Real Estate Planning - Chapter 11

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  • 1/35 Questions

    Jack purchased a life insurance policy on his own life and never designated a beneficiary.  In this case, the life insurance policy death benefit is:

    • Included in Jack's federal gross estate if Jack dies within three years of the initial premium payment.
    • Included in Jack's federal gross estate if Jack paid the premiums until his death.
    • Never included in Jack's federal gross estate.
    • Always included in Jack's federal gross estate.
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Real Estate Quizzes & Trivia
About This Quiz

This quiz, titled 'Real Estate Planning - Chapter 11', assesses knowledge on the inclusion of life insurance policies in federal gross estate calculations, effects of ownership transfers, and implications of viatical settlements. It is essential for learners in finance and estate planning.

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  • 2. 

    Colleen transferred ownership of a whole life insurance policy on her life to an Irrevocable Life Insurance Trust (ILIT) six years ago and retained the right to borrow against the policy.  When Colleen dies, the proceeds of the life insurance policy are:

    • Included in Colleen's federal gross estate if she has any outstanding loans against the life insurance policy.

    • Included in Colleen's federal gross estate if Colleen continued paying the policy premiums after the life insurance policy was transferred to the ILIT.

    • Never included in Coleen's federal gross estate.

    • Always included in Colleen's federal gross estate.

    Correct Answer
    A. Always included in Colleen's federal gross estate.
    Explanation
    When Colleen transferred ownership of the whole life insurance policy to an Irrevocable Life Insurance Trust (ILIT) but retained the right to borrow against the policy, it means that she still has control over the policy and can access its funds. As a result, the proceeds of the life insurance policy will always be included in Colleen's federal gross estate when she dies, regardless of whether she has any outstanding loans against the policy or if she continued paying the premiums after transferring it to the ILIT.

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  • 3. 

    Carol and Joe, unrelated business partners, began operating a drug store in southern Florida.  They funded a buy/sell agreement with a cross-purchase life insurance arrangement.  Carol purchased a life insurance policy with Joe as the insured, and Joe purchased a life insurance policy with Carol as the insured.  If Carol dies, which of the following is/are true?1) The death benefit of the life insurance policy on Carol's life, owned by Joe, is excluded from Carol's federal gross estate.2) The death benefit of the life insurance policy on Carol's life, owned by Joe, is included in Carol's federal gross estate if Carol own's 50% or more of the stock of the drug store.3) The value of the life insurance policy on Joe's life, owned by Carol, is included in Carol's federal gross estate.4) The death benefit of the life insurance policy on Carol's life, owned by Joe, is included in Carol's federal gross estate.

    • 1 only

    • 1 and 3

    • 1, 2, and 3

    • 1, 2, 3, and 4

    Correct Answer
    A. 1 and 3
    Explanation
    If Carol dies, the death benefit of the life insurance policy on Carol's life, owned by Joe, is excluded from Carol's federal gross estate because Carol is not the owner of the policy. However, the value of the life insurance policy on Joe's life, owned by Carol, is included in Carol's federal gross estate because Carol is the owner of the policy.

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  • 4. 

    Many individuals who have been diagnosed with terminal illnesses sell their life insurance policies to viatical settlement providers.  Which of the following statements is true regarding the transfer of a policy from an individual with a terminal illness to a viatical settlement provider?

    • If the individual dies within three years of the transfer , the full proceeds of the insurance policy are included in his federal gross estate.

    • The individual is subject to capital gain taxes on the difference between his adjusted basis in the life insurance policy and the amount paid to him by the viatical settlement provider.

    • Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax.

    • If the individual lives for more than one year after the transfer, the individual will be subject to income tax on the payment from the viatical provider.

    Correct Answer
    A. Regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax.
    Explanation
    The correct answer states that regardless of when the individual dies, the payment from the viatical settlement company is excluded from income tax. This means that even if the individual lives for more than one year after the transfer, they will not be subject to income tax on the payment. This is a benefit for individuals who sell their life insurance policies to viatical settlement providers, as they can receive the payment without having to pay taxes on it.

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  • 5. 

