Cash Surrender Value of Life Insurance
I bought a whole life cash surrender value policy a number of years ago. When I die will my beneficiaries have to pay tax on the cash value? If so, would I be better off cashing in this policy and making another type of investment?
Richard Crew, Beeville, Texas
Good question, Richard. The proceeds from the death of the insured are tax-exempt, which is why whole life insurance is so popular in order to transfer wealth tax-free. Keep in mind that if you cash in a policy early, you may have taxable income.
Think of life insurance as a savings account. You pay premiums into a policy and the insurer uses a portion of your payments to cover the life insurance protection; the rest is invested. After a number of years making premium payments, you are credited with what is called a cash surrender value, or CSV. If should decide to cancel the policy, and the CSV is more than the premiums, the excess is earnings and taxable income. Let’s say your annual premiums are $1,000 and you have had the policy for 20 years, your premiums are $20,000. Then you cash in your policy and receive $30,000, you’ll subtract the $20,000. and pay ordinary income tax on the difference which is $10,000 in earnings.
The life insurance company will issue you a Form 1099-R showing the total proceeds and the taxable part. You will submit this form and be taxed in the year that you cashed in the policy.
Clarify with your CPA
Before you make a decision of whether or not you should cash in your cash surrender value policy, you should talk to your Insurance Agent or CPA for clarity and compliance with requirements imposed by the IRS. A little caution can avoid penalties under the Internal Revenue Code.
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