Ask the Experts!
The professionals at Advanced Underwriting Consultants (AUC) answer the tax questions posed by producers. Here’s the question of the day.
Question: I’ve heard that a withdrawal from cash value life insurance during in the first 15 years of the policy may be subject to taxation. If the withdrawal reduces policy death benefit but does not exceed cost basis, is it still possible that it may be subject to tax?
Answer: Under normal, non-MEC life insurance taxation rules, withdrawals from a universal life policy are generally treated as a tax-free recovery of basis, and taxable only after all basis has been recovered.
In relatively rare situations, a withdrawal may be taxed differently. A withdrawal reduces the policy’s death benefit. Death benefit reductions within the first 15 years of the policy may cause a taxable distribution to be “forced out” of the policy. The force out is required because of federal rules regarding maximum premiums allowed to be paid into life insurance policies. Force outs are taxed on a gain-first basis.
A force out is likeliest to happen if the policy has been stuffed full of premium close to the maximum federal guideline limit.
It is difficult or impossible for a non-actuary to be able to predict accurately when a force out may occur, or how much the force out needs to be. The best advice is to ask prior to taking a distribution or making a policy change during the first 15 years.
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