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Retirement and Other Life Insurance Concepts: Practice Questions

20 free practice questions with explanations. Pick an answer for each, then check your score.

Exam weight: 8 of 100 scored questions on the Life and Health general knowledge exam. Updated 2026-11-04.

Quick study guide

This section mixes several topics that sit around the policy itself: who owns it, selling it, group coverage, retirement plans, why people and businesses buy life insurance, and how the money is taxed.

Ownership and selling a policy

The policyowner holds the contract rights (naming beneficiaries, borrowing, surrendering) even when someone else is the insured. With third-party ownership, the owner needs an insurable interest in the insured when the policy is issued. A policy can later be sold. In a viatical settlement the insured is terminally (or chronically) ill; in a life settlement the seller is usually older but not terminally ill. Either way the buyer pays a lump sum below the death benefit, takes over the premiums and collects the death benefit.

Group life

Group life is usually term coverage issued without individual medical underwriting. In a noncontributory plan the employer pays the whole premium and must cover all eligible employees; in a contributory plan employees share the cost. If coverage ends because employment ends, the NAIC model lets the person convert to an individual policy within 31 days without proof of insurability, at the premium for their age at that time.

Retirement plans

A qualified plan meets Internal Revenue Code rules, including not favoring highly paid employees, in return for tax advantages. A nonqualified plan can be offered only to selected executives; the employer generally deducts the cost only when the employee is taxed on it. Defined benefit plans promise a set retirement benefit; defined contribution plans, such as 401(k) plans, pay whatever the account has grown to. Traditional IRA contributions may be deductible and withdrawals are taxed; Roth IRA contributions are not deductible but qualified withdrawals are tax-free.

Needs and business uses

The human life value approach measures lost future earnings; the needs approach adds up specific family needs and subtracts existing resources, including Social Security survivor benefits. Businesses buy key person coverage to protect against the loss of a vital employee, and fund buy-sell agreements so surviving owners can buy a deceased owner's share.

Item	General federal tax rule
Premiums on personal life insurance	Not deductible
Death benefit paid in a lump sum	Generally income-tax-free
Death benefit paid in installments	Principal tax-free; the interest portion is taxable
Policy dividends	Treated as a return of premium; interest earned on dividends left with the insurer is taxable
Cash surrender	Gain above the owner's cost basis is taxable
Employer-paid group term life	Cost of coverage above $50,000 is taxable to the employee
Modified endowment contract (MEC)	Loans and withdrawals taxed gain-first, plus a 10% additional tax before age 59½

