Discussion:Life Insurance - tax on withdrawals of cash
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Discussion Forum Index --> Advanced Tax Questions --> Life Insurance - tax on withdrawals of cash
Discussion Forum Index --> Tax Questions --> Life Insurance - tax on withdrawals of cash
| 9 May 2008 | |
| Taxpayer has large life insurance policy. "Basis" (premiums paid over the years) is about $20,000. Taxpayer "cashed out" $30,000 of the cash value - assume by surrendering the paid up additional insurance that had been bought over the years with the dividends. Agent told him that since he had paid $20,000 in premiums, only $10,000 of this $30,000 would be taxable. Taxpayer got 1099R showing entire $30,000 to be taxable.
When question was then asked of ins. co. home office they said that the law was changed in 1982 and now the money out is taxable up to the point where you reach the basis. I am 99.9% sure they are right. Must be different than taking annual dividends in cash currently which are only taxed after you use up the basis as from personal experience I know those dividends are considred a return of premiums and not taxable. Any confirming or contrary opinion here? | |
| 10 May 2008 | |
| That's was my first thpught - same as what was told the taxpayer by his local agent. I did find this in doing an internet search.
"Q.I was wondering about the tax implications of withdrawing the cash value of my insurance policy. I was also wondering about how much I will have left in cash and what then happens to the insurance policy. A. The withdrawal of part or the total of the cash value in a life insurance policy constitutes a disposition for tax purposes. What this means is that there could be an amount taxable depending on the value of the policy. The amount is usually reported on a T5 slip and no income tax is deducted at source. The taxable amount is the excess of the amount withdrawn over the adjusted cost basis of the policy. In the case of a partial withdrawal, the adjusted cost basis is prorated to reflect the ratio of the partial cash value withdrawn to the total cash value of the policy. The adjusted cost basis of a life insurance policy is basically the cost of the insurance policy for the holder, which in essence corresponds to the total of the premiums paid, minus the net cost of pure insurance. The adjusted cost basis is calculated by the issuer of the policy. You have to refer to your particular contract to determine what would happen to your policy if you were to withdraw some of the cash value. Usually, a partial withdrawal will not cause the policy to expire in comparison to a total surrender of the policy." BUT - would a large Large Ins Co. such as Northwestern Mutual Life get this wrong? | |
| 10 May 2008 | |
| Can someone explain to me the benefit of doing the above? Was the client given bad advice, or am I missing something?
Could he have just taken a policy loan for 30K, and then never have paid it back? (that is, have it deducted from the death benefit). I mean, that is the key benefit, to have a deferred product, and you can "get to" under the fiction of a loan, lot better than paying penalities/taxes on other deferred products. | |
| 10 May 2008 | |
| Jake, you're an attorney. Attorneys thrive when people make mistakes. At any rate, I would compose a simple inquiry letter to the legal department at NWM asking asking why Code Sec 72(b) does not apply in this case?
As far as the advisability of cashing in an insurance policy, there is no financial product anywhere that is as sophisicated as a whole life insurance policy. And people are very unsophisticated in their understanding. They act emotionally. | |
| 10 May 2008 | |
| I agree with Crow - should have withdrawn up to basis, then borrowed 10K more (tax free) and left death benefit (minus loan) in place. BUT maybe they no longer needed any death benefit or couldn't afford any more premiums. Not a tax-savvy insurance agent, that's for sure. | |
| 10 May 2008 | |
| I thought that the amount borrowed in excess of basis would still be hanging out there and that it would be taxable upon termination of the contract (plus unpaid interest). Am I wrong? | |
| 10 May 2008 | |
| not if held until death and paid off by death proceeds, yes if contract terminated prior to death/maturity | |
| 10 May 2008 | |
| Problem is that the interest on the loan would probably cause the policy to lapse, causing a taxable event after the money has been spent. | |
Death&Taxes (talk|edits) said: | 10 May 2008 |
| If memory serves me correctly, 1982 was when the "3 Year rule" was taken out of the code, but I would not see how this would effect this transaction since basis is always basis and part must be allocated to any distribution under the general rule. Then again, maybe I am only thinking of pension distributions. | |
| 10 May 2008 | |
| quite possibly, but maybe not if they left some cash value in, we don't really know
without an in-force illustration, as any good CLU would have had run for his client. | |
| 10 May 2008 | |
| I'm not a big fan of policy loans, because the client's economic picture has invariably changed over the years. I think that you either have the need for life insurance or you don't. If you need it, but want different economic performance, look into a ยง1035 exchange. If you don't need it, cash it in or sell it through a life settlement company. Borrowing money from the policy just doesn't work for me as a long-term strategy. | |
| 11 May 2008 | |
| I understand that OP had to take the client as he found him. But whole life is still a great product. This is the issue I have with emphasis on 401(k) and the like, especially for the younger client: it's almost inevitable that they will take a bath on it to get at that money (and not for the downpayment on the first home either, haha). Savings is not retirement!~
If they are not going to go with some EE or I-Bonds (and those I-Bonds are far from clunky when you consider that Fed.'s low rates will spur inflation) then why not a whole life product? The whole life is actually far better, but anyway. I'll mention again the article by Arthur Jensen CPA in CPA/NPA Magazine December/March 2008. "Some People Call Life Insurance Contracts The Last Great Tax Shelter". I have been running this off and giving it to clients because he packs a huge amount of tax education into that article (even touches on a little AMT avoidance theory, estate taxes etc.). Question to Kevin, who I think is a CLU: What do they call the polcies that wrap the mutual funds, are they still calling them Universal Life or something like that? | |
