Practice Quiz

Health and Life Insurance

Category - Tax Issues

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If a life insurance policy holder takes out a loan from their whole life insurance policy's cash value, what happens with the portion of the loan that has not been paid back if the policy is later cancelled or lapsed?
  1. The outstanding amount of the loan will be considered as gain and will therefore be treated as taxable income
  2. The outstanding amount of the loan will be considered gain and will therefore not be treated as taxable income
  3. The outstanding amount of the loan will not be considered gain as it came from the policy's cash value
  4. The outstanding amount of the loan will automatically be subject to the maximum amount of estate taxation
Explanation
Answer: A - If a life insurance policy holder takes out a loan from their whole life insurance policy's cash value, if the policy is later cancelled or lapsed, only the portion of the loan that has not been paid back will be considered as gain. Therefore, this amount will also be treated as taxable income and will be subject to income taxation. In this case, the policy holder must include this amount as income on his or her income taxes.
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