Practice questions

Maria buys a life insurance policy on her husband, Luis. She pays the premiums and is named as beneficiary. Who has the right to change the beneficiary or borrow against the cash value?
1. A.Maria, because she is the policyowner
2. B.Luis, because he is the insured
3. C.Nobody, because a third-party-owned policy cannot be changed
4. D.Luis and Maria acting together, because they are married
Show answer
Answer: A. Contract rights such as changing the beneficiary, taking loans and surrendering the policy belong to the policyowner. The insured is simply the person whose death triggers the benefit and has no ownership rights unless he is also the owner. Being married to the owner does not create joint control of the policy.
Source: Texas content outline IV.A
When one person applies for a life insurance policy on another person's life, when must the applicant have an insurable interest in the insured?
1. A.Only at the time of the insured's death
2. B.Both when the policy is issued and when the insured dies
3. C.At the time the policy is issued
4. D.Only if the beneficiary is a business
Show answer
Answer: C. Under the widely tested rule, insurable interest must exist when the policy is issued; it does not have to still exist when the insured dies, so a later change in the relationship does not by itself void the policy. Requiring insurable interest at inception is what stops strangers from buying policies as bets on someone's life (STOLI).
Source: Texas content outline IV.A and III.B.1
A 74-year-old woman who is not terminally ill sells her life insurance policy to a licensed company for a lump sum that is less than the death benefit. This transaction is a:
1. A.Viatical settlement
2. B.Accelerated death benefit
3. C.Life settlement
4. D.Cash surrender
Show answer
Answer: C. Selling a policy to a third party when the insured is not terminally ill is a life settlement; buyers mainly want older policyholders with larger policies. A viatical settlement involves an insured who is terminally or chronically ill. An accelerated death benefit is paid by the insurer under the policy itself, and a cash surrender cancels the policy with the insurer rather than selling it.
Source: Texas content outline IV.B; Texas Department of Insurance: Can I sell my life insurance policy?; Texas Department of Insurance: Life insurance guide (Selling your policy)
An insured whom a physician has certified as terminally ill sells his policy to a viatical settlement provider that meets federal requirements. For federal income tax purposes, the money he receives is generally:
1. A.Taxable to the extent it exceeds the premiums he paid
2. B.Taxable as a capital gain
3. C.Excluded from his income
4. D.Fully taxable as ordinary income
Show answer
Answer: C. IRS Publication 525 says amounts received from a viatical settlement before death are excluded from income if the insured is terminally ill, meaning a physician has certified an illness expected to cause death within 24 months (special limits apply to chronically ill insureds). Taxing the gain above premiums or as a capital gain is closer to how a sale by a healthy policyowner (a life settlement) can be taxed.
Source: Texas content outline IV.B and IV.G.1; IRS Publication 525 (Viatical settlement)
After a life settlement is completed, which statement is true?
1. A.The insured's family still receives the death benefit.
2. B.The insurer refunds all premiums the original owner paid.
3. C.The buyer pays future premiums and receives the death benefit.
4. D.The original owner must keep paying the premiums.
Show answer
Answer: C. The settlement company takes over the policy and the premiums, so the seller makes no more payments but the seller's family no longer gets the death benefit. The insurer is not a party to the sale and refunds nothing. The Texas Department of Insurance also warns that the sale proceeds may be taxable and can affect Medicaid eligibility.
Source: Texas content outline IV.B; Texas Department of Insurance: Can I sell my life insurance policy?
Ken's employer-provided group life coverage ends when he quits his job. Under the NAIC model provisions most states follow, Ken may:
1. A.Convert to an individual policy within 90 days if he passes a medical exam
2. B.Buy an individual term policy for any amount he chooses at his original age
3. C.Keep the group coverage for life at the group premium rate
4. D.Convert to an individual policy without proof of insurability if he applies and pays within 31 days
Show answer
Answer: D. The NAIC group life model requires a conversion privilege: when coverage ends because employment ends, the person can get an individual policy without evidence of insurability if they apply and pay the first premium within 31 days. The individual premium is based on the person's attained age and class of risk, and the amount cannot exceed the group coverage that ended.
Source: Texas content outline IV.C.1; NAIC Group Life Insurance Model Act (Model 565), Section 5H
A terminated employee dies 20 days after his group life coverage ended, before applying for a conversion policy. What happens?
1. A.The insurer pays half the face amount as a compromise.
2. B.The group policy pays the amount he could have converted.
3. C.Nothing is paid, because he never applied for the individual policy.
4. D.Only the premiums deducted from his pay are refunded.
Show answer
Answer: B. The NAIC group life model requires that if a person dies during the conversion period, before the individual policy takes effect, the amount they were entitled to convert is paid as a claim under the group policy. It does not matter that no application was made or premium paid.
Source: Texas content outline IV.C.1; NAIC Group Life Insurance Model Act (Model 565), Section 5J
In a noncontributory group life plan:
