LLQP Ethics & Professional Practice · Component 1.4 · 60% of the exam
A client surrenders a permanent policy and is surprised to receive a tax slip. The agent should explain that:
- the amount received above the adjusted cost basis is a policy gain included in income
- Bonly half of the amount received is taxable because it is treated as a capital gain
- Csurrender proceeds are always tax-free because life insurance proceeds are exempt
- Dthe entire amount received on surrender is taxable as income in the year of the surrender
Correct answer: A) the amount received above the adjusted cost basis is a policy gain included in income
The adjusted cost basis broadly reflects premiums paid less the net cost of pure insurance. Proceeds above it are a policy gain taxed as ordinary income, which surprises clients expecting the tax-free treatment of a death benefit.
Why the other options are wrong
- BA policy gain is ordinary income rather than a capital gain.
- CThe exemption applies to a death benefit, not to a surrender during life.
- DOnly the amount exceeding the adjusted cost basis is included in income.
Exam tip
Death benefit equals tax-free; a lifetime surrender can produce a policy gain.
Common mistake
Assuming everything about life insurance is received free of tax.
What this tests
CISRO competency component 1.4 — Integrate into practice the legal aspects of insurance and annuity contracts — which is weighted at 60% of the Ethics & Professional Practice module. Written against the published curriculum.
More from component 1
- An 'assignee' of a life insurance policy is:
- A corporation as policyowner and beneficiary of a policy on a key employee:
- A 'trustee' named to receive proceeds on behalf of a beneficiary:
- The 'automatic premium loan' (APL) provision:
- A life insurance contract 'matures' when:
- The 'assignment' provision typically states that:
Practice the whole Ethics & Professional Practice module
Timed sets weighted like the exam, and review of every question you miss. Free to start.