Insurance Planning Practice Questions

Test your knowledge! We rounded up some insurance planning practice questions to help you get ready for the CFP® Exam. 

Stop Loss Provisions

This question was discussed in detail during the December 2020 episode of the BIF Bites podcast!

Todd has an unlimited major medical policy with a $350 deductible and 80/20 coinsurance to a $5,000 stop-loss. Todd has a claim of $10,000. How much must he pay out-of-pocket?

1. $1,000
2. $1,350
3. $4,000
4. $4,650

Correct answer: B. $1,350

Instructor insight:

The total claim is $10,000. This brings the policy over the stop-loss limit. The payments from the Insured and Insurer can be determined as follows:

To double check the calculation add the amount paid by Todd ($1,350) to the amount paid by the Insurance Company ($8,650), then subtract the total claim ($10,000). If the amount equals $0, the calculation is correct.

$1,350 + $8,650 - $10,000 = 0

CFP^® Exam tip:

The CFP^® Exam often tests concepts and definitions at the level of application by presenting a real-life scenario. Health Insurance coverage provisions are commonly tested in this manner. Specifically, CFP Board may present a scenario in which the Health Insurance policy benefits will be accessed and ask the candidate to calculate the amounts paid by the insured and/or insurer. To do so with precision you must first have a clear understanding of the core policy provisions and definitions (i.e., deductible, coinsurance provision, stop-loss, and maximum-out-of-pocket).

Cobra

This question was discussed in detail during the August 2020 episode of the BIF Bites podcast!

For how many days does the COBRA election period last?

1. 30 days after termination.
2. 30 days after the actual notice of the event to the qualified beneficiary by the plan administrator.
3. 60 days after termination.
4. 60 days after the actual notice of the event to the qualified beneficiary by the plan administrator.

Correct answer: D. 60 days after the actual notice of the event to the qualified beneficiary by the plan administrator.

Instructor insight:

The COBRA election period starts with the date of the notification and lasts for 60 days.

CFP^® Exam tip:

COBRA has several noteworthy elements that are highly testable on the CFP^® Exam. As you set out to study COBRA, begin with the basics: the qualifying categories of coverage and their associated coverage periods. From there, focus on the 'one-off, bullet-point' facts such as required number of employees and percentage of premiums.

Disability Insurance

This question is discussed in the Practice Question Palooza question episode of the BIF Bites podcast.

Vicki works for XYZ corporation, which pays her individual disability insurance premium. Which of the following is true?

1. The benefits are tax-free to Vicki.
2. The benefits are taxable to Vicki.
3. The corporation cannot deduct the premium.
4. The premiums paid by the corporation are not a tax consequence to Vicki.

Correct answer: B. The benefits are taxable to Vicki.

Instructor insight:

The corporation can deduct the premium. Because Vicki has not paid the premium with after-tax dollars, the benefits will be taxable to her when paid. In questions of this nature, it is important to identify which party is eligible for a tax deduction. If the employer is due a tax deduction, then the other party (the insured), is likely to have taxable benefits when received. In this question, the corporation is deducting the premium which creates a scenario of the benefits being taxable when received by Vicki.

Health Insurance and Health Care Cost Management

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Identify the penalty-free HSA transaction.

1. Cam receives individual HDHP coverage on 12/01/19 and contributes $3,500 to his HSA. He makes $300 monthly HSA contributions in 2020 until he loses HDHP coverage on 11/30/20.
2. Manuel initiates a $2,000 distribution from his employer-sponsored HSA and plans to rollover the funds to his personal HSA. After 90 days, Manuel deposits $1,500 into the personal HSA and uses the remaining $500 for car maintenance.
3. Erykah, age 55, uses her HSA to pay for nonprescription drugs and medicine.
4. Yousef, age 67, uses his HSA to pay for health club dues and nonprescribed nutritional supplements to maintain ordinary good health.

Correct answer: D. Yousef, age 67, uses his HSA to pay for health club dues and nonprescribed nutritional supplements to maintain ordinary good health.

Instructor insight:

Although Yousef’s expenses are considered non-includible medical expenses per IRS Publication 502 (Medical and Dental Expenses), he is over age 65. As a result, the HSA distribution for health club dues and nutritional supplements is subject to tax but will be penalty-free.

Since Cam used the last month rule to maximize his HSA contribution in 2019, HDHP coverage must remain active throughout the testing period that lasts until 12/31/20. His HDHP coverage was lost on 11/30/20, therefore, tax and a 10% penalty will be applied to his excess contributions.

Manuel took a distribution from an employer-provided HSA, but failed to rollover the funds to his personal HSA within the 60-day indirect rollover window. In addition, a portion of the HSA rollover was used for non-medical expenses. Tax and a 20% penalty will be applied to the $500 used for car maintenance.

Erykah’s purchase of nonprescription drugs and medicine using HSA funds is subject to both taxation and a 20% penalty since she is 55 and the items are considered non-includible medical expenses per IRS Publication 502.

