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R. Klein, EA
R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 2882
Experience:  Over 20 Years experience
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we are considering cancelling a life ins policy that builds

Customer Question

we are considering cancelling a life ins policy that builds cash value over time. What percent income tax would we have to pay on this payout?
Submitted: 2 years ago.
Category: Tax
Expert:  R. Klein, EA replied 2 years ago.

Randalltax :

Hello and thanks for asking,

Randalltax :

Generally these types of policies are qualified retirement plans, but not always. Do you know what type of policy this is? Is it an annuity or simply a cash-value life policy either whole-life or universal life?

Randalltax :

The only difference it would make is if it is a qualified plan, it would be subject to a penalty if you are under 59-1/2. If you are over this age, then it won't matter what the type of policy is.

Randalltax :

The tax is not a flat tax on the gain. Rather, it is a factor of adding this income to your total income. Even though it may be a capital gain or other type of income, it will be treated as ordinary income.

Randalltax :

If you are in the 15% tax bracket now, the payout, depending on the gain, may still be in the 15% bracket, or it may bump you up to the 25% or 25% bracket, or higher.

I can give you a general idea, if you tell me the follow facts:

Randalltax :

1. Your filing Status

2. Your estimated income not including this policy payout

3. Your estimated gain if you close this policy

4. Number of dependents

5. Your age and spouse's age

Randalltax :

The withholding is only a "down payment" on the taxes. It does not reflect the actual amount of tax owed on the distributions. 10% is usually the highest the withholding goes.

Customer :

married--35,000-40,000 gain would only be 11oo.oo dependants is zero

age 60 and 72

Randalltax :

OK, if the gain is only 1100, this will not change your tax bracket.

Randalltax :

Your tax is either 10% or 15% depending on your deductions.

Customer :

I'm sorry, I gave the wrong info. We were told the taxable gain would be 11,194.

Randalltax :

Still, not going to change tax bracket. Estimate 15% at most.

Customer :

they said approx fed tax would 1,119 and state 559.

Randalltax :

That's $1680 at the most.

Randalltax :

Wow...we typed at the same time. Me $1680---You $1678

Randalltax :

:)

Customer :

our other option is to keep paying the premiums and try to pay the loan amt off over time that is accruing at 5% interest and is now at 15,000 owed. We don't know what to do.

Randalltax :

How much is the death benefit on the insurance?

Do you have enough life insurance itself?

Customer :

we only have one other policy worth 5000. on my husband and a 25,ooo on me. His funeral expenses are paid in advance.

Customer :

the other amt we have is in an annuity with a guaranteed cash value which is at 77,ooo now I think

Randalltax :

How much is the benefit on this policy?

Customer :

5000.00

Randalltax :

So it sounds like you are upside-down on this policy.

If you cash out now, they will take $15K from you to pay the loan.

If you wait until the insured passes away, you will get $5K toward that loan, but still owe $10K.

Unless your investments are yielding 5% or better AFTER tax, it sounds like it would be better to get out now.

Randalltax :

Otherwise, each year, you get further into debt.

Customer :

okay that was my inclination, just wanted to be sure. thanks so much for your help.

Randalltax :

Have a great day.

Expert:  R. Klein, EA replied 2 years ago.
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