CLU Individual Life Insurance 5 — Questions and Answers
Question 1: Which life insurance ownership arrangement is typically used to keep the death benefit outside the insured's taxable estate under IRC Section 2042?
- Community property ownership
- Irrevocable life insurance trust (ILIT) (Correct answer)
- Cross-purchase buy-sell agreement funded by the insured
- Split-dollar arrangement with the employer
Correct answer: Irrevocable life insurance trust (ILIT)
An ILIT owns the policy so the insured has no incidents of ownership; proceeds are paid to the trust and excluded from the insured's gross estate under IRC Section 2042.
Question 2: Under a third-party ownership arrangement, who has the right to exercise policy options such as surrendering the policy?
- The insured
- The beneficiary
- The policyowner (Correct answer)
- The insurer at its discretion
Correct answer: The policyowner
In a third-party ownership situation, the policyowner — not the insured or beneficiary — holds all contractual rights including the right to surrender, borrow, or change beneficiaries.
Question 3: The misstatement of age provision in a life insurance policy most commonly results in which adjustment?
- Policy cancellation and full premium refund
- Death benefit adjusted to the amount the premium paid would have purchased at the correct age (Correct answer)
- A flat penalty fee added to the death benefit claim
- Automatic conversion to a term policy
Correct answer: Death benefit adjusted to the amount the premium paid would have purchased at the correct age
When age is misstated, insurers adjust the death benefit to what the paid premiums would have purchased at the insured's true age, rather than voiding the policy.
Question 4: Which of the following is a characteristic of graded death benefit life insurance?
- The death benefit increases each year tied to inflation
- Full death benefit is paid only after a specified number of policy years if death is not accidental (Correct answer)
- Premiums decrease as the insured ages
- Coverage is available only through employer groups
Correct answer: Full death benefit is paid only after a specified number of policy years if death is not accidental
Graded benefit policies — often issued on a guaranteed-acceptance basis — pay a limited benefit (often return of premiums plus interest) if the insured dies from natural causes in the first 2-3 policy years.
Question 5: A 'last survivor' (second-to-die) life insurance policy is most commonly used to fund which planning need?
- Income replacement at the death of the breadwinner
- Estate liquidity to pay federal estate taxes after the death of the surviving spouse (Correct answer)
- Key person replacement for a business partner
- Funding a child's education upon parental death
Correct answer: Estate liquidity to pay federal estate taxes after the death of the surviving spouse
Second-to-die policies pay at the death of the last surviving insured, aligning perfectly with the estate tax liability that arises when the surviving spouse dies and the marital deduction is exhausted.
Question 6: Under the life insurance policy loan provision, what is the tax treatment of a loan taken against a non-MEC policy's cash value?
- The loan is taxable as ordinary income in the year received
- The loan is income-tax-free as long as the policy remains in force (Correct answer)
- The loan is taxable only if it exceeds the policy's cost basis
- Loans are subject to capital gains tax
Correct answer: The loan is income-tax-free as long as the policy remains in force
Policy loans from non-MEC life insurance are not taxable events as long as the policy remains in force, because they are treated as debt, not a distribution of gain.
Question 7: Which statement accurately describes the paid-up additions dividend option?
- Dividends reduce future premiums dollar-for-dollar
- Dividends purchase small increments of single-premium whole life that immediately add to cash value and death benefit (Correct answer)
- Dividends are deposited into a savings account outside the policy
- Dividends purchase one-year term insurance equal to the base policy face amount
Correct answer: Dividends purchase small increments of single-premium whole life that immediately add to cash value and death benefit
Paid-up additions use dividends to buy small amounts of fully paid-up whole life insurance, increasing both the death benefit and cash value without requiring evidence of insurability.
CLU Individual Life Insurance 5
Which life insurance ownership arrangement is typically used to keep the death benefit outside the insured's taxable estate under IRC Section 2042?