Unit 14 – Social Security and Tax Considerations

Covered Workers
Social Security, also known as Old Age, Survivors, and Disability Insurance (OASDI) benefits are determined by a formula based on earnings. Nearly 90% of working people are covered and pay SS taxes. Employees pay 50% of the employment tax, while self-employed employees pay 100%. A worker who has worked 40 quarters is considered ‘fully insured’
Types of benefits
-monthly retirement benefits for retired workers at least age 62
-monthly benefits for spouses of retired workers
-monthly survivor benefits for the spouse and certain other survivors of deceased workers
-monthly disability benefits for disabled workers and their dependents
-a modest lump-sum death benefit payable at a worker’s death
Eligibility for Social Security
most workers are covered, including common-law employers and employees, most self-employed persons, Armed Forces Personnel, and employees of nonprofit organizations. Excluded worker groups are railroad workers, federal employees hired before 1984, and state & local government employees unless they do not have a retirement program or have entered into an agreement with the social security administration.
Fully Insured
a person is fully insured after acquiring 40 quarters of coverage (10 years of covered employment). once a person has acquired 40 quarters, the person is fully insured for life, even if that person spends no further time in covered employment.
a person is fully insured if:
-that person has at least six quarter of coverage and
-that person has acquired at least as many quarters of coverage as there are years elapsing after 1950 and before the year in which that person dies, becomes disabled, or reaches, or will reach age 62, whichever comes first
Currently Insured
A person is currently insured after acquiring at least six quarters of coverage during the full 13-quarter period ending with the calendar quarter in which the person:
-died
-most recently became entitled to disability benefits; or
-became entitled to retirement benefits
If a worker is only currently insured at death, Social Security benefits would be payable only to a dependent child in addition to the lump-sum death benefit of $255.
Disability Insured
the status requires that the worker be fully insured and have earned at least 20 quarters of coverage in the 40 calendar quarter periods ending with the calendar quarter in which the disability begins. The requirement is altered if the worker is disabled before 31.
Primary Insurance Amount (PIA)
The PIA for a worker is based on the averag elevel of earnings of that worker and is updated and published annually in tables by the federal government. Most types of Social Security benefits are some percentage of the PIA as set for the year for the worker’s earnings level.
Dual Benefit Liability
often a person is eligible to receive more than one social security benefit. for example, a spouse who has reached age 65 may be eligible to receive a retirement benefit based on her own earning and also a benefit on her late husband’s earnings – in this case the person is entitled to receive only the larger of the two benefit amounts instead of both.
Retirement Benefits
by working and paying social security taxes, individuals earn “credits” toward social security benefits. Higher lifetime earnings equal higher benefits. The “full retirement age” is 65 for those born before ’38 and will increase to 67 for those born after ’60.
Survivor Benefits
Social Security survivors benefits can be paid to:
-a widow or widower
-a disabled widow or widower–as early as age 50
-a widow or widower at any age if that person takes care of the deceased’s child who is under age 16 or disabled and receiving Social Security benefit.
-unmarried children under age 18 or up to age 19 if they are attending high school full time
-stepchildren, grandchildren, or adopted children under certain circumstances
-children at any age who were disabled before age 22 and remain disabled
-dependent parents age 62 or older
lump-sum death benefit
a $255 lump sum paid to the surviving spouse or eligible child.
surviving spouse’s benefit
the eligible surviving spouse of a fully insured worker is entitled, at the spouse’s normal retirement age, to a monthly life income equal to the worker’s primary insurance amount (PIA) at death. Spouse can elect reduced benefits starting as early as age 60. If the surviving spouse has a child under 16, they can receive an additional 75% of the workers PIA. The blackout period is the period of years during which no social security is payable which is between the time the youngest child of the worker attains the age of 16 and the spouse’s age is 60.
Disability Benefits
has a five month elimination period and is defined as “the inability to engage in any substantially gainful activity by reason of medically determinable physical or mental impairment that can be expected to result in death or that has continued or can be expected to continue for at least 12 full months.”
Maximum Family Benefit
When several members of a family are entitled to receive benefits, the family may run up against an overall limitation on benefit payments called the maximum family benefit. Like the PIA, a maximum family benefit is established for each level of average earnings and is updated annually.
Retirement Earnings Limit
Once a retiree reaches normal retirement age, there is no restriction on the amount the retiree can earn while still being employed without losing social security benefits.
Taxation of Social Security Benefits
A portion (up to 85%) of the Social Security retirement income benefit is includable in the worker’s adjusted gross income for tax purposes. Various formulas apply depending on the level of adjusted gross income, whether the taxpayer is married or single, and if married, whether filing separate or joint returns.
Individual Life Insurance
life insurance proceeds are subject to inclusion in the deceased’s estate for federal estate tax purposes if any of the following apply:
-the estate was the named beneficiary
-the deceased was the policyowner
-the deceased transferred the policy to another person within three years of death
cash surrender value
if a policyowner surrenders a policy for its cash value, some of the cash value received may be subject to ordinary income tax if it exceeds the sum of the premiums paid for the policy. Generally, the amount equal to premium payments i snot taxable. Any additional amount in excess of the premium payments made would be taxable as income.
