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Barbara
Barbara, Enrolled Agent
Category: Tax
Satisfied Customers: 2962
Experience:  18+ years of experience in tax preparation; 25+ years of experience as a real estate/corporate paralegal.
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if i cancel a life insurance policy that has a cash payout

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if i cancel a life insurance policy that has a cash payout do I have to pay tax even although it is after tax savings? Also is there any penalties? I have had the policy for 12 years I am 55 The monthly premium is $150 of which $100 went to life insurance and $50 went to the savings plan. I did not get a tax break on the savings so I guess that makes it pre tax dollars?


bkb1956 :

Welcome and thank you for giving me the opportunity to assist you with your tax question.

bkb1956 :

A life insurance policy is similar to a savings account. You deposit money into the life insurance policy in the form of premiums, the insurer uses a portion of your deposits to pay for the life insurance benefit and the remainder is invested. If you pay for enough years, your policy builds up a cash surrender value, or CSV. If the CSV is more than the premiums and you surrender the policy (cancel it), the excess is earnings and taxable income. For example, if you paid $1,000 in policy premiums for 20 years and you cash in the policy and receive $30,000, you'll pay ordinary income tax on $10,000 in earnings.


You should receive a Form 1099-R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b of Form 1040.


 

Customer:

I have paid say $150 for say 12 years = $21,600 for the life insurance and savings of which a third went to the savings portion - about $7,000. The surrender value is about $9,000. Would I therefore pay no tax based on the total premium of $21,600 or just tax on the $2,000 gain on the savings portion?

bkb1956 :

Is the cash value is more than the premiums you paid, the excess is earnings and taxable income. Likewise, if the premiums you paid are more than the cash value, there is no excess.

bkb1956 :

The first word in my last response should be "if" not "is." Sorry.

Customer:

ok, is the premium the whole payment including the life insurance portion?

bkb1956 :

Was what you paid monthly apportioned in any way or was it $150.00/month premium?

Customer:

It was a single monthly payment but it was broken out in the contract details I believe.

bkb1956 :

Then you would have to do the calculations on what amount pertains to the life insurance portion and what amount pertains to the savings portion.

bkb1956 :

It would seem that you would pay tax on the gain on the savings portion, based on what you are telling me.

Customer:

ok, thank you

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Geoffrey,

Just a short note to thank you for the "good" service rating and the generous bonus. It is most appreciated. If you have any questions in the future, please feel free to put "for bkb1956" in the subject line, and I will be happy to assist you. Recommendations to family and friends are always appreciated. Thank you again, and best regards.