CEA Life Insurance & Estate Liquidity 5 — Questions and Answers
Question 1: The primary advantage of a life insurance policy loan compared to surrendering the policy for cash is:
- Loan proceeds are taxable income while surrender proceeds are not
- The policy remains in force and the death benefit is preserved (Correct answer)
- Loan repayment is required within 12 months by law
- The loan creates a step-up in basis for the cash value
Correct answer: The policy remains in force and the death benefit is preserved
Policy loans allow the owner to access cash value while keeping the policy in force, preserving the death benefit for estate liquidity purposes.
Question 2: In community property states, which portion of a life insurance policy purchased with community funds is generally includable in the deceased spouse's gross estate?
- The full face value of the policy
- None, because community property passes automatically to the survivor
- One-half of the policy value (Correct answer)
- The entire cash value but not the death benefit
Correct answer: One-half of the policy value
Because community property is owned 50/50, only half the policy's value is attributed to the deceased spouse's estate.
Question 3: A Modified Endowment Contract (MEC) is created when a life insurance policy fails the:
- IRC §7702 cash value accumulation test
- Seven-pay test under IRC §7702A (Correct answer)
- Transfer-for-value rule
- Economic benefit test for split-dollar arrangements
Correct answer: Seven-pay test under IRC §7702A
A policy becomes an MEC if cumulative premiums paid in the first seven years exceed what would fund the policy on a seven-pay basis, triggering LIFO tax treatment on distributions.
Question 4: Which of the following correctly describes the 'waiver of premium' rider in the context of estate liquidity planning?
- It waives estate taxes on insurance proceeds at death
- It keeps the policy in force without premium payments if the insured becomes totally disabled (Correct answer)
- It allows the beneficiary to waive receipt of proceeds and redirect them to charity
- It eliminates the need for Crummey notices in an ILIT
Correct answer: It keeps the policy in force without premium payments if the insured becomes totally disabled
The waiver of premium rider ensures that disability does not cause a policy lapse, protecting the estate's expected liquidity from the death benefit.
Question 5: For estate tax purposes, life insurance payable to a named beneficiary (not the estate) is included in the decedent's gross estate if the decedent:
- Paid all the premiums personally
- Possessed any incident of ownership at death (Correct answer)
- Purchased the policy more than three years before death
- Named a revocable beneficiary rather than irrevocable
Correct answer: Possessed any incident of ownership at death
IRC §2042 includes life insurance in the gross estate if the decedent held any incident of ownership at the moment of death, regardless of beneficiary designation.
Question 6: A business uses a 'key-person' life insurance policy primarily to:
- Provide a tax-deductible executive benefit
- Protect the business against financial loss from the death of a critical employee (Correct answer)
- Fund the employee's retirement at a preferential tax rate
- Create an obligation for the employee not to compete
Correct answer: Protect the business against financial loss from the death of a critical employee
Key-person insurance indemnifies the business for lost revenue, recruitment costs, and operational disruption caused by the death of an indispensable employee.
Question 7: An estate planner recommends a 'life insurance retirement plan' (LIRP) using an overfunded permanent policy. The primary tax advantage is that:
- Premiums are deductible as a business expense
- Policy loans and withdrawals up to basis can provide income-tax-free retirement income if the policy stays in force (Correct answer)
- Death benefits are subject to capital gains tax instead of income tax
- The policy's investment gains are taxed at qualified dividend rates
Correct answer: Policy loans and withdrawals up to basis can provide income-tax-free retirement income if the policy stays in force
When a permanent policy is kept in force until death, loans against its cash value can be repaid by the income-tax-free death benefit, effectively providing tax-free retirement income.
CEA Life Insurance & Estate Liquidity 5
The primary advantage of a life insurance policy loan compared to surrendering the policy for cash is: