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 – 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 – April 21

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: My client is age 72 and has been taking RMDs from his IRA for a couple of years now. When he retires later this year, he will also be required to take RMDs from his employer-sponsored Section 403(b) annuity. When is his deadline to take the 2014 RMD for the employer-sponsored plan?

Answer: If your client retires this year, he is required to take the 2014 RMD by April 1, 2015. Any subsequent RMDs must be taken by December 31 of the year for which the RMD is required.

The fact that your client is already taking RMDs on his IRA does not affect the deadline to take his first RMD from the employer-sponsored plan. Therefore, your client should take his IRA RMD by December 31, 2014, and his 403(b) RMD by April 1, 2015.

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 – April 14

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: My client owns a life insurance contract where he is the insured and his daughters are the beneficiaries. Can he make a Section 1035 exchange so that an ILIT becomes the owner of the policy? If so, does the three-year rule that would bring the full death benefit back into his estate still apply?

Answer: Section 1035 requires consistent ownership before and after the exchange for it to be tax-free. Since an ILIT is a legally distinct entity, the ownership change would generally disqualify it for Section 1035 treatment, and it would simply be a surrender of the old policy followed by the purchase of a new policy in the name of the ILIT.

It could be argued that if the ILIT is a grantor trust, the grantor/original policy owner is still the constructive owner of the life insurance policy; therefore Section 1035 would apply. However, if this analysis is true, Section 1035 would apply, but the individual would not avoid the rule bringing the death benefit back into his estate if he dies within three years from the transfer.

As you can see, the bottom line is that an individual cannot make a Section 1035 exchange into an ILIT and avoid the three-year rule. If he wants to get the life insurance policy inside an ILIT, he would either have to (1) take the risk of the full death benefit being brought back into his estate if he dies within three years, or (2) surrender the policy for its cash value, pay income taxes on any gain, transfer money to the ILIT, and have the ILIT purchase a policy on his own life.

If he chooses the latter, he faces gift taxes on the transfer of money to the ILIT if such transfers are more than the $14,000 exclusion amount in 2014. He also faces potential problems with the policy being considered a modified endowment contract (MEC). Both options have risks or costs, and so it’s up to the client to decide which option suits him best.

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 – April 3

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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, age 62, is planning on working for the first half of this year and then retiring and filing for Social Security benefits. He expects to earn about $45,000 in the first half of the year. Will his Social Security benefits be reduced in 2014?

Answer: Probably not, but it depends on how much your client earns per month after he files for his retirement benefits.

Ordinarily, if an individual is younger than full retirement age (FRA), there is a limit to how much he can earn and still receive full Social Security benefits. If the individual is younger than FRA during all of 2014, the Social Security Administration (SSA) deducts $1 from the retiree’s benefits for each $2 he earns above $15,480. If he reaches FRA in 2014, the SSA deducts $1 from his benefits for each $3 he earns above $41,400.

Therefore, under the general rule, your client’s Social Security benefits would be decreased by about $15,000 on the year (i.e. the difference between his $45,000 yearly earnings and the $15,480 limit, divided by 2).

However, there’s a special rule that applies to the first year of retirement when the individual files for benefits mid-year. Under this rule, he can receive his full Social Security check for any whole month he’s retired, regardless of his first-half earnings, as long as he earns $1,290 or less each month thereafter. However, if the retiree earns more than $1,290 in any month, his Social Security benefit for that month will be completely withheld. After 2014, the $15,480 yearly threshold (indexed for inflation) will apply in until the year in which he reaches FRA.

Here’s an example from the SSA to provide further illustration of the rule:

John Smith retires at age 62 on October 30, 2014. He will earn $45,000 through October.

He takes a part-time job beginning in November earning $500 per month. Although his earnings for the year substantially exceed the 2014 annual limit ($15,480), he will receive a Social Security payment for November and December. This is because his earnings in those months are $1,290 or less, the monthly limit for people younger than full retirement age. If Mr. Smith earns more than $1,290 in either of those months (November or December), he will not receive a benefit for that month. Beginning in 2015, only the annual limit will apply to him.

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 – March 31

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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 failed to take his RMD last year. What’s the penalty for failure to take an RMD, and is there any way to have the penalty waived?

Answer: The penalty is 50% of the shortfall in the amount of distributions. For example, if your client was required to make a $5,000 distribution in 2013 but failed to take a distribution at all, the penalty tax is $2,500 (50% of $5,000). This penalty is reported on Form 5329 and Form 1040, line 58.

The IRS can waive part or all of the 50% penalty if he can show that the shortfall was due to reasonable error and that he is taking reasonable steps to remedy the shortfall.

To have the penalty waived, your client should first take the 2013 RMD this year. Keep in mind that this distribution is still in 2014, meaning taxes are due on the distribution for the 2014 taxable year. Also note that the taxpayer still needs to take his 2014 RMD by December 31 of this year.

Next, your client should fill out Form 5329, Part 8, as normal with one exception. On line 52 (where the shortfall would normally be calculated), he should enter “RC” and the amount of the RMD that he wants waived in parentheses. He should then subtract the amount he wants waived from the amount of the shortfall, and fill in line 52 with that number. It will be $0 if he’s requesting the full RMD waived. Next, he should fill in line 53 as normal.

Here’s what it would look like assuming the RMD was $5,000, and he is requesting a waiver of that full amount:

50  Minimum required distribution for 2013       .  .  .  .  .  .  . . .  .  .  $5,000

51  Amount actually distributed to you in 2013  .  .  .  .  .  .  .  .  .  .  .  .  .  . -0-

52  Subtract line 51 from line 50. If zero or less, enter -0- (RC $5,000) .  . -0-

53  Additional tax. Enter 50% of line 52      .  .  .  .  .  .  .  .  .  .  .  .   .  .  .     -0-

In addition to filling out Form 5329, your client must attach a “statement of explanation” showing that the shortfall was due to reasonable error and that he remedied the shortfall (or is in the process of remedying the shortfall).

The bottom line is that to ask for a waiver, your client should take the 2013 RMD as soon as possible, file Form 5329, and attach a statement of explanation.

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.