    Last year, Jerry gave a life insurance policy with a $400,000 death benefit to his son, Brad.  At the time of the gift, the value of the life insurance policy was $50,000 and Jerry had to pay $5,000 in federal gift tax.  Jerry unexpectedly died this year.  What amount will be included in Jerry's federal gross estate related to this life insurance policy?

    • $5,000

    • $400,000

    • $405,000

    • $455,000

    Correct Answer
    A. $405,000
    Explanation
    The correct answer is $405,000. The federal gross estate includes the value of property owned by the deceased at the time of their death, including life insurance policies. In this case, the value of the life insurance policy at the time of the gift was $50,000, which is included in the gross estate. Additionally, the amount of federal gift tax paid by Jerry, which is $5,000, is also included in the gross estate. Therefore, the total amount included in Jerry's federal gross estate related to this life insurance policy is $50,000 + $5,000 = $405,000.

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  • 6. 

    Four years ago, Marvin gave a life insurance policy with a  $750,000 death benefit to his daughter, Marsha.  At the time of the gift, the value of the life insurance policy was $65,000, and Marvin paid $10,000 in federal gift tax.  Marvin unexpectedly died this year.  What amount will be included in Marvin's federal gross estate related to this life insurance policy?

    • $0

    • $10,000

    • $65,000

    • $750,000

    Correct Answer
    A. $0
    Explanation
    Marvin's federal gross estate will include $0 related to this life insurance policy because he gave the policy as a gift to his daughter four years ago. Once a gift is made and the donor no longer has any incidents of ownership or control over the policy, it is excluded from the donor's estate for federal estate tax purposes. Therefore, the value of the life insurance policy will not be included in Marvin's federal gross estate.

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  • 7. 

    Louie gave a $1,000,000 life insurance policy on his own life to his brother.  At the date of the gift, the life insurance policy was valued at $200,000.  Which of the following statements regarding the gift of this life insurance policy is correct?

    • If Louie dies two years after this gift, his federal gross estate will include $200,000.

    • If Louie dies four years after this gift, his federal gross estate will include $200,000.

    • If Louie dies two years after this gift, his federal gross estate will include $1,000,000.

    • If Louie dies four years after this gift, his federal gross estate will include $1,000,000.

    Correct Answer
    A. If Louie dies two years after this gift, his federal gross estate will include $1,000,000.
    Explanation
    When Louie gave the $1,000,000 life insurance policy to his brother, the policy was valued at $200,000. However, if Louie dies two years after giving the gift, his federal gross estate will include the full value of the policy, which is $1,000,000. This means that the value of the policy will be included in Louie's estate for tax purposes.

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  • 8. 

    As part of his employee benefits package, Larry's employer provided him with a $50,000 term life insurance policy.  Larry named his wife, Cynthia, as the sole beneficiary of the life insurance policy.  Which of the following statements is true with regard to this life insurance policy?

    • Because the term insurance policy is part of a group term life insurance policy, the death benefit payable to Cynthia is considered taxable income.

    • At Larry's death, the death benefit payable to Cynthia will be included in Larry's federal gross estate.

    • Larry cannot change the beneficiary of the life insurance policy without Cynthia's prior written approval.

    • If Cynthia dies before Larry, her federal gross estate will include the life insurance policy death benefit.

    Correct Answer
    A. At Larry's death, the death benefit payable to Cynthia will be included in Larry's federal gross estate.
  • 9. 

    James owned a life insurance policy with his brother Fred, as the insured.  When James died, his will specifically bequeathed the policy to his sister, Lolita.  Which of the following statements regarding the value of the life insurance policy to include in James' federal gross estate is not true?

    • If the life insurance policy is a term life insurance policy, the value is the unused premium.

    • Because Fred is still alive, the value of the policy included in the gross estate is zero.

    • If the life insurance policy is a whole life policy in pay status, the value is equal to the unearned premium plus the interpolated terminal reserve.

    • If the life insurance policy is a paid-up or single premium life insurance policy, its value is its replacement cost.

