Surrendering whole life policies

[ajwilliams78]

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.

[DavidD66]

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.

[ajwilliams78]

Thank you for the response.  I will definitely ask for the information.  Thanks again!

[zlark]

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.

[JamesG1]

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.

[zlark]

The interest on the dividends were taxed, not the actual dividends, so the answer is the same?

[JamesG1]

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.

[zlark]

James - Thanks so much for the clarification.  

[ajwilliams78]

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.

[SusanY1]

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. 

[ajwilliams78]

Thank you.  I appreciate the information.  

[ajwilliams78]

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.

[RobertG]

If your basis exceeds the distribution there will be no taxable gain or loss. 

Therefore, withholding would not be necessary.

[billjans]

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?

[Mike9241]

were prior withdrawals tax-free? if so they represent a return of premium.