1. A.Employees share the premium, so only those who sign up are covered.
2. B.Each employee must pass a medical exam to be covered.
3. C.Employees pay the entire premium through payroll deduction.
4. D.The employer pays the entire premium and all eligible employees must be covered.
Show answer
Answer: D. Noncontributory means employees contribute nothing; the NAIC model requires such a plan to insure all eligible employees, except those who reject coverage in writing. In a contributory plan employees pay part of the cost and choose whether to enroll, which is why insurers usually require a minimum share of eligible employees to join to limit adverse selection. Group coverage is normally issued without individual medical exams.
Source: Texas content outline IV.C.2; NAIC Group Life Insurance Model Act (Model 565), Section 1A(2); Texas Department of Insurance: Life insurance guide (Group life insurance)
Which feature describes a nonqualified deferred compensation plan rather than a qualified retirement plan?
1. A.It can be offered only to a select group of executives.
2. B.Its assets must be held in trust for the exclusive benefit of employees.
3. C.It must follow Internal Revenue Code rules to earn its tax advantages.
4. D.It must pass nondiscrimination tests that protect lower-paid employees.
Show answer
Answer: A. A nonqualified plan does not have to meet the qualified-plan rules, so an employer can limit it to chosen executives; the IRS describes top-hat plans as maintained primarily for a select group of management or highly compensated employees. Nondiscrimination testing, a trust for the exclusive benefit of employees, and meeting Code requirements are all features of qualified plans.
Source: Texas content outline IV.D.1–2; IRS: A guide to common qualified plan requirements; IRS Publication 5528: Nonqualified Deferred Compensation Audit Technique Guide
Under a typical unfunded nonqualified deferred compensation plan, when can the employer take a tax deduction for the deferred pay?
1. A.Never, because nonqualified plans give no deduction
2. B.When it records the promise in its books
3. C.Each year as the promised benefit grows
4. D.When the amount is included in the employee's income
Show answer
Answer: D. The IRS explains that the employer's deduction generally comes when the amount is includible in the employee's income, which for an unfunded plan is usually when it is paid. In an unfunded plan the employee has only the employer's promise, and any money the employer sets aside (for example, in a rabbi trust) stays available to the employer's general creditors. A qualified plan, by contrast, lets the employer deduct contributions when made.
Source: Texas content outline IV.D.2; IRS Publication 5528: Nonqualified Deferred Compensation Audit Technique Guide
A retirement plan that promises a specified monthly benefit at retirement, often based on salary and years of service, is a:
1. A.Defined benefit plan
2. B.401(k) plan
3. C.Profit-sharing plan
4. D.Defined contribution plan
Show answer
Answer: A. The IRS describes a defined benefit plan (a traditional pension) as one that promises a specified monthly benefit at retirement. In a defined contribution plan, the benefit is whatever the individual account holds after contributions and investment gains or losses. Profit-sharing and 401(k) plans are both types of defined contribution plans.
Source: Texas content outline IV.D.1; IRS: Retirement plan definitions
Which statement is true of a Roth IRA but not of a traditional IRA?
1. A.Investment earnings are taxed every year.
2. B.Contributions are not deductible, but qualified distributions are tax-free.
3. C.The original owner must take required minimum distributions during life.
4. D.Contributions may be deductible if the owner qualifies.
Show answer
Answer: B. Roth IRA contributions are never deductible, but qualified distributions come out tax-free, and the original owner does not have to take required minimum distributions. A traditional IRA is the one where contributions may be deductible, withdrawals of deductible contributions and earnings are taxed, and lifetime minimum distributions are required. Neither type taxes earnings while they stay in the account.
Source: Texas content outline IV.D.1; IRS: Traditional and Roth IRAs; IRS: Roth IRAs
An agent estimates how much life insurance a client needs by calculating the present value of the income the client is expected to earn for his family over his remaining working years. This is the:
1. A.Human life value approach
2. B.Needs approach
3. C.Seven-pay test
4. D.Replacement cost method
Show answer
Answer: A. The human life value approach measures the economic value of the insured's future earnings (after the insured's own expenses and taxes) that the family would lose. The needs approach instead totals specific needs such as final expenses, debts, income for dependents and education, then subtracts existing assets, other insurance and Social Security survivor benefits. The seven-pay test is a tax test for modified endowment contracts.
Source: Texas content outline IV.E.1
A corporation buys a life insurance policy on its chief engineer, pays the premiums and names itself beneficiary. Which statement is true?
1. A.Premiums aren't deductible; proceeds can be tax-free if notice and consent rules are met.
2. B.By law, the death benefit must be paid to the engineer's family or to his estate.
3. C.The corporation can deduct the premiums as an ordinary and necessary business expense.
4. D.The engineer must report the premiums the corporation pays as taxable wages each year.
Show answer
