Advanced Underwriting Consultants

Ask the Experts – August 5, 2015

Question:  If a business transfers a life insurance policy insuring the life of an employee to the employee are there any tax consequences?

Answer:  Yes.

When a business transfers a life insurance policy to an employee without consideration the value of the policy is taxable to the employee as compensation. For transfers after February 2004, the Treasury Regulations generally treat the policy’s gross cash value as the income tax value of the compensation.

Where the employee is a stockholder of the corporation, the value of the policy may be treated as a dividend if the exchange was part of a stock redemption plan.

On the other hand, if an employer transfers a policy to an employee or shareholder, if the employee’s or shareholder’s rights in the life policy are subject to a risk of forfeiture, the full value of the policy is not taxable until the employee’s rights become substantially vested.

Ask the Experts – July 20, 2015

Question:  If my client receives Social Security survivor benefits from her deceased spouse and then gets re-married, is she still eligible for the survivor benefits?

Answer:  It depends.

If your client re-marries before age 60, she cannot receive survivor benefits as a surviving spouse while married. If, however, remarriage occurs after age 60, the client will continue to qualify for benefits on her deceased spouse’s Social Security record.

If the client re-marries after 60 and stays married long enough to become eligible for spousal benefits, she may be eligible for three types of benefits: one based on the deceased spouse’s record, another based on the new spouse’s record and the third based on her own record. While she may be eligible for three different types of benefits, the Social Security Administration will generally pay ONLY whichever benefit is the highest.

Your client may be able to collect a certain type of benefit now and then switch to a higher benefit later.

Ask the Experts – July 2, 2015

Question:  My client has an IRA with substantially equal periodic payments set up in order to avoid the additional tax on early distributions.  Can she roll out part of the funds in the IRA if they are not needed to satisfy the SEPP requirements?

Answer:   No.

As we discussed in the preceding question and answer, substantially equal periodic payments can be established as a way to avoid the additional 10% tax on distributions from a qualified account if money is needed before a person reaches 59 ½. A person who has established a SEPP plan cannot modify the payments or the account. If a modification occurs, the IRS will go back and retroactively apply the additional 10% penalty tax on all of the distributions that have been made  from the account pre 59 ½. The IRS however allows for a modification or termination of the SEPP plan when the owner reaches the age 59 ½ or has taken the SEPP distributions for 5 years, whichever is longer.

If a person tries to roll over part of the money in an account being used for SEPP distributions, the IRS will consider the SEPP plan busted. The IRS will apply the additional 10% tax to all of the prior distributions taken to that point.

Ask the Experts – May 21, 2015

Question:  If my client makes a transfer of his life insurance policy to his daughter, does that violate the transfer for value rule?

Answer:  Probably not, so long as the transfer is made by gift.

Internal Revenue Code Section 101(a) says that life insurance death proceeds are usually income tax free.  Subsection (2) of that Code Section says that there are certain circumstances under which it is possible for the death benefit to become income taxable.  The circumstances arise when a policy is transferred for valuable consideration to anyone except:

  • The insured
  • A partner of the insured
  • A partnership that includes the insured as a partner
  • A corporation of which the insured is an officer or shareholder.

In this case, the transfer is from the insured to his daughter.  Since the daughter is not an exempt transferee according to the preceding list, we should rightly be worried about the transfer for value rule.

If the client in this case receives anything of value in return from his daughter for making the policy transfer to her, it will be a transfer for value—and the death proceeds of the life insurance policy paid to her will be subject to income taxes.  On the other hand, if the client makes a gift of the policy to the daughter, the transfer is not “for value” and thus the death benefit will still be income tax free.

Ask the Experts – March 24, 2015

Question: Does a divorce nullify my client’s ex-spouse as a life insurance beneficiary?

Answer: It depends on the relevant state’s laws.

Several states have enacted legislation that works to effectively nullify an ex-spouse as a primary beneficiary for an insurance policy. One of these states is the State of Florida. In 2012 the state passed F.S. 732.703 which voids the designation of a former spouse as a beneficiary of an interest in an asset that will be transferred or paid upon the death of the decedent if:

  • The decedent’s marriage was judicially dissolved or declared invalid before the decedent’s death and
  • The designation was made before the dissolution or order invalidating the marriage.