    Correct Answer
    A. Because Fred is still alive, the value of the policy included in the gross estate is zero.
    Explanation
    The value of the life insurance policy to include in James' federal gross estate is not true because Fred is still alive. The value of the policy would not be zero just because Fred is alive. The value of the policy would depend on the type of policy it is, such as term life insurance, whole life policy in pay status, or paid-up/single premium life insurance policy.

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  • 10. 

    Which of the following is not a reason for using life insurance in an estate plan?

    • The proceeds of the life insurance policy can be used to create liquidity for the decedent's estate.

    • The proceeds of the life insurance policy can be used to eliminate any debt for the decedent's surviving spouse.

    • The insured can borrow the death benefit from the life insurance policy to fund his retirement.

    • Expected future education expenses can be funded with the death benefit of the life insurance policy.

    Correct Answer
    A. The insured can borrow the death benefit from the life insurance policy to fund his retirement.
    Explanation
    Using life insurance to borrow the death benefit for retirement is not a reason for including it in an estate plan. Life insurance is typically used in estate planning to create liquidity for the decedent's estate, eliminate debt for the surviving spouse, and fund expected future education expenses. However, borrowing the death benefit for retirement is not a common or recommended use for life insurance in an estate plan.

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  • 11. 

    Which of the following statements regarding term life insurance is correct?

    • The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.

    • The cash accumulation account of a term life insurance policy is invested in the bond portfolios of the insurer.

    • The cash accumulation account of a term life insurance policy is invested in individual stocks selected by the insured.

    • The premium of a term life insurance policy will decrease as the pure cost of life insurance increases.

    Correct Answer
    A. The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract.
    Explanation
    The premium on a term life insurance policy reflects the actuarial risk that the insured will die during the term of the contract. This means that the higher the risk of the insured dying, the higher the premium will be. Actuaries use statistical data and mortality tables to assess the likelihood of death for individuals based on factors such as age, health, and lifestyle. They then calculate the premium based on this risk assessment. Therefore, the premium is directly linked to the actuarial risk of death during the term of the policy.

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  • 12. 

    Travis, 28, and his wife, 26, have recently moved into a new home.  They financed $350k of the $500k purchase price and utilized all of their savings to pay the down payment of $150k.  Travis's wife stays at home with their 3-year old son, Alex, and is expecting a baby in two months.  Which of the following statements s not correct?

    • Travis should consider a 30 year term life insurance policy on his life which could fund his children's educational needs if he should die during the term.

    • A universal life insurance policy would provide Travis with the insurance protection of a term life insurance policy and would also provide him with a tax-deferred savings mechanism.

    • A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death.

    • Travis should consider a whole life insurance policy on his life which could fund his children's educational needs or pay off the mortgage if he dies while those needs exist, and which could also provide Travis with a source of funds if he lives through his retirement.

    Correct Answer
    A. A whole life insurance policy would provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death.
    Explanation
    A whole life insurance policy would not provide Travis with the least expensive temporary life insurance needed to eliminate the mortgage at his death. Whole life insurance policies are typically more expensive than term life insurance policies, and they provide coverage for the entire lifetime of the insured rather than a specific term. In this case, Travis should consider a term life insurance policy that covers the duration of the mortgage, as it would be a more cost-effective option for providing the necessary coverage.

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  • 13. 

    Mary selected her son as the beneficiary of a whole life insurance policy on her life.  Which of the following statements concerning this beneficiary designation is incorrect?

    • Mary could have chosen her son and her daughter as co-beneficiaries.

    • If Mary lists her nephew as the contingent beneficiary of the whole life insurance policy, her nephew will collect the death benefit if her son dies before Mary.

    • If Mary entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime.

    • At Mary's death, her son will receive the death benefit of the life insurance policy.

    Correct Answer
    A. If Mary entered an irrevocable beneficiary designation, she is the complete owner of the life insurance policy and can amend the irrevocable beneficiary designation at anytime.
  • 14. 

    Which of the following statements regarding universal life insurance policies is true?

    • As long as the premium of a universal life insurance policy is pad the insurer guarantees that the life insurance policy will remain in force.

    • A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost.

    • Funds within the cash accumulation account of a universal life insurance policy cannot be used to pay the policy premium.

