Practice Quiz

FINRA Series 6

Category - Series 6

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Which of the following statements regarding the taxes associated with a variable life insurance policy is false?
  1. Earnings on a variable life insurance policy grow tax-free.
  2. Payments to beneficiaries upon the death of the policyholder are taxed as ordinary income.
  3. One variable life policy can be exchanged for another variable life policy without triggering any tax consequences under Section 1035 of the tax code.
  4. If a policyholder withdraws some of the cash value associated with the policy, taxes need only be paid on the amount that exceeds the total amount of the premiums paid to date.
Explanation
Answer: B - The statement that payments to beneficiaries upon the death of the policyholder are taxed as ordinary income is false. When a policyholder dies, the death benefit received by the beneficiaries is tax-free. The death benefit will, however, be included in calculating any estate taxes that might be due. All the other choices are true statements. Unlike the tax treatment of variable annuities, the IRS uses first-in, first out (FIFO) accounting when determining whether the withdrawals have come from earnings or premium payments; therefore, when a policyholder withdraws some of the policy’s cash value, it is assumed to be a withdrawal of premiums first, and that amount of the withdrawal is tax-free.
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