Florida 2-15 Life, Health and Variable Annuity AgentGeneral Knowledge of Life InsuranceMedium
A policyowner has a $500,000 whole life policy with a cash value of $75,000. They decide to surrender the policy for its cash value. At the time of surrender, the total premiums paid were $60,000. How much of the surrendered cash value will be subject to taxation?
- A$75,000
- B$15,000
- C$0
- D$60,000
Show answer & explanationAnswer & explanation
Correct answer: B. $15,000
When a life insurance policy is surrendered for its cash value, any amount received that exceeds the total premiums paid (cost basis) is considered taxable income. In this case, $75,000 (cash value) - $60,000 (premiums paid) = $15,000 taxable gain.
Why the other options are wrong
- A. The entire cash value is not taxable; only the portion exceeding the cost basis is subject to tax.
- C. This would be incorrect; there is a gain, so some amount will be taxable.
- D. The premiums paid represent the cost basis, not the taxable amount.
Cash Value Surrender Taxation
When a permanent life insurance policy is surrendered, the amount by which the cash value received exceeds the total premiums paid (cost basis) is considered taxable income.
- Taxable amount = Cash Value - Premiums Paid
- Only the gain is taxed
- Applies to permanent policies
Memory trick: Cash in, gain out, tax follows.