    • A universal life insurance policy allows the insured to select the csh accumulation account investments.

    Correct Answer
    A. A universal life insurance policy will be cancelled if the pure cost of insurance protection increases and the cash accumulation account does not have the funds to pay the additional cost.
  • 15. 

    Raphael is the owner of a variable life insurance policy on his life.  His wife, Isabel is the designated beneficiary.  Which of the following statements is correct?

    • If Isabel dies before Raphael, Isabel must include the value of the life insurance policy in her federal gross estate.

    • At Raphael's death, the variable life insurance policy death benefit will be paid to Isabel.

    • When the beneficiary of a life insurance policy is the wife of the insured/owner, the death benefit payable to the wife is included in the insured's probate estate.

    • As beneficiary, Isabel can borrow against the death benefit during Raphael's life.

    Correct Answer
    A. At Raphael's death, the variable life insurance policy death benefit will be paid to Isabel.
  • 16. 

    Jason is the owner of a paid-up whole life insurance policy on his own life.  All of the following statements are correct except:

    • Jason has title to the whole life insurance contract.

    • Jason can borrow against the cash value of the whole life insurance policy.

    • The death benefit of the whole life insurance policy will be included in Jason's federal gross estate.

    • If Jason gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium.

    Correct Answer
    A. If Jason gifts the whole life insurance policy to his son, the value for gift tax purposes is the sum of the policy's interpolated terminal reserve plus any unearned premium.
  • 17. 

    Jim purchased a yacht from Ronald for $200k seven years ago.  The terms of the sale included a note of $50k and cash for the remaining amount.  Ronald had a zero basis in the yacht.  Immediately after purchasing the yacht, Jim's business began to fail and Jim could no longer make the payments.  In exchange for the note, Jim gave Ronald a life insurance policy on his life with a face value of $50k.  This year, Jim died and Ronald received the death benefit as the designated beneficiary of the policy.  How much of this death benefit is taxable to Ronald?

    • $0

    • $50,000

    • $150,000

    • $200,000

    Correct Answer
    A. $50,000
    Explanation
    The correct answer is B. The transfer of the life insurance policy for the note is a transfer for valuable consideration. If a life insurance policy is transferred for valuable consideration, the death benefit in excess of the transferee's adjusted basis will be subject to income tax. Ronald did not have any basis in the boat, so correspondingly, he does not have any basis in the note and must recognize gain to the extent any value is received. As such the $50,000 death benefit received is taxable income to Ronald

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  • 18. 

    In which of the following situations would the death benefit of a life insurance policy be taxable, partially or wholly?

    • Deborah, as designated beneficiary, received the $80k death benefit of Larry's life insurance policy. Larry had purchased the policy for $35k from his employer when he retired in 1997.

    • Clean-it, LLAC, received the $100k death benefit of David's life insurance policy. In 1990, David, the owner of 50% of the stock of Clean-it, LLC sold the policy to Clean-it for $12,000 as part of an entity-type buy-sell agreement.

    • Weakam, Ullo, and Evans, LLP, received the $1MM death benefit of a life insurance policy on Randy Evans, one of the managing partners. Randy had sold the policy to Weakam, Ullo, and Evans, LLP in 1945 when the business was just starting out as part of an entity-type buy-sell agreement.

    • Adam sold a $100k death benefit life insurance policy to Dawson for $35k as part of cross-purchase buy-sell agreement. Dawson and Adam were the only two shareholders of Cupper Corporation and each owned a policy on the other.

    Correct Answer
    A. Adam sold a $100k death benefit life insurance policy to Dawson for $35k as part of cross-purchase buy-sell agreement. Dawson and Adam were the only two shareholders of Cupper Corporation and each owned a policy on the other.
    Explanation
    The death benefit of a life insurance policy would be taxable, partially or wholly, in the situation where Adam sold a $100k death benefit life insurance policy to Dawson for $35k as part of a cross-purchase buy-sell agreement. This is because the policy was sold between shareholders of Cupper Corporation, indicating a business-related transaction. In such cases, the death benefit is considered taxable as it is seen as a part of the business arrangement rather than a personal life insurance policy.

