Is the surrender value of whole life insurance taxable as normal income or as long term capital gains?

Question

My insurance company has told me that over $6000 of the value will be taxable. I've had the policy for 20+ yrs and am hoping that the $6k is taxed at the LOWER long term capital gains rate - not as normal income, which is almost twice as much.

Answer 1

No.  Life insurance is taxed at ordinary income....always.  It IS NOT subject to capital gains tax at all.

Of course that's only if there's a gain.  You can also 1035 exchange it to a new contract or an annuity contract.  If there's any substantial gain you could (for an example) annuitize the contract into payments over 5 years and spread the taxable income over a period to lessen the impact.

You could also borrow it out which wouldn't be taxable either.  But, the simple answer to your question is "ordinary income."

Hope that helps,

Jeff

Answer 2

If the surrender value exceeds the total of premiums paid into the policy you have, no doubt, had the policy for more than one year therefore the only the amount that exceeds the premiums paid into the policy would be taxed. That gain would be taxed as a long term capital gain.

On the other hand if your surrender value is below the total premiums paid into the policy there is no gain and the amount you receive is not taxable.

From IRS TAX TIP 2008-35

Almost everything you own and use for personal purposes, pleasure or investment is a capital asset. When you sell a capital asset, the difference between the amounts you sell it for and your basis, which is usually what you paid for it, is a capital gain or a capital loss.Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.

Capital gains are classified as long-term or short-term, depending on how long you hold the property before you sell it. If you hold it more than one year, your capital gain or is long-term. If you hold it one year or less, your capital gain is short-term.

Answer 3

From IRS Publication 525:

"Surrender of policy for cash.   If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. In general, your cost (or investment in the contract) is the total of premiums that you paid for the life insurance policy, less any refunded premiums, rebates, dividends, or unrepaid loans that were not included in your income.

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 or on lines 12a and 12b of Form 1040A."

Answer 4

You only pay capital gains tax on the GAIN.  The gain is, interest.

Most of the time, with whole life, you don't HAVE a gain.  You take all the premiums you've ever paid in, and subtract that from what you get out.  MOST of the time, that's a negative number - you don't get out, more than you paid in.  So there's no gain.

Since you've been told you HAVE a "gain", you pay taxes on the "gain" portion.  If you've held the policy longer than a year, it's long term capital gains, NOT normal income.