Universal or Whole Life Insurance

[Bonnie]

Does anyone know if you cash in a whole life policy or universal life insurance policy for the cash value in it then is it taxable? I'm just asking for future reference as we are thinking of cashing ours in. I could ask the agent but felt I'd be more likely to get an accurate answer here.

[Koss]

Insurance Proceeds

It depends on how the policy is structured. In all likelihood, part of it will be taxable, and part of it will be a return of your original contributions or premiums.

In most cases, when you cash in this type of policy, it is actually distribution from a retirement plan. The accumulation of cash value in the policy is a tax-deferred retirement savings vehicle. Like an IRA, capital gains accumulate within the policy and are not taxed until money is withdrawn.

The taxable portion will probably be calculated for you. You'll get a 1099-R with a gross distribution in Box 1, but the taxable amount in Box 2 may be less.

This type of distribution is usually subject to the 10% penalty, unless you qualify for one of the exceptions, or unless you are 59 1/2 or older.

[S T]

Exchange

You might be able to accomplish a Section 1035 Exchange.

Sandy

[Jesse]

Is there any type of policy were it would not be any taxable proceeds?

I have a client that has always had interest from a life insurance policy and this year she said she cashed it in and she thinks it is a tax free transaction.

I had her call the company and they claim no 1099R will be issued. I thought this to be strange as I still think part of it should be taxable and part of it a return on her investment.

[Burke]

Is there any type of policy were it would not be any taxable proceeds?
I I had her call the company and they claim no 1099R will be issued. I thought this to be strange as I still think part of it should be taxable and part of it a return on her investment.

Whether a life insurance policy (or part of it, I should say) is taxable or not depends entirely on how long it has been in existence, the premiums that were paid, whether it may have paid dividends, and its underlying cash value. These transactions were determined to be a taxable event by a change in tax law some time back (may have been 1986 or prior). The same reasoning is now applied to these as other investments; i.e, if you get back more than you put in it, after adjusting for the cost of the actual insurance, then you have a taxable gain. If the policy was not kept for very long, it wouldn't have any taxable gain. Note that dividends paid from mutual life insurance companies were never taxable each year that they were paid, but they are used to calculate if there is taxable gain at surrender. Of course, death proceeds are not.

[S T]

Cashed out

Burke provided some good information.

Jesse, I would say if she cashed out the policy then there could be some taxable gain, however, she could have exchanged it under Sect 1035 rules and not inucr any taxable amounts. Just had a couple this year that transacted an exchange from one John Hancock Policy to another and the code was Section 1035 exchange.

Sandy

[AZ-Tax]

Borrow from the policy for a non taxable event..

Every policy has loan provision so I suggest they borrow from their policy for which a non taxable event takes place. Remember, loans need not be paid back. The Insurer collects the loan upon the death of the insured. If they don't like the policy for some reason, then I suggest going the 1035 exchange route.

[Jesse]

Thanks for the insight. I'll have to talk to her again because it just seems I'm not receiving the all the facts. She said it was a policy her Dad took out on her when she was a child back in the 60's and the amount she received was "only around $3,000", one of those clients that it seems easier to pull teeth than get documentation, everything is always written down - as if by seeing the actual 1098's will reveal some type of confidential info that she doesn't want me know. I will again ask for documentation rather than just her word.