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  • 19. 

    Pamela's dad, Tim, died on August 10 of this year.  Six years ago, Tim had gifted ownership of a paid-up $1MM whole life insurance policy on his life with a replacement value of $150k and an adjusted basis of $100k to Pamela.  If Pamela, as designated beneficiary, receives the death benefit of the life insurance policy this year, how much will be taxable to her?

    • $0

    • $50,000

    • $100,000

    • $1,000,000

    Correct Answer
    A. $0
    Explanation
    Since the ownership of the life insurance policy was gifted to Pamela six years ago, the policy is considered a gift and not taxable to her. Therefore, the death benefit of $1,000,000 will not be taxable to her.

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  • 20. 

    Jerry is the owner, the insured, and the beneficiary of a whole life insurance policy.  Which of the following situations regarding this scenario is incorrect?

    • When Jerry dies, his federal gross estate will include the death benefit of the life insurance policy.

    • When Jerry dies, his probate estate will include the death benefit of the life insurance policy.

    • Jerry's estate will include the death benefit in its taxable income.

    • If Jerry designates a new beneficiary before he dies, and the beneficiary is alive at the tie of Jerry's death, the death benefit will be excluded from his probate estate.

    Correct Answer
    A. Jerry's estate will include the death benefit in its taxable income.
    Explanation
    When Jerry dies, his probate estate will include the death benefit of the life insurance policy. If Jerry designates a new beneficiary before he dies, and the beneficiary is alive at the time of Jerry's death, the death benefit will be excluded from his probate estate. However, Jerry's estate will not include the death benefit in its taxable income. Life insurance death benefits are generally not considered taxable income to the beneficiary.

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  • 21. 

    Which of the following is not a valid settlement option for the designated beneficiary of a life insurance policy?

    • A lump-sum payment of the death benefit.

    • Individual Retirement Account Rollover.

    • Life Annuity

    • Term Annuity.

    Correct Answer
    A. Individual Retirement Account Rollover.
    Explanation
    An individual retirement account (IRA) rollover is not a valid settlement option for the designated beneficiary of a life insurance policy. An IRA rollover involves transferring funds from one retirement account to another, typically from a 401(k) to an IRA. It is not a settlement option for a life insurance policy, which typically offers options such as a lump-sum payment, life annuity, or term annuity to the beneficiary.

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  • 22. 

    Jackie's father died last month and she is the listed beneficiary on his insurance.  Jackie has contacted the insurer and has requested a lump-sum payment of the death benefit of the life insurance policy.  Which of the following statements regarding this lump-sum payment is true?

    • When Jackie receives the lump-sum payment of the death benefit from the insurer, part of the payment will be taxable.

    • Because Jackie has elected a lump-sum payment of the death benefit, she will actually receive a payment less than the face value of the policy.

    • Had Jackie elected the life annuity, each payment would have been excluded from her gross income.

    • Jackie could have elected to leave the death benefit on deposit with the insurer and continue the tax-deferred growth of the policy.

    Correct Answer
    A. When Jackie receives the lump-sum payment of the death benefit from the insurer, part of the payment will be taxable.
    Explanation
    When Jackie receives the lump-sum payment of the death benefit from the insurer, part of the payment will be taxable because life insurance death benefits are generally not taxable, but any interest or earnings on the benefit received as a lump sum may be subject to taxation.

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  • 23. 

    Who has the right to surrender a life insurance policy for its cash surrender value?

    • The insured of the life insurance policy.

    • The owner of the life insurance policy.

    • The beneficiary of the life insurance policy.

    • The insurer of the life insurance policy.

    Correct Answer
    A. The owner of the life insurance policy.
    Explanation
    The owner of the life insurance policy has the right to surrender it for its cash surrender value. This means that the policyholder can choose to terminate the policy and receive the cash value that has accumulated over time. The insured, beneficiary, or insurer do not have the authority to surrender the policy for its cash value.

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  • 24. 

    At age 69, John, a widower, needs more than his pension and Social Security income to pay his living and medical expenses.  His children do not have the resources to help him and he has already liquidated his individual retirement accounts.  Which of the following is true if John decides to surrender his whole life insurance policy to the insurer?

    • John would receive the present value (using the actuarial factors according to John's life expectancy) of the life insurance policy death benefit.

    • Any amount of surrender value paid to John would reduce the death benefit payable to the listed beneficiary of the policy dollar-for-dollar.

    • To surrender the life insurance policy, John must receive the approval of the listed beneficiary of the life insurance policy.

    • The surrender value of the policy would be paid to John and the life insurance contract would be cancelled.

    Correct Answer
    A. The surrender value of the policy would be paid to John and the life insurance contract would be cancelled.
    Explanation
    If John decides to surrender his whole life insurance policy to the insurer, the surrender value of the policy would be paid to him and the life insurance contract would be cancelled. This means that John would receive a lump sum payment from the insurer in exchange for canceling the policy. This would provide John with additional funds that he can use to pay for his living and medical expenses. However, it's important to note that surrendering the policy would mean that John would no longer have life insurance coverage.

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  • 25. 

    Gayle is the owner and insured on a $1MM face value life insurance policy in pay status.  Gayle's adjusted basis in the life insurance contract is $250k.  If Gayle gifts this life insurance policy to her daughter and listed beneficiary, Celeste, which of the following statements is correct?

    • After the date of the gift, any dividends paid on the life insurance policy will be taxable to Gayle.

    • Celeste can amend the beneficiary designation of the life insurance policy to include her son, Matt, as a co-beneficiary.

    • If Celeste dies before Gayle, Celeste's probate estate will include the replacement value of the life insurance policy.

    • If Gayle dies within 3 years of the gift of the life insurance policy to Celeste, the death benefit will be included in Gayle's probate estate.

    Correct Answer
    A. Celeste can amend the beneficiary designation of the life insurance policy to include her son, Matt, as a co-beneficiary.
    Explanation
    When Gayle gifts the life insurance policy to Celeste, Celeste becomes the owner of the policy and has the right to amend the beneficiary designation. Therefore, Celeste can add her son, Matt, as a co-beneficiary to the policy.

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  • 26. 

    The owner of a life insurance policy has decided to surrender the life insurance policy to the insurer.  Since inception of the life insurance contract, the owner has paid premiums of $100,000 and received cash policy dividends equal to $20,000.  If at the surrender date, the owner receives a cash payment of $140,000 from the insurer, what is his gain/loss subject to income tax on the life insurance policy?

    • $0

    • $20,000

    • $40,000

    • $60,000

    Correct Answer
    A. $60,000
    Explanation
    The gain/loss subject to income tax on the life insurance policy is $60,000. This is calculated by subtracting the total amount paid in premiums ($100,000) and the cash policy dividends received ($20,000) from the cash payment received at surrender ($140,000). Therefore, the owner has a gain of $60,000 that is subject to income tax.

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  • 27. 

    Mr. Fahey, age 71, has been paying the premium on a whole life insurance policy for the past 30 years.  The policy has a $1,000,000 death benefit and has built up a cash value of $250,000.  Mr. Fahey's adjusted basis in the life insurance policy is $200,000.  Which of the following statements is not correct?

    • If the insurer pays Mr. Fahey a life insurance policy dividend of $3,000, his adjusted basis in the whole life policy will increase to $203,000.

    • If the insurer pays Mr. Fahey a life insurance policy dividend of $4,000, his adjusted basis in the whole life policy will decrease to $196,000

    • The cash surrender value of Mr. Fahey's whole life insurance policy would be equal to the cash value of the policy less a life insurance policy surrender charge.

    • Mr. Fahey can take a loan from the cash value of the life insurance policy without suffering any income tax consequences.

    Correct Answer
    A. If the insurer pays Mr. Fahey a life insurance policy dividend of $4,000, his adjusted basis in the whole life policy will decrease to $196,000
    Explanation
    If the insurer pays Mr. Fahey a life insurance policy dividend of $4,000, his adjusted basis in the whole life policy will decrease to $196,000. This statement is not correct because the payment of a dividend does not affect the adjusted basis of a life insurance policy. The adjusted basis is determined by the premiums paid, not the dividends received. Therefore, the adjusted basis would remain at $200,000 regardless of the dividend amount.

