1. ©2014, College for Financial Planning, all rights reserved. Session 11 Taxation of Life Insurance, Disability Insurance, and Annuities CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning

2. Session Details Module6 Chapter(s)1 and 2 LOs6-1 Identify characteristics of a form of cash value life insurance policy. 6-2 Analyze a situation to identify an income tax implication of an insurance policy. 6-3 Identify characteristics of a form of annuity contract. 6-4 Analyze a situation to identify an income tax implication of a commercial annuity. 11-2

3. Payouts from Life Insurance 11-3 PayoutImplication Lump-sum payment of surrender value before insured’s death To extent that surrender value exceeds insured’s cost, taxable as ordinary income in year received Installment payments of surrender value before insured’s death Insured’s cost prorated over installment period, with amounts received in excess of cost taxable as ordinary income

4. Payouts from Life Insurance PayoutImplication Lump-sum payment of policy proceeds to beneficiary upon insured’s death Exempt from income tax Settlement option payments of policy proceeds to beneficiary upon insured’s death May be partially taxable when paid or credited to beneficiary (annuity treatment) 11-4

5. Modified Endowment Contract MEC Rules Life insurance contract o meets state law definition o meets IRC definition o issued on or after June 21, 1988 o fails to meet the 7-pay test Distributions treated on LIFO basis o withdrawals o loans o dividends received as cash or used to pay a loan 10% penalty tax on taxable portion 11-5

6. Disability Insurance Benefits If employer paid—benefits fully taxable If employee paid—benefits fully excluded If employer & employee paid— benefits partially taxable If taxable—benefits subject to FICA and FUTA for first 6 months 11-6

7. Annuity Contracts Fixed Annuity: Fixed annuity payment guaranteed upon payment of level or flexible premiums Variable Annuity: Amount of annuity payment varies according to investment performance of underlying assets Deferred Annuity: Annuitant pays now for future fixed or variable payments Accumulation of Earnings: Grows on a tax- deferred basis 11-7

8. Commercial Annuities Nonperiodic distributions Post-August 13, 1982, Contract: Fully taxable interest to the extent that cash surrender value of contract exceeds the investment (LIFO) Pre-August 14, 1982, Contract: Nontaxable premium dollars treated as first distributed (FIFO) Distribution prior to age 59½ Inclusion of taxable amount as ordinary income 10% premature withdrawal penalty on taxable portion of withdrawal 11-8

9. Annuitized Distributions Fixed Annuity—Exclusion ratio Variable Annuity—Amount excluded 11-9 If annuity start date before 1987, exclusion applies to ALL payments received. Partial annuitization allowed—after 2010

10. Review Question 1 Which one of the following is not a test that must be met in order for a product to be defined as life insurance for federal income tax purposes? a.the cash value accumulation test b.the cash guideline premium test and corridor test c.the premium value test 11-10

11. Review Question 2 Which one of the following does not correctly state a characteristic of a commercial annuity? a.With an annuity, there is a maximum annual contribution per year, which is adjusted yearly for inflation. b.An annuity is a contract in which investments are made in exchange for a promise of regular frequent payments for the rest of a taxpayer’s life or a fixed period of time. c.Annuity contracts may vary regarding the payment time period and the frequency of the payments. d.An annuity payment is generally part return of capital and part interest payment. 11-11

12. Review Question 3 Which one of the following statements is true regarding non- periodic distributions from an annuity contract prior to the annuity start date, issued after August 13, 1982? a.A non-periodic distribution is first considered a tax-free return of principal and then a taxable interest payment. b.A non-periodic distribution is prorated equally between a tax-free return of principal and a taxable interest payment. c.A non-periodic distribution is taxed under the exclusion ratio rules. d.A non-periodic distribution is taxed first as a taxable interest payment until the interest payments are completely exhausted and then as a tax-free return of principal. 11-12

13. Review Question 4 Which one of the following statements correctly describes the method for calculating the exclusion amount for variable annuity payments? a.The investment in the annuity contract is divided by the number of expected payments. b.The number of expected payments is divided by the investment in the annuity contract. c.The total expected return is divided by the investment in the annuity contract. d.The investment in the annuity contract is divided by the total expected return. 11-13

14. Review Question 5 Derrick Johnson is about to begin receiving payments from a deferred fixed annuity that he purchased many years ago. His investment in the annuity contract was $40,500. He is to receive $300 per month for the rest of his life. His current life expectancy, based on IRS tables, is 15 years. What amount, if any, of each monthly payment is taxable to Derrick? a.$0 b.$75 c.$100 d.$225 e.$300 11-14

15. ©2014, College for Financial Planning, all rights reserved. Session 11 End of Slides CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning