Federal Tax Considerations for Life Insurance & Annuities

Flashcards covering vocabulary terms related to federal tax considerations for life insurance and annuities.

Earned income

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

Gross income

A person's income before taxes or other deductions.

FIFO (First In, First Out)

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

LIFO (Last In, First Out)

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.

Nonprofit organization

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

Policy endowment

Maturity date.

Policy proceeds

In life insurance, the death benefit.

Pretax contribution

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

Rollover

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

Surrender

Early termination of a policy by the policyowner.

Tax deductible

A reduction of taxable income, resulting in lower tax liability.

Taxable

Subject to taxation, payable to state and federal government.

Tax deferred

Taxes on investments or gains (such as interest or dividends) are paid at a future date instead of in the period in which they are incurred tax.

Vesting

The right of a participant in a retirement plan to retain part or all of the benefits.

Qualified Plans

An employer-sponsored retirement plan approved by the IRS, offering benefits like deductible contributions and tax-deferred growth.

traditional IRA

Allows individuals with earned income to make tax deductible contributions regardless of age.

Roth IRA

A form of an individual retirement account funded with after-tax contributions.

Profit-sharing plans

Qualified plans where a portion of the company's profit is contributed to the plan and shared with employees.

401(k)

Qualified retirement plan allows employees to take a reduction in their current salaries by deferring amounts into a retirement plan.

403(b) plan

Qualified plan available to employees of certain nonprofit organizations and public-school systems.

Rollover

A tax-free distribution of cash from one retirement plan to another.

Transfer

A tax-free transfer of funds from one retirement program to a traditional IRA or a transfer of interest in a traditional IRA from one trustee directly to another.

MEC (Modified Endowment Contract)

An overfunded life insurance policy = failed the 7-pay test.

7-pay Test

Established by the IRS to determine if an insurance policy is overfunded.

What are some examples of qualified plans? (5)

-IRA -401K -HR-10 (Keogh) -SEP -SIMPLE

Who qualifies for tax sheltered annuities or 403(b) plans? (2)

1. nonprofits under Sec 501c(3)

2. employees of public school systems

What is required to qualify an individual to contribute to a traditional IRA?

Earned income

For a retirement plan to be qualified, it must be designed for whose benefit?

the employees

If a retirement plan is qualified, what does that mean?

The plan has favorable treatment

Why are dividends in life insurance policies not taxable?

Not considered income and area return of unused premium

What is the penalty for excessive contributions to a traditional IRA?

6%

What qualified plan is suitable for the self-employed?

HR-10/Keogh

What is the primary purpose of a 401K plan?

Provide retirement income

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

No

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

The portion that exceeds the total premiums paid.

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

Cash value growth is tax deferred

An employer is sponsoring a qualified retirement plan for its employees where the employer contributes money whenever the business has profit. What is this type of plan called?

Profit-sharing plan.

In qualified plans, are employer contributions taxed as income to the employees?

No

What type of a plan is a 401K?

Qualified profit sharing plan

In what form of payment must the contributions to a tradional IRA be made?

In cash

What are the consequences of withdrawing funds from traditional IRA prior to the age of 59 1/2?

10% penalty

SIMPLE plans are available to groups of how many employees?

No more than 100

What portion of a nonqualified annuity payment would be taxed?

Interest owned on principal

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

To determine whether a life insurance policy is classified as a modified endowment contract (MEC).

What are the income tax benefits of a qualified plan? (3)

1. Employer contributions are tax deductible

2. Not taxed as income to the employee

3. The earnings accumulate tax deferred

What is the name for an overfunded life insurance policy?

Modified Endowment Contract (MEC)

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?

Only the interest portion is taxable.

What is the rollover mandatory rate?

20%

Death benefits payable to a beneficiary under a life insurance policy are generally not what?

subject to income tax by the federal govt

Life insurance death proceeds are?

generally not taxed as income

If taken as a lump sum, life insurance proceeds to beneficiaries are passed?

Free of federal income taxation