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  • 28. 

    Which of the following statements is true?

    • Life insurance policy dividends are taxable as dividend income.

    • Life insurance policy dividends kept on deposit with the insurer will generate tax-deferred interest income.

    • If a life insurance policy lapses, any outstanding loans will be required to be repaid to the insurer immediately at the lapse.

    • If a life insurance policy owner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured.

    Correct Answer
    A. If a life insurance policy owner takes a loan from the policy, the death benefit of the policy will be reduced by any outstanding loans plus the accumulated interest due on the loan at the death of the insured.
    Explanation
    When a life insurance policy owner takes a loan from the policy, the death benefit of the policy will be reduced by the amount of the outstanding loan plus the accumulated interest due on the loan at the time of the insured's death. This means that if the insured dies before repaying the loan, the loan amount and any accrued interest will be deducted from the death benefit that is paid out to the beneficiaries.

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  • 29. 

    Warren purchased a single premium life insurance policy on his life 15 years ago for $65,000.  The current value of the policy is $155,000.  Which of the following statements regarding Warren's life insurance policy is true?

    • If Warren takes a loan of $140,000 against the cash surrender value of the life insurance policy, he will have long-term capital gain of $65,000.

    • If Warren takes a loan of $65,000 against the cash surrender value of the life insurance policy, he will not have any capital gain.

    • If Warren takes a loan of $75,000 against the cash surrender value of the life insurance policy, he will recognize $10,000 of long-term capital gain.

    • If Warren takes a loan of $155,000 against the cash surrender value of the life insurance policy, he will recognize $90,000 of long-term capital gain.

    Correct Answer
    A. If Warren takes a loan of $155,000 against the cash surrender value of the life insurance policy, he will recognize $90,000 of long-term capital gain.
    Explanation
    Because Warren's life insurance policy was funded with a single premium payment, the policy is considered a modified endowment contract (MEC). Any loan from a MEC is considered capital gain to the extent there is any gain in the contract. Therefore, answer D is correct because Warren takes a $155,000 loan from the contract and has $90,000 ($155,000 - $65,000) of capital gain. Warren must recognize capital gain to the extent of the capital gain inherent in the policy before receiving a return of capital. In this answer B, Warren would recognize $65,000 of capital gain if he took a loan of $65,000.

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  • 30. 

    Twelve years ago, Paul purchased a single premium $1,000,000 life insurance policy on his own life for $150,000 and named his daughter as the sole beneficiary.  Paul gifted ownership of the policy to Holly this year when the value of the life insurance policy was $200k.  Paul paid $15k of gift tax on the transaction.  At Paul's death, how much of the death benefit that Holly receives will be subject to income tax.

    • $0

    • $785,000

    • $800,000

    • $1,000,000

    Correct Answer
    A. $0
    Explanation
    When Paul gifted ownership of the life insurance policy to Holly, it was considered a gift and not a sale. Therefore, Holly will not have to pay income tax on the death benefit she receives. The value of the policy at the time of Paul's death does not affect the taxability of the death benefit. Since Paul paid gift tax on the transaction, there will be no additional income tax on the death benefit. Hence, the correct answer is $0.

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  • 31. 

    The owner of a whole life insurance policy would like to exchange his life insurance policy for any annuity on his life.  Currently, the value of the life insurance policy is $150,000 excluding a $50,000 loan the owner has against the life insurance policy, and the owner's adjusted basis in the policy is $65,000.  Which of the following statements is true?

    • If the owner exchanges the life insurance policy for an annuity, the owner must recognize a $135k capital gain on the exchange.

    • The owner's basis in the annuity after the exchange will be $115,000.

    • The exchange will be considered a transfer for valuable consideration.

    • If the annuity has a death benefit, the beneficiary will have to include the death benefit in her taxable income at the owner's death.

