Individual Life Insurance Planning Flashcards

When a life insurance policy lapses and the policyowner selects the extended term nonforfeiture option, the result is:

Answer: A term policy for the original face amount for a period supported by the cash value

Extended term uses the cash value as a single premium to purchase term insurance for the original face amount, extended for as long as the cash value supports.

Which of the following is an advantage of using life insurance cash value for retirement supplementation compared to a traditional IRA?

Answer: Policy loans from life insurance are generally income-tax-free

Policy loans from a properly structured life insurance contract are generally income-tax-free, whereas IRA withdrawals are typically taxable as ordinary income.

Under the IRC Section 7702 definition of life insurance, what is the consequence of a policy becoming a Modified Endowment Contract (MEC)?

Answer: Loans and withdrawals become subject to income tax and a 10% penalty if taken before age 59½

A MEC is still life insurance, but distributions (loans and withdrawals) are treated as income-first (LIFO) and subject to a 10% penalty if taken before age 59½.

A client names a minor child as sole beneficiary of a life insurance policy. What problem may arise at claim time?

Answer: A court-appointed guardian may be required to manage the funds until the child reaches majority

Minors cannot legally receive large sums directly, so a court-appointed guardian or custodian is typically required to manage the proceeds, which can be costly and slow.

The concept of 'insurable interest' in life insurance requires that the policyowner:

Answer: Must have a financial or emotional stake in the continued life of the insured at policy inception

Insurable interest (a financial, business, or close personal relationship) must exist at policy inception; it is not required to continue until the insured's death.

Which type of life insurance is most suitable for covering a 15-year mortgage obligation if the primary concern is minimum cost?

Answer: Decreasing term insurance

Decreasing term insurance provides a death benefit that declines over time, mirroring an amortizing mortgage balance, at a lower cost than level-premium alternatives.

A client insists on being the owner, insured, AND naming their estate as beneficiary. What estate planning risk does this create?

Answer: The death benefit will be included in the insured's gross estate for federal estate tax purposes

When the insured holds incidents of ownership, the death benefit is includable in the gross estate under IRC §2042, potentially triggering federal estate taxes.