17 Free Utah Life & Health Practice Questions: Annuities, Tax and Qualified Plans (2026)

Answer: C

For non-qualified annuities surrendered during the accumulation phase, the IRS requires taxation on a LIFO (last-in-first-out) basis. This means the earnings (the last money in) are considered withdrawn first and taxed as ordinary income. Only after all earnings are exhausted is the return of principal (cost basis) received tax-free. Option B describes the exclusion ratio, which applies only during the annuitization (payout) phase. Option A is incorrect because earnings are taxable. Option D is incorrect because annuity gains are taxed as ordinary income, not capital gain.

Answer: D

Traditional IRA contributions may be tax-deductible if the taxpayer (or spouse) is not covered by an employer retirement plan, or if covered, depending on modified adjusted gross income (MAGI) thresholds. Roth IRA contributions, however, are made with after-tax dollars and are never tax-deductible, regardless of income or employer plan coverage. Option A incorrectly reverses the deductibility. Option B is false because deductibility depends on income and plan coverage for traditional IRAs, and Roth contributions are never deductible. Option C misstates the timing rules; deductibility for traditional IRAs is not based on before/after the filing deadline in that way, and Roth contributions are never deductible.

Answer: B

Under a life annuity with period certain (e.g., 10 years certain and life), if the annuitant dies before the period certain expires, payments continue to the beneficiary for the remainder of the guaranteed period. In this case, 7 years of payments have been made, so 3 years remain on the 10-year guarantee. Payments do not stop (A), are not typically commuted to a lump sum unless specified (C), and do not continue for life to the beneficiary (D)—the obligation ends after the period certain is satisfied.

Answer: A

Section 1035 of the Internal Revenue Code allows for the tax-free exchange of certain insurance contracts, including life insurance for life insurance, life insurance for an annuity, endowment for life insurance or annuity, and annuity for annuity, provided the exchange meets specific requirements (same insured/owner, no receipt of money or other property). This enables the policyholder to upgrade or change contracts without triggering immediate taxation of gain. Section 72(e) deals with annuity taxation. Sections 402(c) and 408(d)(3) govern rollovers from qualified plans and IRAs, respectively, not insurance-to-insurance exchanges.

Answer: D

A bail-out provision permits withdrawal without surrender charges when the current interest rate falls below a specified threshold. Here, the current rate (1.5%) is below the 2% threshold, so the owner may withdraw without surrender charges. Option A is incorrect because the bail-out provision overrides surrender charges when triggered. Option B is incorrect; while a 1035 exchange is tax-free, it is not the action described by the bail-out provision. Option C is incorrect because surrendering would still subject earnings to income tax, and the bail-out provision allows withdrawal without surrender charges, not tax-free treatment.

Answer: C

A Roth IRA distribution is tax-free and penalty-free if the account has been open for at least 5 years and the distribution is made on or after age 59½, due to disability, or to a beneficiary after death. Here, the account is 8 years old (>5 years) and the owner is 60 (>59½), so the earnings distribution qualifies. Option A is incorrect because the distribution is not taxed as ordinary income when qualified. Option B is incorrect because neither tax nor penalty applies. Option D is incorrect because Roth IRA qualified distributions are not taxed as capital gains.

Answer: A

The seven-pay test compares the total premiums paid into a life insurance policy during the first seven years to the amount that would be required to pay up the policy in seven years with level annual premiums. If the actual payments exceed this amount, the policy is classified as a modified endowment contract (MEC). Option B is incorrect because the seven-pay test does not apply to annuities. Option C is incorrect because the exclusion ratio pertains to annuity taxation, not life insurance. Option D is incorrect because the seven-pay test is unrelated to qualified plan nondiscrimination testing.

Answer: C

Moving funds from a traditional IRA to a Roth IRA is a Roth conversion. The amount converted is treated as a distribution from the traditional IRA and is included in taxable income for the year of conversion. Option A is incorrect because while the transfer may be trustee-to-trustee, it is still a taxable conversion. Option B is incorrect because although the 60-day rule applies to rollovers, a Roth conversion is taxable regardless of whether it is done via direct transfer or 60-day rollover. Option D is incorrect because traditional to Roth IRA conversions are permitted and commonly used for tax planning.

Answer: D

The surrender charge starts at 10% in year 1 and declines by 1% each year. At the end of year 1: 10%, year 2: 9%, year 3: 8%, year 4: 7%, year 5: 6%, year 6: 5%, year 7: 4%. Therefore, surrendering at the end of year 7 incurs a 4% charge. Option A (3%) would apply at the end of year 8. Option B (7%) applies at the end of year 4. Option C (10%) applies only in year 1.

