How much of my surrendered life insurance policy should I pay taxes on?

How much of my surrendered life insurance policy should I pay taxes on?

by Alan M. Schapire, CPA | Jan 10, 2018

My father opened a whole life insurance policy in 2004 in my name. When I turned 18 the policy became mine. This year I surrendered the policy for the cash value. My father paid the premiums up until when I surrendered the policy, and I am 25 now. The premiums he paid are almost the equivalent of the cash surrender value. Do I pay taxes on the whole amount? Do I pay taxes on only the gains of the policy? Or do I not pay any taxes because the amount spent on the policy is almost equal to the cash value when I surrendered it?

There are various considerations when surrendering a life insurance policy. The life insurance company should be able to provide a complete history of the data needed to calculate any taxable gain. The simplest explanation I have seen addressing this issue is an article from Zacks Investment Research, “How to Calculate Taxable Income When Cashing Out Life Insurance Pre-Death.”

The premiums which your father paid on your behalf would be includible in the cost basis calculation. If someone other than you originally was the beneficiary of the policy and then it was transferred to you when you turned 18, there may have been a taxable gift at that time. That should not affect your calculation now upon surrendering the policy.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Alan M. Schapire, CPA, is a principal with Convergent Financial Strategies LLC in Wayne, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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