Replacement, Cancellation, Taxation and Social Security Disability — practice questions

5.3% of the exam ≈8 real questions 9 free questions here

Right-to-return periods, replacement notices, taxation of life insurance and annuities, and Social Security disability: about 8 of the 150 combined questions.

Where people lose points

• Under 60: a 10- to 30-day return period; 60 or older: at least 30 days.
• The replacing insurer notifies the existing insurer within 3 working days.
• A replacement policy carries a 30-day unconditional refund right.
• Death benefits are generally income-tax-free; a MEC's gain comes out first.

Questions and answers, explained

All 6 questions above, with the correct answer and why it is correct. Everything here is on replacement, cancellation, taxation and social security disability.

1. An employer pays the entire premium for $200,000 of group term life insurance on a 52-year-old employee. What amount of coverage generates imputed income, and how is the cost measured?

   • A$150,000, measured by the IRS Table I uniform premium rate for the employee's ageCorrect
   • B$200,000, measured by the employer's actual premium outlay
   • C$200,000, measured by the IRS Table I uniform premium rate
   • DNone; employer-paid group term life is fully excludable from income

   Why: IRC Section 79 excludes the first $50,000 of employer-provided group term life; the cost of the excess $150,000 is imputed to the employee using the IRS Table I uniform premium rates for his age bracket, not the employer's actual cost. Any premium the employee pays with after-tax dollars reduces the imputed amount. Choice D forgets the $50,000 ceiling on the exclusion. Outline IV.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

2. At age 55, a man withdraws $25,000 from a nonqualified deferred annuity he funded with $80,000 of after-tax premium. The contract is now worth $130,000. How is the withdrawal taxed?

   • AEntirely tax-free, as a return of his cost basis
   • BThe full $25,000 is ordinary income, plus a 10% penaltyCorrect
   • C$9,615 is taxable, using an exclusion ratio
   • DThe $25,000 is taxed as long-term capital gain

   Why: Withdrawals from a deferred annuity issued after August 13, 1982, come out gain-first on a LIFO basis; with $50,000 of gain in this contract the entire $25,000 is ordinary income, and the 10% penalty applies because he is under 59½. Choice C misapplies the exclusion ratio, which governs annuitized payments under a settlement option — not lump-sum withdrawals during the accumulation period. Outline IV.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

3. Under current federal law, at what age must an individual born in 1955 begin required minimum distributions from a traditional IRA, and which account requires no distributions during the owner's lifetime?

   • AAge 70½; a Roth IRA requires none
   • BAge 72; a traditional IRA requires none
   • CAge 73; a Roth IRA requires noneCorrect
   • DAge 75; a SEP IRA requires none

   Why: SECURE 2.0 set the required beginning age at 73 for people who turned 72 after 2022 and reach 73 before 2033, rising to 75 for those born in 1960 or later; the first distribution may be deferred to April 1 of the following year. Roth IRA owners are never required to take lifetime distributions, which is why choice A is right on the account but wrong on the outdated 70½ age. Outline IV.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

4. At age 50, Carlos funds a cash value life insurance policy with a single premium of $100,000, and the contract fails the seven-pay test, making it a modified endowment contract (MEC). At age 52, when the contract has $30,000 of gain, he withdraws $20,000. What is the tax consequence?

   • AThe withdrawal is a tax-free return of premium under FIFO ordering rules
   • BOnly the amount exceeding his premium basis is taxable, with no penalty
   • CThe withdrawal is entirely tax-free, but the policy’s death benefit becomes taxable
   • DThe entire $20,000 is taxed as ordinary income under LIFO, plus a 10% penaltyCorrect

   Why: Distributions from a MEC — withdrawals and loans alike — are taxed on a LIFO basis, meaning gain comes out first, and taxable amounts distributed before age 59½ also incur a 10 percent penalty. Because the contract holds $30,000 of gain, the entire $20,000 withdrawal is gain and is fully taxable plus the penalty. Option A describes the FIFO treatment that applies to withdrawals from non-MEC life policies, and option C is wrong because the death benefit remains income-tax-free even in a MEC. Outline IV.G (tax treatment — MECs); IRC §7702A.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

5. Which statement about a modified endowment contract (MEC) is correct?

   • ADeath benefit proceeds paid to the beneficiary lose their income-tax-free treatment entirely.
   • BPolicy loans are received income-tax-free, exactly as they are with a non-MEC policy.
   • CA loan is a taxable distribution of gain first, with a 10% penalty before age 59 1/2.Correct
   • DWithdrawals are treated as a tax-free return of basis first, on a FIFO basis.

   Why: MEC status changes only the taxation of lifetime distributions: loans, withdrawals and assignments come out gain-first (LIFO) and are taxable to the extent of gain, plus a 10% penalty on the taxable amount before age 59 1/2 absent an exception. Option B is the closest distractor and states the ordinary non-MEC rule that loans are not taxable, which is precisely what MEC status removes. Option A is wrong because the death benefit paid to a beneficiary remains income-tax-free even in a MEC.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

6. A worker generally achieves fully insured status for Social Security retirement benefits after earning how many credits (quarters of coverage)?

   • A6 credits
   • B20 credits
   • C40 creditsCorrect
   • D24 credits

   Why: A worker can earn up to 4 credits per year, so 40 credits equals roughly 10 years of covered work. Six credits earned in the 13-quarter period ending with death or disability confers only 'currently insured' status, which provides limited survivor benefits, not retirement benefits.

   Reference CA Life objectives II.D, II.F and II.H (Replacement and cancellation; taxation; Social Security disability)

Topics inside this domain

• California's protections for senior insurance buyers
• California free look periods and life insurance replacement

Drill other domains

• Basic Insurance Concepts and Contract Law (17.3%)
• The Insurance Marketplace, Licensing and Ethics (9.3%)
• Life Insurance Basics, Underwriting and Claims (7.3%)
• Types of Life Policies and Group Life (8%)
• Annuities (5.3%)
• The Life Insurance Contract and Riders (9.3%)

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