Answer: D

For a non-MEC life insurance policy, the cost recovery rule (also called the basis recovery rule) applies to withdrawals: amounts withdrawn are treated as a return of premium (non-taxable) to the extent they do not exceed the policy's cost basis (total premiums paid). Only amounts exceeding the basis are taxable as ordinary income. Policy loans are not taxable when taken (they are treated as debt). Withdrawals follow first-in-first-out (FIFO), not LIFO. Dividends are generally considered a return of premium and are not taxable unless they exceed the policy's basis.

Answer: B

While still employed, access to 401(k) funds for rollover to an IRA is generally restricted. Most plans permit in-service withdrawals or rollovers only after reaching age 59½, or upon specific events like separation from service, disability, or plan termination. The one-rollover-per-12-months rule (Option C) applies only to IRA-to-IRA rollovers, not to rollovers from qualified plans like 401(k)s. Option A is incorrect due to age and service restrictions. Option D is incorrect because Section 1035 exchanges apply only to insurance contracts (life insurance, annuities, endowments), not to qualified plan-to-IRA rollovers, which are governed by IRS rollover rules under Sections 402(c) and 408(d)(3).

Answer: A

Distributions from traditional IRAs used to pay for health insurance premiums while receiving unemployment compensation are exempt from the 10% early withdrawal penalty under IRC § 72(t)(2)(B), but the amount is still included in taxable income as ordinary income. The exclusion ratio applies only to non-qualified annuities, not IRAs. Option B incorrectly applies the exclusion ratio. Option C is incorrect because the penalty is waived. Option D is incorrect because the distribution is not tax-free; only the penalty is waived.

Answer: A

For non-qualified annuities, withdrawals during the accumulation phase follow LIFO (last-in, first-out) taxation. Earnings are withdrawn and taxed as ordinary income first; only after all earnings are exhausted is the return of principal tax-free. Since the withdrawal exceeds earnings, the earnings portion is taxable as ordinary income, and the principal portion is tax-free. The 10% early withdrawal penalty applies only to the taxable portion if under age 59½, but the scenario does not specify the penalty applicability, and option D incorrectly taxes the entire withdrawal and applies the penalty unconditionally.

Answer: B

B is correct because a qualified Roth IRA distribution (made after age 59½, death, disability, or for a first-time home purchase, and after a 5-year holding period) is entirely free of federal income tax and the 10% early withdrawal penalty. A is incorrect because qualified Roth distributions are not taxed as ordinary income. C is incorrect because both contributions and earnings are tax-free in a qualified distribution. D is incorrect because the exclusion ratio applies to non-qualified annuity payments, not Roth IRA distributions.

Answer: B

B is correct because in a fixed annuity, the insurance company invests the premiums in its general account and guarantees a minimum interest rate, bearing the investment risk. In a variable annuity, the owner allocates funds to sub-accounts (similar to mutual funds), so the investment risk and returns vary with market performance, and the owner bears the risk. A is incorrect because it reverses the concepts: fixed annuities are not index-linked (that describes indexed annuities), and variable annuities do not guarantee returns from the general account. C is incorrect because fixed annuities offer principal protection via the insurer's guarantee, but variable annuities do not guarantee principal; liquidity is not the primary differentiating factor. D is incorrect because both fixed and variable annuities typically offer a death benefit (e.g., greater of account value or premiums paid), and variable annuities often include a guaranteed minimum death benefit (GMDB) as an option, not a defining difference.

Answer: C

A 403(b) plan, available to employees of public schools, certain tax-exempt organizations, and ministers, allows for elective deferrals (pre-tax) and, if the plan document permits, designated Roth (after-tax) contributions. Option A is incorrect because 403(b) plans are for employees of tax-exempt organizations and public schools, not for-profit corporations. Option B is incorrect because employer contributions are permitted but not required for the plan to be qualified.

Answer: B

For non-MEC life insurance policies, cash value withdrawals are taxed using the FIFO (first-in, first-out) rule: the basis (total premiums paid) is recovered tax-free first, and any amount exceeding the basis is taxable as ordinary income. Option A incorrectly applies the LIFO rule, which is used for non-qualified annuities and MECs. Option C incorrectly characterizes excess as capital gain; it is ordinary income. Option D is incorrect because only the basis portion is tax-free.