Answer: A. This is key person insurance. Premiums are not deductible when the payer is directly or indirectly a beneficiary of the policy (26 U.S.C. § 264). For an employer-owned policy, the death benefit is fully excludable only if the employee was notified and consented in writing before issue and an exception applies, for example the insured was a director or highly compensated employee; otherwise the exclusion is limited to the premiums paid. Because the company is the beneficiary, the engineer is not taxed on the premiums.
Source: Texas content outline IV.E.2.a and IV.G.1; 26 U.S.C. § 264 (premiums not deductible); 26 U.S.C. § 101(j) (employer-owned life insurance)
Three co-owners set up a cross-purchase buy-sell agreement funded with life insurance. How many policies are needed?
1. A.Six
2. B.Three
3. C.One
4. D.Nine
Show answer
Answer: A. In a cross-purchase plan each owner buys a policy on each of the other owners, so the number of policies is n × (n − 1): 3 × 2 = 6. In an entity (stock redemption) plan, the business itself owns one policy on each owner, which would need only three. Either way, the death benefit gives the buyers the cash to purchase the deceased owner's share.
Source: Texas content outline IV.E.2.b
A widow, age 40, receives Social Security survivor benefits while caring for her children. When her youngest child turns 16, her own benefit stops and she cannot get a widow's benefit until at least age 60 (50 if disabled). This gap is known as the:
1. A.Waiting period
2. B.Probationary period
3. C.Elimination period
4. D.Blackout period
Show answer
Answer: D. The blackout period is the gap between the end of the caregiving parent's benefit (when the youngest child reaches 16) and the earliest age for a widow's or widower's benefit, age 60 or 50 if disabled. Agents often plan life insurance to fill it. Elimination, probationary and waiting periods are health and disability policy terms.
Source: Texas content outline IV.F; 42 U.S.C. § 402(e), (g) and (s) (widow's and mother's/father's benefits)
A beneficiary chooses to receive a $120,000 death benefit as ten annual payments of $14,000 instead of a lump sum. How is each payment taxed?
1. A.Nothing is taxed until the total paid exceeds $120,000.
2. B.The full $14,000 is taxable income.
3. C.$12,000 is tax-free and $2,000 is taxable interest.
4. D.The full $14,000 is tax-free.
Show answer
Answer: C. A death benefit is generally income-tax-free, but interest earned while the insurer holds it is taxable. IRS Publication 525 says to divide the amount held ($120,000) by the number of installments (10) to find the excluded part, here $12,000 a year; the remaining $2,000 of each payment is interest. A lump sum would have been entirely tax-free.
Source: Texas content outline IV.G.1; IRS Publication 525 (Life insurance proceeds received in installments)
A policyowner uses the dividends from a participating whole life policy to reduce her premiums. For federal income tax purposes, these dividends are:
1. A.Taxable as qualified dividends, like stock dividends
2. B.Generally not taxable, being treated as a return of premium
3. C.Taxable as ordinary income in the year paid
4. D.Deductible by the policyowner as an expense
Show answer
Answer: B. IRS Publication 550 says insurance dividends the insurer keeps and uses to pay premiums are not taxable; policy dividends are treated as a partial return of the premium and reduce the owner's cost basis. What is taxable is the interest credited on dividends left with the insurer to accumulate. Policy dividends are not corporate stock dividends.
Source: Texas content outline IV.G.1; IRS Publication 550 (Dividends on insurance policies); IRS Publication 525 (Surrender of policy for cash: cost basis)
An employer pays for $150,000 of group term life insurance on an employee, who contributes nothing. For federal income tax purposes:
1. A.The employee is taxed on the death benefit instead of the premium.
2. B.None of the coverage is taxable, because it is term insurance.
3. C.The cost of all $150,000 of coverage is taxable to the employee.
4. D.The cost of the $100,000 of coverage above $50,000 is taxable to the employee.
Show answer
Answer: D. Under Internal Revenue Code § 79, the cost of the first $50,000 of employer-provided group term life coverage is excluded from the employee's income. The cost of coverage above $50,000, reduced by anything the employee pays, is taxable wages (often called imputed income) and is subject to Social Security and Medicare taxes. The death benefit itself is still generally tax-free to the beneficiary.
Source: Texas content outline IV.G.2; 26 U.S.C. § 79; IRS Publication 15-B (Group-term life insurance coverage)
A life insurance policy is funded so quickly that it fails the federal seven-pay test and becomes a modified endowment contract (MEC). Which statement is true?
1. A.Loans and withdrawals are taxed gain-first, with a possible 10% additional tax before 59½.
2. B.Premiums paid into the policy become deductible on the owner's tax return.
3. C.The policy loses its cash value and becomes a term policy with no savings.
4. D.The death benefit becomes fully taxable to the beneficiary when the insured dies.
Show answer
Answer: A. A policy fails the seven-pay test (26 U.S.C. § 7702A) if premiums paid in the first seven years exceed what seven level annual premiums for a paid-up policy would be. A MEC's loans and withdrawals are then taxed gain-first, and the taxable portion carries a 10% additional tax unless the owner is 59½ or older, disabled, or receiving substantially equal periodic payments (26 U.S.C. § 72(v)). The death benefit remains generally income-tax-free, and premiums are still not deductible.
Source: Texas content outline IV.G.3; 26 U.S.C. § 7702A (modified endowment contract); 26 U.S.C. § 72(e)(10) and (v)

Where these questions come from: Texas content outline (Pearson VUE #124401, effective 1 Sep 2026), Life and Health general knowledge, section IV: Retirement and Other Insurance Concepts — 8 of 100 scored questions. See how we write questions.