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 – June 17, 2015

Question: If my client activates the income rider on my annuity, does that qualify for the substantially equal periodic payments exception to the early distribution penalty?

Answer:  Not necessarily.

The IRS gives us three methods under Code Section 72(t) to determine substantially equal periodic payments in order to avoid the 10% additional tax on distributions taken from qualified accounts before age 59 ½. The methods can be found in Revenue Ruing 2002-62, they are:

  • Required minimum distribution method
  • Amortization method
  • Annuitization method

Each of these methods requires its own calculation based upon the account value and the life expectancy of the account owner. Simply receiving a set amount each year from an income rider does not necessarily meet these calculation requirements.

The payments from the income rider would have to exactly equal to the Section 72(t) substantially equal periodic payments determined by one of these methods to qualify as an exception to the additional tax on early distributions.

There is a free calculator for Section 72(t) distributions at

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 17, 2015

Question: Do IRA distributions count as income for the Affordable Care Act (ACA)?

Answer:  Yes, any taxable portion of an IRA distribution is included in income for determining whether or not an individual qualifies for tax credits or cost assistance subsidies under the ACA.

Beginning in 2014 an individual’s Modified Adjusted Gross Income (MAGI) is used to determine whether or not a person will be eligible for insurance premium tax credits or cost assistance subsidies. The ACA uses the same calculations to determine MAGI as the IRS.

MAGI is determined by figuring a person’s Adjusted Gross Income (AGI) and then adding back certain income.  Generally AGI includes all of your taxable income for the year minus certain adjustments. Many of the items that are deducted from income to determine AGI are actually added back to arrive at MAGI. Most importantly, some types of income that are not included in AGI are added to determine MAGI–for example, the non-taxable portion of social security, and tax-exempt interest is included in MAGI, but not in AGI. For many folks this means their MAGI is higher than their AGI.

The taxable portion of an IRA distribution is included in AGI, and is therefore also included in MAGI. The taxable portions of IRA distributions are just one of many types of income included in MAGI. For more information on determining MAGI please see the IRS’s Modified Adjusted Gross Income Computation worksheet.

Ask the Experts – October 24, 2014

Question:  My client’s CPA believes that the death benefit from a modified endowment contract is income taxable.  Is the CPA correct?

Answer:  No.

The authority for this answer requires stitching together a few different parts of the Internal Revenue Code.

Section 101(a) says that the death benefit of a life insurance policy is generally income tax free.

(a)   Proceeds of life insurance contracts payable by reason of death

(1)   General rule

Except as otherwise provided in paragraph (2), subsection (d),subsection (f), and subsection (j), gross income does not include amounts received (whether in a single sum or otherwise) under a life insurance contract, if such amounts are paid by reason of the death of the insured.

Section 7702 defines life insurance, and sets out the kinds of guideline premium tests that must be met for a contract to qualify.  MEC life policies must (and do) meet the tests in Section 7702.

Section 7702A explains how the separate seven-pay test works.  Contracts that fail to meet the 7702A seven-pay test are MECs—but they are also still life insurance, because they meet the tests in Section 7702.

Finally Section 72(e)(10) explains that MECs are taxed differently from “normal” life policies for the purpose of lifetime distributions.  Nothing in Sections 7702A, 101 or 72 says that MECs are taxed differently from normal life policies with regard to the death proceeds.  Therefore, the death proceeds of a MEC life policy are income tax free.

There are lots of third party sources online that confirm the same conclusion.  Here’s a link to one:

Ask the Experts – October 6, 2014

Ask the Experts!

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

Question: I have a 50 year old client who recently did an in-service conversion of her 403b account to a designated Roth account.  She now wants to take a hardship distribution from her designated Roth account.  Does she have to worry about the 10% penalty tax on the distribution of converted amounts?

Answer:  Yes.

Just as with regular Roth IRA conversions, there is a special tax rule about withdrawing converted amounts within five years of the conversion.  Here is the applicable Q & A from Notice 2010-84.

Q-12. Are there any special rules relating to the application of the 10% additional tax under § 72(t) for distributions allocable to the taxable amount of an in-plan Roth rollover made within the preceding 5 years?

A-12. Yes, pursuant to §§ 402A(c)(4)(D) and 408A(d)(3)(F), if an amount allocable to the taxable amount of an in-plan Roth rollover is distributed within the 5-taxable-year period beginning with the first day of the participant’s taxable year in which the rollover was made, the amount distributed is treated as includible in gross income for the purpose of applying § 72(t) to the distribution.

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 – October 3, 2014

Ask the Experts!

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

Question: Are there ways to minimize income taxes on Social Security retirement benefits?

Answer: Taxpayers often try to minimize the amount of their Social Security retirement benefits subject to taxation with a number of strategies. Particularly, taxpayers can delay filing for Social Security and use their available retirement accounts or assets in the meantime.

For example, let’s say Maude plans to retire at age 62 and needs $40,000 per year on which to live. Also assume that Maude’s PIA is $2,000 per month, or $24,000 per year.

If Maude files at age 62, she will receive $18,000 per year from Social Security ($24,000 reduced by 25%), and presumably make up the extra $22,000 per year from her tax-deferred retirement accounts. Therefore, the $22,000 is added to her adjusted gross income, and her provisional income is $31,000 ($22,000 AGI + ½ of $18,000 Social Security benefits). Since Maude’s provisional income exceeds $25,000, she includes $3,000 of her Social Security benefits in her gross income (i.e. half of the excess of $31,000 provisional income over $25,000 base amount).

Let’s say Maude files at age 70 instead, where she would earn delayed retirement credits at 8% of her PIA per year. In this case, her benefit would be $31,680 per year, requiring her to take out only $8,320 per year from her personal retirement accounts. Her provisional income in this situation is $24,160 ($8,320 AGI + ½ of $31,680 Social Security benefits); therefore, no portion of her Social Security retirement benefits would be taxable.

We’ve purposefully used elementary examples to show how delaying Social Security while using other means until filing for benefits can help avoid taxes on one’s Social Security benefits. We did not take into account the myriad variables that should be taken into account when deciding whether to file for benefits early or later.

Additionally, there are other ways to reduce provisional income. For example,

  • Keep assets inside qualified retirement plans, since distributions from tax-qualified plans are generally added to AGI.
  • Liquidate tax-qualified retirement plans before filing for Social Security benefits.
  • Invest in after-tax retirement plans, such as Roth IRAs or designated Roth qualified accounts.

As usual, the benefits of reducing the amount of Social Security benefits should be weighed against the costs of each of these strategies.

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.