    Correct Answer
    A. The owner's basis in the annuity after the exchange will be $115,000.
    Explanation
    The correct answer is B. In an exchange of a life insurance policy for an annuity, the owner of the life insurance policy must recognize gain to the extent he receives boot in the exchange. Outstanding loans against the life insurance policy are considered boot. In this problem, the owner has potential gain of $135,000 ($150,000 + $50,000 - $65,000), and must recognize gain to the extent he had a loan outstanding, or $50,000. Normally, the owner's adjusted basis in the life insurance policy will be carried over to the annuity, but if the owner recognizes any gain on the exchange or pays additional expenses, he will increase his adjusted basis in the annuity by the gain recognized or the expenses paid. Because the owner had to recognize gain on the loan, he will increase his adjusted basis by this recognized gain of $50,000. After the exchange, the owner's adjusted basis in the annuity if $115,000, the adjusted basis in the life insurance policy increased by the amount of gain recognized on the transaction ($65,000 + $50,000). This answer is incorrect as an exchange is not considered a transfer for valuable consideration.

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  • 32. 

    Sally was recently diagnosed with stage four lung cancer.  Her doctors have given her 9 months to live.  She has many medical expenses and needs money.  If Sally sells a whole life insurance policy, with a $1MM face value and a $250k adjusted basis to a viatical settlement provider for $350,000, how much capital gain will Sally have to recognize for income tax purposes on the sale?

    • $0

    • $250,000

    • $350,000

    • $1,000,000

    Correct Answer
    A. $0
    Explanation
    When Sally sells a whole life insurance policy to a viatical settlement provider, the amount she receives is considered a return of her investment in the policy, rather than a capital gain. Therefore, she does not have to recognize any capital gain for income tax purposes on the sale.

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  • 33. 

    In an attempt to exclude the death benefit of a paid up $500k face value whole life insurance policy from his gross estate, Jerry gifted the policy to his daughter.  Six months prior to the gift, Jerry had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor.  What is the gift tax value of the gift of this policy?

    • The replacement cost of the life insurance policy.

    • The life insurance policy's interpolated terminal reserve plus any unearned premium.

    • $500,000 discounted for Jerry's six month life expectancy.

    • The cash surrender value of the life insurance policy.

    Correct Answer
    A. $500,000 discounted for Jerry's six month life expectancy.
    Explanation
    The gift tax value of the gift of this policy is $500,000 discounted for Jerry's six month life expectancy. This means that the value of the gift is determined by discounting the face value of the policy to account for Jerry's shortened life expectancy. This is because the gift tax value is based on the economic value of the gift at the time it is made. Since Jerry is expected to pass away within a year, the value of the policy is reduced to reflect this.

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  • 34. 

    In an attempt to exclude the death benefit of a paid up $500k face value whole life insurance policy from his gross estate, Jerry gifted the policy to his daughter.  Six months prior to the gift, Jerry had been diagnosed with a terminal illness and given a 12 month life expectancy by his doctor.  Jerry died 4 years after the gift of the life insurance policy.  What amount is included in his federal gross estate related to this whole life insurance policy?

    • $0

    • $250,000

    • $500,000

    • $500,000 discounted for Jerry's six months life expectancy.

    Correct Answer
    A. $0
    Explanation
    When Jerry gifted the whole life insurance policy to his daughter, he effectively transferred ownership and control of the policy. As a result, the policy is no longer considered part of Jerry's estate and therefore, $0 is included in his federal gross estate related to this whole life insurance policy.

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  • 35. 

    Which of the following is not considered an incident of ownership?

    • The right to change the beneficiary of a life insurance policy.

    • The insured making cash gifts to the owners of the life insurance policy of the premium amount.

    • The right to take loans against the cash value of the life insurance policy.

    • A provision in an ILIT that directs the trust to pay the federal estate taxes of the insured.

    Correct Answer
    A. The insured making cash gifts to the owners of the life insurance policy of the premium amount.

Quiz Review Timeline (Updated): Mar 19, 2023 +

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

  • Current Version
  • Mar 19, 2023
    Quiz Edited by
    ProProfs Editorial Team
  • Apr 13, 2015
    Quiz Created by
    Ddeckert

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