

      Profit Sharing plan

    • D.

      401 (k) Plan

    Correct Answer
    B. HR-10 Plan
    Explanation
    The HR-10 Plan, also known as a Keogh Plan, is a qualified retirement plan designed for self-employed individuals or small business owners like Kacie. It allows her to contribute a percentage of her self-employment income to the plan, up to a certain limit, and receive tax advantages. The contributions made to the HR-10 Plan are tax-deductible, and the earnings on the contributions grow tax-deferred until retirement. This plan offers Kacie the opportunity to maximize her tax advantages while planning for her retirement.

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  • 11. 

    Richard is a teacher at the local school.  His employeer has agreed for the past 3 years to reduce his pay by a specified amount and invest it for him.  He has a

    • A.

      401 (k)

    • B.

      Section 457

    • C.

      TSA

    • D.

      HR 10

    Correct Answer
    C. TSA
    Explanation
    The correct answer is TSA. TSA stands for Tax-Sheltered Annuity, which is a type of retirement plan available for certain employees of public schools, non-profit organizations, and some government organizations. In this case, Richard's employer has agreed to reduce his pay by a specified amount and invest it in a TSA for him. This allows Richard to save for retirement in a tax-efficient manner, as contributions to a TSA are made on a pre-tax basis, and any earnings on the investments grow tax-deferred until withdrawn.

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  • 12. 

    What life insurance event is not taxable?

    • A.

      Interest income only

    • B.

      Monthly income of principle and interest

    • C.

      Dividends recieved exceed the premiums paid by $700

    • D.

      Lump sum death benefit recieved by the beneficiary

    Correct Answer
    D. Lump sum death benefit recieved by the beneficiary
    Explanation
    A lump sum death benefit received by the beneficiary is not taxable. This is because life insurance proceeds paid out as a death benefit are generally not considered taxable income. The purpose of life insurance is to provide financial support to the beneficiary after the insured person's death, and taxing the death benefit would go against this purpose. Therefore, the lump sum death benefit received by the beneficiary is not subject to income tax.

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  • 13. 

    What is not an advantage of gifting with life insurance?

    • A.

      The entire gift is guaranteed even if only onepremium is paid

    • B.

      The IRS needs very little documentation

    • C.

      The size of the giftis determined by the size of the death benefit

    • D.

      All of these are advantages

    Correct Answer
    D. All of these are advantages
    Explanation
    All of the options mentioned in the question are advantages of gifting with life insurance. The fact that the entire gift is guaranteed even if only one premium is paid, the IRS requiring very little documentation, and the size of the gift being determined by the size of the death benefit are all advantages of using life insurance as a gifting method. Therefore, all of these options are indeed advantages.

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  • 14. 

    A tax on the right of heirs to recieve  property from a deceased person is a(n)

    • A.

      Federal Income tax

    • B.

      Inheritance Tax

    • C.

      Estate tax

    • D.

      None of the Above

    Correct Answer
    B. Inheritance Tax
    Explanation
    An inheritance tax is a tax imposed on the right of heirs to receive property from a deceased person. This tax is specifically levied on the transfer of assets from the deceased's estate to the beneficiaries. Unlike estate tax, which is based on the total value of the deceased's estate, an inheritance tax is based on the value of the individual inheritances received by the beneficiaries. Therefore, the correct answer is Inheritance Tax.

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  • 15. 

    Janelle is asking you, an agent, about any taxation issues related to his $100,000 personal Whole Life policy.  You find that her understanding  is correct on all points, except:

    • A.

      Since her policy is a personal policy, she cannot deduct the premiums she pays for the policy.

    • B.

      Annual increases in the policies cash value are not taxable at the time they credited to the policy

    • C.

      The interest that she pays on personal loans that she might take from the policy is tax deductible for the life of the loan.

    • D.

      Upon surrender of the policy, she will be taxed on any amount by which the cash value at the time of surrendershould exceed the premiums paid to date of surrender.

    Correct Answer
    C. The interest that she pays on personal loans that she might take from the policy is tax deductible for the life of the loan.

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Our quizzes are rigorously reviewed, monitored and continuously updated by our expert board to maintain accuracy, relevance, and timeliness.

  • Current Version
  • Mar 21, 2023
    Quiz Edited by
    ProProfs Editorial Team
  • Mar 25, 2012
    Quiz Created by
    Vivian Tayor
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