If this law applies the asset will pass as if the former spouse predeceased the decedent. This can create a number of consequences. If there is a contingent beneficiary named then the asset will go to the contingent beneficiary. If there is no contingent beneficiary, the asset will likely end up as part of the decedent’s probate estate.  Probate assets are subject to the probate process, and therefore become potentially accessible by the decedent’s creditors. The probate process also tends to be long and drawn out, which delays the beneficiary’s ability to access the asset as well.  Your client may want the ex-spouse to remain the beneficiary despite the divorce. These laws would frustrate that desire. An individual could affirm the beneficiary designation after divorce in order to name that ex-spouse as beneficiary.

For these reasons it is important for financial professionals to stay in contact with clients and remain up to date on their life situations. A check on clients’ current life circumstances might save a lot of headaches later as well as present the opportunity to address clients’ changing needs.

Ask the Experts – March 10, 2015

Question: I have a client turning 70 ½ this year in 2015. I know she is still eligible to contribute to a Traditional IRA for 2014, but not for 2015. If she opens a new IRA and contributes $6,500 for 2014, will she have to take a required minimum distribution for 2015 from that account?

Answer:  No

IRS Publication 590 Individual Retirement Arrangements clarifies that an individual can make contributions to their IRA for a given year until the due date for filing their tax return for that year, not including extensions. In other words an individual generally has until April 15, 2015 to make a contribution to their IRA for 2014.

Publication 590 also gives us the rules for determining when required minimum distributions must start and how to calculate them. An individual must receive at least a minimum amount from their IRA beginning with the year they turn 70 ½. In order to figure the amount for the required minimum distribution, the account balance as of December 31 for the preceding year is divided by the applicable distribution period or life expectancy factor for the individual.

In this case the individual client made the initial contribution in 2015 for year 2014. Since the account was opened in 2015, there is no account balance as of December 31 2014. Because there is a zero account balance as of December 31, 2014 there is no required minimum distribution due for 2015 from this account. The client will have to take required minimum distributions from this account in 2016 and for the following years.

Ask the Experts – July 21, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: I have a client whose son will be applying for financial aid as a college student soon. Does life insurance owned by my clients (the parents) count against him when determining his eligibility for financial aid?

Answer: No. When applying for financial aid, they will need to fill out a FAFSA. On the FAFSA, the parents and the student are required to list their investments, which will be taken into account in determining the student’s eligibility for financial aid. The instructions on the FAFSA provide the following:

Investments do not include the home you live in, the value of life insurance, retirement plans (401(k) plans, pension funds, annuities, non-educational IRAs, Keogh plans, etc.) or cash, savings and checking accounts already reported in questions 41 and 90.

Emphasis added. Therefore, purchasing life insurance, like contributing to a retirement plan, may be an effective way to minimize your client’s investments for student loan eligibility purposes.

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Ask the Experts – July 14, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: If my client is going through bankruptcy and receives a life insurance death benefit from on his father’s life during the proceeding, will the death benefits be protected from creditors?

Answer: It depends on the state. In bankruptcy, the debtor is able to exclude certain assets from his bankruptcy estate (referred to as exemptions). While the bankruptcy code sets forth the federal bankruptcy exemptions, Congress has given the states the choice to create their own exemptions that the state can either require residents to use, or allow residents to use (with the option to instead choose the federal exemptions).

Currently, every state has created its own set of asset protection laws, and 19 states and the District of Columbia have given their residents a choice between the state exemptions and the federal exemptions.

The federal government doesn’t protect the death benefits a debtor receives as a beneficiary unless the debtor is a dependent of the insured, and then they are protected only to the extent necessary for support of the debtor.

For example, consider the recent bankruptcy case In re Sizemore (12/5/13), where a debtor going through bankruptcy received $100,000 from her ex-husband’s life insurance policy. Being a resident of Kentucky, the debtor had the choice of using either federal or state exemptions. The debtor sought to exempt the entire amount under the federal bankruptcy protections, but the bankruptcy court held that life insurance proceeds were part of the bankruptcy estate. Therefore, the life insurance proceeds could not be excluded from the debtor’s bankruptcy estate.

