RFC Insurance, Risk Management & Taxation 3 — Questions and Answers
Question 1: Which type of disability insurance provision allows the insured to increase coverage without evidence of insurability as income rises?
- Residual disability rider
- Cost-of-living adjustment rider
- Guaranteed insurability rider (Correct answer)
- Own-occupation definition
Correct answer: Guaranteed insurability rider
A guaranteed insurability rider allows the insured to purchase additional disability coverage at specified intervals without undergoing medical underwriting.
Question 2: A married couple files a joint return. Under the capital gains exclusion for a primary residence, how much gain can they exclude upon sale of their home?
- $250,000
- $500,000 (Correct answer)
- $750,000
- No exclusion applies to married couples
Correct answer: $500,000
Under IRC Section 121, married couples filing jointly can exclude up to $500,000 of gain from the sale of a primary residence if they meet the ownership and use tests.
Question 3: What is the primary purpose of an irrevocable life insurance trust (ILIT)?
- To allow the grantor to access policy cash values tax-free
- To keep life insurance proceeds out of the grantor's taxable estate (Correct answer)
- To convert term insurance into permanent coverage
- To provide asset protection from business creditors
Correct answer: To keep life insurance proceeds out of the grantor's taxable estate
An ILIT is designed to own life insurance policies so that death benefits are excluded from the grantor's gross estate, reducing potential estate taxes.
Question 4: Under the risk management process, which step involves quantifying the potential financial impact of identified risks?
- Risk identification
- Risk analysis (Correct answer)
- Risk control
- Risk financing
Correct answer: Risk analysis
Risk analysis (or risk evaluation) involves assessing the frequency and severity of potential losses to quantify their financial impact.
Question 5: A client pays $3,000 in long-term care insurance premiums. Which statement is correct regarding the tax deductibility of these premiums?
- They are fully deductible as a medical expense without limitation
- They are deductible as a medical expense up to age-based limits set by the IRS (Correct answer)
- They are deductible only if the policy is employer-sponsored
- Long-term care premiums are never tax deductible
Correct answer: They are deductible as a medical expense up to age-based limits set by the IRS
Premiums for qualified long-term care insurance are deductible as medical expenses subject to age-based limits that are annually adjusted by the IRS.
Question 6: Which of the following is an example of risk retention?
- Purchasing an umbrella liability policy
- Establishing a self-insured retention fund (Correct answer)
- Transferring operational risk to a contractor
- Buying reinsurance on a commercial policy
Correct answer: Establishing a self-insured retention fund
Risk retention occurs when an individual or organization intentionally sets aside funds to cover potential losses rather than transferring the risk to an insurer.
Question 7: For federal income tax purposes, the inside buildup of cash value in a life insurance policy is:
- Taxed annually as ordinary income
- Tax-deferred until the policy is surrendered or lapses (Correct answer)
- Always tax-free regardless of how the policy terminates
- Subject to a 3.8% net investment income surtax each year
Correct answer: Tax-deferred until the policy is surrendered or lapses
The growth of cash value inside a life insurance policy accumulates tax-deferred, meaning no income tax is owed until the policy is surrendered or distributed.
RFC Insurance, Risk Management & Taxation 3
Which type of disability insurance provision allows the insured to increase coverage without evidence of insurability as income rises?