Advanced Underwriting Consultants

Question of the Day – May 15

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  I have a customer who purchased a non-MEC participating whole life policy several years ago.  The policy has a loan against it, and the owner has chosen to have the policy dividends repay the loan.  How will the dividends used to repay the loan affect the client’s basis in the contract?

Answer:  Dividends used to repay the loan are treated as taxable distributions, and will reduce basis to zero, then will be taxable.

Code Section 72(e) deals with this question.  That Code Section provides that a dividend, when declared, reduces the policy owner’s basis in the life contract.

If the policy owner uses a dividend to buy PUAs, the basis in the contract is increased by the amount equal to the distribution.  Thus, there is no net effect on basis.

However, if the dividend is used to pay a debt of the policy owner—the policy loan—it would not increase the basis in the contract.  That makes sense, because the loan itself did not reduce the policy owner’s basis—so a repayment of the same loan should not increase basis.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day. 

Question of the Day – September 25

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  I have a customer who purchased a participating whole life policy several years ago.  The policy owner has chosen to have the policy dividends buy paid-up additions (PUAs).  Do the dividends used to buy PUAs increase the client’s basis in the contract?

Answer:  Dividends used to buy PUAs have no net effect on basis.

Code Section 72(e) deals with this question, although the words don’t address the issue directly.  There are two possible ways of looking at dividends buying PUAs, both of which lead to the conclusion that there is no net effect on basis.

On the one hand, dividends buying PUAs may be looked at as money that never has left the insurance policy itself.  Therefore, there is no increase or reduction in the owner’s basis in the policy—as the transaction is completely internal to the policy itself.

The other possible way of interpreting the Code Section is that a dividend, when declared, reduces the policy owner’s basis in the life contract.  When the policy owner uses the dividend to buy PUAs, the basis in the contract is increased by a like amount.  Thus, there is no net effect on basis.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.