I have an individual whole life policy for myself and I also opened independent whole life policies for each of my 2 boys. I am considering surrendering all three whole life policies, but am concerned with the possible tax implications for doing this. My policy has a "Net Cash Value" of $6996. There is another section showing the dividends for the policy. The "Maximum Dividend Available" is $415 with another line that is labeled "Paid Up Additions Face Amount" of $2019. I would like to know if I will be responsible for taxes on the "Net Cash Value" amount, the "Maximum Dividend Available", or the "Paid Up Additions Face Amount". The boys policies are similar, but much lower in value. Any help would be greatly appreciated.
The amount you will be taxed on upon the surrender of a whole life insurance policy is the difference between the cash-surrender value and your cost basis. In order to determine how much tax you will pay when you opt to take your cash-surrender value, you must first determine the total sum of premiums that you have paid into the policy over its lifetime, less any prior withdrawals. In the event that your basis is larger than the cash-surrender value of the policy, you will still receive the cash-out amount but will not be required to pay any tax on these funds.
Your insurance company can easily provide this information to you. I suggest you contact them and ask them for the necessary information to determine what your taxable amount would be upon surrender.
Thank you for the response. I will definitely ask for the information. Thanks again!
If I may, I'd like to tag onto this question.
We too are considering surrendering my 40 year old whole life insurance policy. At first, we paid the annual premium and then the premiums were paid from the yearly dividend. I see that the taxable amount is net of the cash value – premiums paid. Is this the same ruling when the dividends paid the premium? We reported interest on the dividends when filing our tax returns from the 1099 INT. Want to be sure the 1099 R will be correct. Thanks so much.
Is this the same ruling when the dividends paid the premium? Yes, it is.
The dividends were taxed so the premiums paid by the dividends should be added to the premiums you paid from out-of-pocket funds.
The interest on the dividends were taxed, not the actual dividends, so the answer is the same?
Excuse me for adding confusion to the issue.
"The good news is that dividend payments received from participating life insurance policies aren’t subject to taxes by the Internal Revenue Service since the insurance companies generated the gains off of their policyholders. In essence, the dividend payments are treated as refunds for overpayment of the premium." Per Investopedia.
The dividends are not taxed and are not to be added to the premiums you paid from out-of-pocket funds.
See also here.
I've decided to surrender the accounts. The form I must fill out with the company is requiring me to determine if I should have taxes withheld. The cost basis for all of the accounts is much greater than the net cash value to be received. I have the option of withholding no taxes (Federal and State), choosing a certain percentage for just Federal, choosing a certain percentage for just State, or choosing a percentage for both Federal and State. I'm not sure what to do. I do not plan on using the money, so it will be available should I need to pull from for next tax season.
Since it appears that you do not have any taxable gain in the policy at the moment and you indicate that you will have the money set aside should it be needed for taxes, I would elect no withholding.
There is no need to have it withheld if you will be able to have it readily available should it be needed to pay any tax due next year. It doesn't sound like you would be in any danger of an underpayment penalty situation, either, given the information that you have shared.
So I looked into the policies. Each policy does include a "maximum dividend available", a "paid-up additions face amount", and a "paid-up additions cash value".
My policy shows a maximum dividend of $469.56, "paid-up additions face amount" of $2277, and a "paid-up addition cash value" of $469.56.
My oldest's account is: "max. div available" $213.18, "paid-up additions face amount" is $843, and "paid-up additions cash value" is $80.21.
My youngest's account is: "max. div available" $182.11, "paid-up additions face amount" is $2021, and "paid-up additions cash value" is $182.
This is all of the information I can see on the policies. We have never received any tax forms in the pass for interest earned on these accounts. Is it still advisable to not withhold? I just don't want to too surprised next tax year.
If your basis exceeds the distribution there will be no taxable gain or loss.
Therefore, withholding would not be necessary.
A comment I have on this thread is that my insurance company subtracted prior withdrawals from the premiums paid to determine the cost basis, which was then used to determine the taxable amount. I am about to follow up and ask the insurance company for a year-to-year breakdown of the cost basis because in my opinion the cost basis should be used to determine the amount of prior withdrawals, not using the prior withdrawals total to determine the cost basis. Does anyone have an opinion on this?
were prior withdrawals tax-free? if so they represent a return of premium.
In my somewhat limited experience, when you cash in a whole life policy, be it the entire policy or only part of it, if anything is taxable the insurance company will send you a tax reporting document of some type. I know when I cashed mine in over 10 years ago, I received a 1099-R for the taxable portion of the payout. My taxable portion was basically the dividends that has accrued over the life of the policy.
In my case, additional paid-up insurance was used over a number of years to pay premiums. When the policy was surrendered, the insurance company considered the value of these to be withdrawals from the policy, which were then subtracted from the premiums paid to determine the basis.
One additional clarification, the additional paid-up insurance was purchased using the dividends received on the base policy.
One additional clarification, the additional paid-up insurance was purchased using the dividends received on the base policy.
What you did with the dividends is irrelevant. It's still taxable income when you cash out the policy.
Now the accuracy of that above statement assumes you had the same type of whole life policy I did. But like I said, if it's taxable/reportable on your tax return, you'll get a 1099-R (or some other tax reporting document) from the insurance company at tax time.
Sorry for the late reply. For a number of years, paid-up additional insurance was used to pay the premiums. Upon surrendering the policy, the insurance company considered these payments to be prior withdrawals. My contention is that the dividends used to purchase the paid-up additional insurance were a reinvestment in the policy and should be added to the basis of the policy, thereby reducing the taxable amount upon surrendering the policy.
Yes, the dividends used to pay your premiums can be added to the basis of the policy, but only if you reported them as taxable income in the year they were received.
Did you receive a 1099-DIV from the insurance company for these dividends? If yes, they can be added to your basis. If no, they can't be added to your basis.
The dividends were used to purchase additional paid-up insurance which was then used to pay premiums. My understanding is that the IRS position is that "Dividends used to purchase paid-up additional insurance or to pay premiums on the same policy are not taxable. This is because the dividend distribution and simultaneous premium payment, or purchase of paid-up additional insurance, for the same amount will cancel each other out."
"Dividends used to purchase paid-up additional insurance or to pay premiums on the same policy are not taxable.
Actually, it depends on the type of whole life policy one has. For the whole life policy I used to have, if the dividends are never "paid out" and you never sell or cash out the policy, then the statement is true that the dividends are not taxable. But when you cash out the policy, the dividends become taxable not matter what they were used for; be it buying additional insurance or anything else.
Generally, if you cash out a whole life policy and they send you a 1099-R, 1099-DIV or any other type of tax reporting document, then whatever portion of the payout is reported on that document is reportable on the tax return. The taxability of it may very well be a different matter. But it is reportable. Otherwise, they would not have issued the document.
I did get at 1099-R with the taxable amount in Box 2a. Can you provide an example of when an amount on a 1099-R is reportable but not taxable when a life insurance policy is surrendered?
Can you provide an example of when an amount on a 1099-R is reportable but not taxable when a life insurance policy is surrendered?
Not really. I've only had two whole life policies I've cashed out in my life. Both times a portion (not all) of the cashout was reported on a 1099-R and both times the entire amount reported was taxable. Perhaps another reading this thread can enlighten both of us?