Also consider In re White (5/16/14), a bankruptcy case using Alabama state exemptions. Under Alabama’s bankruptcy exemption laws, death benefits of a life insurance policy are exempted from the estate if the beneficiary is the person who effected the policy in the first place.

In White, a married couple were going through divorce. The wife, who was the insured on a $50,000 life policy, died, and her husband was the beneficiary. The husband claimed that the proceeds from the policy on his wife’s life were protected from his creditors under Alabama exemption laws. He argued that he was the one who effected the policy because (1) she obtained the life insurance through his employer, and (2) he paid the premiums.

The bankruptcy court, however, ruled that because the wife was the owner of the policy, she was the one who effected the policy. Therefore, the death benefits were not protected under Alabama’s exemption laws.

A client going through bankruptcy should check with a local bankruptcy attorney to fully understand his state’s exemption laws that may apply.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – July 7, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: If my client has a simplified employee pension (SEP) plan and works after he turns age 70 ½, can he wait until he retires to start taking RMDs?

Answer: Unfortunately, the IRS says that even though SEP and SIMPLE IRAs are employer-sponsored retirement plans, they are still IRAs, and therefore the IRA rules for RMDs apply. An owner of an IRA must start taking RMDs in the year the taxpayer turns 70 ½, so even if your client keeps working, he will nevertheless be required to take distributions from his SEP plan.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.

Ask the Experts – June 12, 2014

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The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: My client is trying to decide between setting up a SIMPLE or SEP IRA for her small business. What should I tell her?

Answer: Without more details, you can only speak in generalities. You should start with the differences between the two.

A SIMPLE IRA (savings incentive match plan for employees) is very similar to a 401(k) plan in that it’s primarily a way for an employee to choose to contribute the employee’s money to a pension plan.

SIMPLE IRAs may include both employee deferrals and employer contributions. The employer must either (1) match the employee’s deferral dollar-for-dollar, generally up to 3% of the employee’s salary; or (2) make a 2% nonelective contribution to all eligible employees—regardless of whether the employee made a contribution.

An employee’s deferral limit for a SIMPLE IRA is $12,000 (in 2014, indexed for inflation).  The employee’s deferral must be deposited by the employer within 30 days from the end of the month in which the election was made, and the employer’s matching or 2% nonelective contribution must be made by the time tax returns are due in the following year.

To implement a SIMPLE IRA, an employer must have 100 or fewer employees who receive more than $5,000 per year. Every employee who earns at least $5,000 from the employer is an eligible employee and must be allowed to participate in the SIMPLE plan.

A SEP IRA (simplified employee pension) is easier to describe and implement than a SIMPLE IRA. It’s essentially an IRA set up on behalf of an employee to which the employer makes contributions based on a percentage of the employee’s compensation (the maximum compensation taken into account is $260,000 in 2014). The percentage contributed must be the same for every eligible employee.  There are no employee deferrals into a SEP plan.

An eligible employee is one who (1) is 21 years or older, (2) has worked 3 of the last 5 years or more, and (3) earned $550 in compensation. The contribution limit is 25% of the employee’s salary, or $52,000 (in 2014, indexed for inflation), whichever is lesser.

Understanding the differences between these plans can help your client decide which plan makes more sense. For example, if the business consists of only your client, the most important aspect is probably the contribution limits.

If the business generates relatively small amounts of income, a SEP IRA will limit the owner’s contribution. For example, let’s say your client has a side business bringing in $16,000 per year in salary. Under a SEP, the most he may contribute is $4,000 (25% of $16,000). On the other hand, with a SIMPLE IRA, he may make the full $12,000 contribution and have the business make a matching $480 contribution (3% of $16,000).

But if he earns $100,000 per year through his business, the business may contribute $25,000 (25% of $100,000) under a SEP, and he can only defer $12,000 (plus a $3,000 matching contribution from the business) under a SIMPLE plan.

Sources: I.R.C. § 408(k), (p); § 402(h)(2)(A).

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.