CEA Life Insurance & Estate Liquidity 4 — Questions and Answers
Question 1: Variable life insurance differs from whole life insurance primarily because:
- It has no cash value accumulation
- The death benefit and cash value fluctuate based on separate account investment performance (Correct answer)
- Premiums are guaranteed never to increase
- It can only be purchased through employer groups
Correct answer: The death benefit and cash value fluctuate based on separate account investment performance
Variable life ties cash value and potentially the death benefit to investment sub-accounts chosen by the policyholder, introducing market risk.
Question 2: When computing the includable amount of a life insurance policy in a decedent's gross estate where the decedent held 'incidents of ownership,' the value used is typically the:
- Net premium reserve (interpolated terminal reserve) plus unearned premiums (Correct answer)
- Face amount of the policy only
- Cash surrender value at date of death
- Original premium paid by the decedent
Correct answer: Net premium reserve (interpolated terminal reserve) plus unearned premiums
For estate tax valuation of policies on someone else's life, the IRS uses the interpolated terminal reserve plus unearned premiums as the policy's fair market value.
Question 3: A charitable remainder trust (CRT) combined with life insurance is sometimes called a 'wealth replacement trust' because the life insurance is used to:
- Provide income to the charity during the donor's lifetime
- Replace the value of assets donated to the CRT for the donor's heirs (Correct answer)
- Fund the annuity payments from the CRT
- Pay the income tax on the CRT's investment gains
Correct answer: Replace the value of assets donated to the CRT for the donor's heirs
Heirs lose the donated assets to charity at the CRT's termination, so life insurance on the donor is purchased (often in an ILIT) to restore that wealth for beneficiaries.
Question 4: Which of the following is NOT an 'incident of ownership' that would cause life insurance to be included in the insured's gross estate?
- Right to change the beneficiary
- Right to surrender the policy for cash
- Right to assign the policy
- Being named as the policy's contingent beneficiary (Correct answer)
Correct answer: Being named as the policy's contingent beneficiary
Being a contingent beneficiary is not an incident of ownership; incidents of ownership include control rights over the policy itself, not just receiving benefits.
Question 5: A key purpose of using life insurance in an estate freeze strategy is to:
- Convert appreciated assets to cash without capital gains tax
- Fund the estate tax liability that arises from assets transferred at a frozen value (Correct answer)
- Increase the value of the taxable estate for step-up in basis purposes
- Satisfy required minimum distribution rules for IRAs
Correct answer: Fund the estate tax liability that arises from assets transferred at a frozen value
Estate freeze techniques (GRATs, SCINs, installment sales) shift appreciation but may leave an estate tax liability; life insurance provides funds to pay that tax.
Question 6: Under IRC §7702, a life insurance contract must satisfy either the cash value accumulation test or the guideline premium test to:
- Qualify for the annual gift tax exclusion
- Receive favorable income tax treatment as life insurance (Correct answer)
- Be eligible for a deduction as a business expense
- Avoid the transfer-for-value rule
Correct answer: Receive favorable income tax treatment as life insurance
IRC §7702 defines what qualifies as life insurance for federal tax purposes, ensuring policies aren't primarily investment vehicles.
Question 7: A self-canceling installment note (SCIN) in an estate plan often uses life insurance because the note:
- Requires insurance as collateral for the lender
- Cancels at the seller's death, potentially creating income tax for the buyer, while insurance provides liquidity to cover it (Correct answer)
- Is backed by a life insurance policy's cash value as the payment source
- Converts to a gift upon death, triggering gift tax that insurance must cover
Correct answer: Cancels at the seller's death, potentially creating income tax for the buyer, while insurance provides liquidity to cover it
When a SCIN cancels at death, the forgiven balance may generate taxable income for the buyer-heir; life insurance can fund this unexpected tax burden.
CEA Life Insurance & Estate Liquidity 4
Variable life insurance differs from whole life insurance primarily because: