Chapter 6 Review Questions

Under the general tax rules that apply to life insurance all of the following are true EXCEPT:

a.  beneficiaries need not pay income taxes on death benefits
*b.  a policy owned by the insured at the time of death will not be included in insured's taxable estate
c.  a policy loan secured by the policy is not subject to income taxation
d.  if a policy is surrendered, the cash value in excess of the policyholder's cost basis is taxable as ordinary income

In order to receive lifetime settlement proceeds totally tax-free, the insured must be:

*a. diagnosed with a terminal illness and have a life expectancy of 24 months or less
b.  diagnosed with a chronic illness that limits at least two "activities of daily live"
c.  an individual, not a corporation
d.  all of the above


Those diagnosed as chronically ill under HIPAA receive lifetime settlement proceeds tax-free:

a.  if the proceeds are used for long-term care costs
b.  up to an inflation-adjusted limit if not used for long-term care costs
c.  only if the settlement company is licensed by the state in which the viator resides
*d.  all of the above are true
In a senior settlement (i.e., the viator is not terminally or chronically ill) which of the following is true?

*a.  any proceeds that represent the viator's cost basis are received free of income tax
b.  any proceeds in excess of the viator's cost basis are subject to tax as ordinary income
c.  any proceeds in excess of the viator's cost basis are subject to tax as capital gains
d.  all of the above are true

Which of the following amounts received in a senior settlment are subject to income taxes under the capital gains rule?

a.  all proceeds received under a senior settlement
b.  any proceeds in excess of the viator's cost basis
*c.  any proceeds in excess of the policy's cash value
d.  none of the above are true


A viator owns a $500,000 whole life insurance policy with a cost basis of $17,500.  The policy's cash value is $65,000.  If the viator sold the policy for $150,000, the tax consequence is:

a.  $17,500 received tax free
b.  $85,000 subject to capital gains tax
c.  $47,500 subject to taxation as ordinary income
*d.  dependent on the insured's life expectancy  


A business owns a $2 million key-employee policy on an executive who is about to retire.  The company has a paid $23,000 in premiums on the convertible term policy.  If business sells the policy for $400,000 which of the following is/are true?

a.  the business owes taxes on a $377,000 capital gain
b.  the tax status depends on the age, life expectancy of the executive  
c.  the tax status depends on whether the executive is diagnosed as terminally ill
d.  there is not enough information to answer this question   

Which of the following is true regarding estate taxation of policies sold in a viatical settlement?

*a.  the sale of the policy effectively removes it from the insured's estate
b.  the sale of the policy will remove the policy from the insured's estate if the sale took place more than three years prior to the insured's death
c.  all policies sold in a viatical settlement are added back to the insured's estate for estate tax purposed
d.  none of the above are true

The president of a closely-held business is diagnosed with terminal cancer and is not expected to live more than a year.  The business owns a $3 million key-person policy. The company has paid premiums of $75,000, and the policy has a cash value of $125,000.  The company sells the policy for $2.5 million and uses part of the funds as a signing bonus to attract a replacement executive.  Which of the following is true regarding this viatical settlement?

a. the entire proceeds are received income tax free
b. some of the proceeds are tax-free, some are taxed as capital gains
c. some of the proceeds are taxed as ordinary income, some as capital gains
*d. some of the proceeds are tax-free, some are taxed as ordinary income, some as capital gains

A viator owns a $500,000 whole life insurance policy with a cost basis of $17,500.  The policy's cash value is $65,000.  If the viator sold the policy in a senior settlement for $150,000, the tax consequence is:

a.  $17,500 received tax free
b.  $85,000 subject to capital gains tax
c.  $47,500 subject to taxation as ordinary income
*d. all of the above