Cash out Life insurance and Taxes

[retiredandbusy]

I have 2 whole life insurance policies. Both have cash value associated with them. I am thinking about cashing them out.

Policy 1 has a cash value of $22,000 with a cost basis about 52,000. I know if I cash this one out I will not have to pay any income tax.

Policy 2 has a cash value of $90,000 with a cost basis of $58,000. If I cash this one out I would owe tax on the gain $32,000.

The question is, if I cash both out in the same year, my cost basis on both policies is about $110,000 and my cash out total is $112,000. Can I use one to offset the other on taxes or is each policy taxed separately?
TIA

 

[Jay1958]

No, you will not be able to offset the loss in one policy against the gain in the other policy.

Gain on surrender of a life insurance policy

The general tax rule is that any gain from the surrender of policy to the extent the cash surrender value plus any outstanding policy loans exceed the investment in the policy, will be subject to tax at ordinary income tax rates.

Loss on surrender of a life insurance policy

The general tax rule is that a loss recognized upon the surrender of policy is not deductible to the policy owner. However, in some limited cases a taxpayer may be able to deduct the loss if it was incurred in a trade or business.

Disclosure: This reply is from an insurance producer and discusses general tax rules. Prior to taking action, you should consult with a licensed tax advisor.

 

[Jay1958]

Possible Planning Strategy:

For the policy in the loss position, you may wish to consider a 1035 Exchange, where you transfer the life insurance cash value to an annuity. Since your cash value is lower than your cost basis, the higher basis will transfer from the life insurance policy to the annuity contract, allowing it to accrue greater value before the growth becomes taxable.

For example, you exchange your whole life insurance policy that has a $22,000 cash value (assuming cash value and surrender value are equal) and a $52,000 cost basis for an annuity. The annuity will inherit the $52,000 cost basis, even though it will be funded with only $22,000. This allows for $30,000 of growth in the annuity before gains become taxable.

Disclosure: Before considering this strategy, you should discuss its suitability with a licensed insurance producer in your state and discuss your specific tax situation with a licensed tax advisor.

 

[DHK]

I am thinking about cashing them out.

Why?

 

[Lloyds of Lubbock]

Just to get some further info?
How old are you and how old are the policies?
Jay is spot on regarding your tax liabilities.
Do you feel you no longer need the coverage?
Do you think you have to much coverage and these are excess?
Do you just not want to pay for them anymore?
I would think the larger policy could be premium offset.
It seems a shame that you have held on to these policies during a low interest rate period and now that dividends are trending up (for now) you want to cash them in.
Have you gotten inforce illustrations as that is always a good starting point.
I would especially look at the YOY IRR it may be a better deal than you think.
Good luck whatever you choose to do.

 

[Allen Trent]

I have 2 whole life insurance policies. Both have cash value associated with them. I am thinking about cashing them out.

Policy 1 has a cash value of $22,000 with a cost basis about 52,000. I know if I cash this one out I will not have to pay any income tax.

Policy 2 has a cash value of $90,000 with a cost basis of $58,000. If I cash this one out I would owe tax on the gain $32,000.

The question is, if I cash both out in the same year, my cost basis on both policies is about $110,000 and my cash out total is $112,000. Can I use one to offset the other on taxes or is each policy taxed separately?
TIA

generally no, but there are some IRS regs pertaining to Annuities with losses being able to be deducted on a tax return as an intemized deduction.

So, couple possibilities:

1. If insurable & still want some paid up forever insurance, could buy a new Life insurance policy with single deposit & 1035 exchange both your old policies into the new one. So, that would make the new contract start with total cash value of $112,000 & a cost basis of $110k because both the gain & loss would flow into the new contract from the previous carrier reporting if you do a carrier to carrier 1035 exchange & never take possession of the money.

2. Could do the same as #1 above, but do the 1035 exchange into a new NQ Annuity contract if you dont want the tax free death benefit for some unknown reason.

Both 1 & 2 should be looked at closely if you plan to cash the money out soon as new life & annuity contracts purchased could have load fees up front or Surrender charge schedules that could lower the account value below what you deposited.

Lastly, if these are WL policies, you can also just ask the carrier how much Paid up Life insurance each would provide as all WL policies by law have to have Reduced Paid up as a non-forfeieture option.

The real question is, are you wanting to eliminate the premium & keep tax free insurance inforce or are you trying to harvest all the cash to spend it elsewhere. The reasons for you plan will change what you likely should do, etc

If just wanting to eliminate the premiums, there are ways to modify the WL policies to have the dividends &/or PUAR values pay part or all of your premiums on the policy & maintain the policy or elect reduced paid up with the policy or 1035 exchange to a new carrier

 

[retiredandbusy]

Thanks for all the replies.
No, I do not want an Annuity.
No, I do not need the cash.
I will soon be 72 and not a big need for life insurance. Kids are grown. I have taken care of wife financially.
The smaller policy has increasing premiums that do not justify the benefit.
The larger policy cash value is more than the face value and yes I can now let the dividends pay for the premium.

 

[Lloyds of Lubbock]

The larger policy cash value is more than the face value and yes I can now let the dividends pay for the premium.
This does not sound right but let's say it is.
Cash out the policy and pay the tax.
Pull your basis out out and RPU the policy.
All the best whatever you do.

 

[Allen Trent]

.
The larger policy cash value is more than the face value and yes I can now let the dividends pay for the premium.

This is likely not true. My guess is you think the original base policy death benefit is all that would be paid at death. If dividends have been either buying paid up insurance each year or accumulating at interest, that added amount will also be part of the death benefit.

Ask them to either change dividend to pay premium or have them elect a reduced paid up policy. (Assumimg no current loans on the policy)

 

[Lloyds of Lubbock]

Whether you want the insurance or not, get an inforce.
At least you will know exactly what you have.
If you think the cash value is greater than the db, you don't know what you have.
If you have a 100k cv with a 60k basis cash it in have them hold a % of your 40k gain for taxes and call it a day.
If you want the coverage, numeous options have been suggested as actions you can take.