Policy loans
are not taxable as income because they are treated as a debt against the policy.
Modified Endowment Contract (MEC)
to discourage the use of life insurance contracts with high premiums as investments, federal law subjects all permanent policies to a test. A life insurance policy that fails the test will be considered an MEC which makes the policy subject to less favorable tax treatment. A policy must meet the seven-pay test to not be considered an MEC. The total aggregate premiums paid at any time during the policy’s initial seven years must not exceed the total premium that would have been paid on a seven-year level annual premium basis for the same period.
Premiums
premiums paid for individual life insurance are considered to be a personal expense and are not tax deductible. When a business buys group term life, it is considered a business expense and is tax deductible unless the business buys life insurance to perpetuate the business in which case the premiums are considered to be a capital investment and are not tax deductible.
Policy Proceeds
Life insurance proceeds may or may not be subject to federal income taxes and or estate taxes. The following rules generally apply:
-Lump sum settlements are not taxable as income. true whether individual or business. therefore an individual or corporate beneficiary pays no federal income tax on life insurance proceeds.
-installment payments: are partially taxable as income. the basic concept is that the principal is returned tax free, however, each installment received is part principal and part interest, and the interest portion of the installment is taxable as income.
Accelerated Benefits
accelerated/living benefits paid by a life insurance policy fall into the same category as a policy’s death benefits–that is, accelerated benefits are received income tax free as long as they are qualified. Qualified means the insured has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death 24 months or less after the certification. Once certified, access to the money without having to pay taxes on it will be granted.
Dividends & Surrender Values
dividends paid to participating policy-owners are generally not taxable as income. They are considered a return of premium. Interest earned on dividends is taxable. Generally speaking, any amount above the premiums paid (earned from interest/dividends) is taxable.
Cash Value Accumulation
permanent life products, variable and universal life products, annuities, qualified retirement plans, and IRAs may accumulate cash values that are not taxed unless and until withdrawn.
Group Life Insurance
proceeds from a group life policy are not subject to federal income tax when received by the beneficiary as a lump-sum payment. premium payments are not deductible by the employee but by the corporation as a biz expense. Employer paid policies are not considered income until $50,000 in coverage is exceeded.
Doctrine of Economic Benefit
if an employee receives property or benefit in lieu of income and that property or benefit would have been taxable income if received in cash, an economic benefit has been received and will be taxed accordingly.
Federal Estate Tax
imposed on estates that exceed certain amounts. life insurance proceeds are includable in a deceased insured’s gross estate:
-if the proceeds are payable to the estate, either directly or indirectly
-if the deceased possessed any incidents of ownership in the policy at death (rights to change the beneficiary, assign the policy, or borrow against the policy)
-if the policy was assigned by the insured, other than for full and adequate consideration, within three years of death.
Charitable Uses of Life Insurance
two ways to make charitable gifts of life insurance: the first is to make an outright gift of a policy on the life of the donor. The charity is the beneficiary. The donor may give the charity cash each year to pay the premium which is a cash gift and is deductible. Charity must be given ownership.
Second method: the donor can retain ownership of the policy, make the charity the beneficiary, and continue to pay the premiums. In this case the premium payments are not tax-deductible. Proceeds will be part of the donor’s estate but wash out as a charitable deduction. Benefit to donor is that they can change the beneficiary is needed.
Gifts of Life Insurance
first method: to give a policy to the donee. If this gift involves transfer of all incidents of ownership from the donor to the donee, it may qualify for a present interest gift tax exclusion and the donor will not incur gift tax liability. This is true as long as the replacement value does not exceed the IRS annual limit. second method: make a gif tof the premiums. as long as the amount of premium paid plus all other gifts during the same year to the same donee is equal or less than the IRS annual gift tax exclusion, there are no tax implications. The recipient does not have to pay income tax either.
Transfer for Value Rules
if the benefits were transferred to a person in exchange for valuable consideration (such as money, services, or something else of value), the proceeds would be taxable as income. any profit received by the investor would be taxable as income. exceptions include: assignment of benefits as collateral security, transfers between a policyholder and insured, and transfers to a partner or corporation of the insured.
Section 1035 (Policy Exchanges)
under IRS section 1035(a), certain exchanges of insurance policies and annuities may occur as nontaxable exchanges. If a policyowner exchanges a life insurance policy for another life policy with the same insured and beneficiary and a gain is realized, it will not be taxed as income under section 1035(a). Qualifying policies include:
-a cash value life insurance policy to another cash value life insurance policy
-a cash value life insurance policy to an annuity
-an annuity to another annuity
Business Insurance
premiums paid by companies for life insurance policies used for business purposes are not deductible as business expenses unless they are group life. Proceeds from life policies purchased for business purposes are received by the company income tax free. business based life insurance is not included in the individuals estate unless they possess some incident of ownership, even if they are a business owner/partner.