CFP^® Exam insight:

HSAs have numerous planning uses including coverage of annual health care expenses, tax-deferred investment gains, annual above-the-line tax deduction for contributions, and, can serve as a pool of funds for long-term care costs. Remember this multi-purpose characteristic of HSAs as you work through problems on your exam.

Life Insurance (Individual)

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Match the policy type to the correct description:

Correct answer:

Instructor insight:

Term Life: The most affordable life insurance for younger individuals. Covers a set time period and promises to pay benefits only if the insured dies during the policy term.

Whole Life: As the name implies, provides coverage for the whole of the insured's life.

Universal Life: Pairs lower costs of term and the cash value features of whole life. Ability to adjust face amount and premium payments (with additional underwriting) offers flexibility to the insured.

Variable Life: Increased the opportunity for cash value fund to grow, but with greater investment risk to the insured.

CFP^® Exam insight:

Extend your understanding of the life insurance policy types by reviewing CFP® Board's Contextual Variables and identifying the life phases, special circumstances, and financial situations in which any of the policy types would be an ideal risk management method.

Annuities

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP^® Exam postponement to September 2020.

Ingrid, age 70, has owned a flexible premium deferred variable annuity for 10 years. She will begin annuity distributions this year. The total investment in Ingrid’s annuity is $150,000. The anticipated monthly annuity payment is $1,200 and her life expectancy (per IRS Table V) is 16 years.

Select the amount (rounded to the nearest dollar) of Ingrid’s annual annuity income that will be subject to taxation:

1. $9,374
2. $5,026
3. $14,400
4. $0

Correct answer: B. $5,026

Instructor insight:

This problem can be solved by using the Exclusion Ratio formula:

Ingrid’s total investment in the contract was $150,000. This amount is divided by the annual annuity payments ($1,200 x 12) times the life expectancy factor of 16.

Therefore, 65.1% of each annuity payment will be excluded from taxation. The amount subject to tax can be found by subtracting the excluded percentage from 1:

1 – 0.651 = 0.349

Finally, the taxable percentage is multiplied by the total annual payments to solve for the taxable amount:

$14,400 x 0.349 = $5,026

CFP® Exam insight:

If annuity payments continue beyond the life expectancy noted on IRS Table V, all income generated from the annuity is considered taxable income.

Property and Casualty Insurance

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

Match each homeowners form to the appropriate name:

Correct answer:

CFP® Exam insight:

Work toward memorizing the type of residence that is covered by each homeowners form and the extent of the included coverage. For example, single-family, residential homes are covered by HO-2, HO-3, and HO-5 forms. The higher the number of these forms, the greater the extent of the coverage.

Disability Income Insurance

This question is a part of BIF's Special Webinar series which was created to help students affected by the July 2020 CFP® Exam postponement to September 2020.

On July 1st Harold suffers severe spine and brain injuries as the result of a horrible motorcycle accident that leaves him in a coma. Doctors do not feel he will survive beyond a year.

Harold has group long-term disability insurance with a 30-day elimination period, and a benefit of 40% of Harold’s gross salary of $10,000 per month, payable until age 65. The group policy has a split definition of disability, with “own occupation” for 2 years and “any occupation” to age 65. Harold’s employer pays 60% of the premium and Harold pays 40%.

Harold also has an individual disability income insurance policy with a flat $2,000 per month benefit, 90-day elimination period, with benefits payable to age 65. This policy also has a split definition of disability with own occupation for two years and a modified definition to age 65. Harold pays for this policy himself with after-tax dollars each year. 

Harold’s most recent statement from Social Security shows an estimated disability income benefit of $1000 per month.

Assuming Harold is in a 22% marginal income tax bracket, what will be Harold’s aggregate net after-tax disability income benefits in the year the injury occurred?

Correct answer: The net after-tax aggregate amount for this year is $24,173.

Instructor insight:

Group policy: After a 30 day elimination period, the policy will pay $4,000 per month for 5 months his year. The total for this year is $20,000. Sixty percent of the benefits, $12,000 is taxable at 22%. Taxes total $2,640. The net after tax amount this year is $17,360.

Individual policy: After a 90-day elimination period, the policy will pay a benefit of $2,000 per month for 3 months this year. The total for this year is $6,000 The policy is paid for with after-tax dollars, therefore, there is no tax.

Social Security disability: After a 5-month waiting period, Social Security will pay a disability benefit of $1,000 for one month this year. Because of Harold’s income 85% of the benefit, $850, is taxable at 22%. The tax is $187, resulting in an after-tax benefit of $813 this year.

$17,360 + $6,000 + $813 = $24,173

CFP® Exam insight: The Exam will likely ask a similar question. Break each coverage down individually to identify the amount of benefit, the term, and the tax treatment. The information about coverage may be presented in a table as part of a case study.

This question is complicated. Let's hope you get lucky and your question(s) only asks about two types of coverage.

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