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Tax on UL cash-out?
Old 05-16-2012, 10:57 AM   #1
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Tax on UL cash-out?

I was surprised. I am considering cashing out a $75K UL policy I have held for over 30 years. I have roughly $16K in cash value. The UL is getting more expensive, we really don't need it any longer, so I called the office to discuss the process.
I was told my $16K would quickly drop to $12.5K after the tax was paid. Surprise, surprise for me. I expected a little tax, or maybe none, but $3,500 was much more than expected.
I know little about insurance (never liked it, know I need it) but over 20% of the cash value going to tax?? Does that sound correct to some of you folks, much wiser and knowleagable in the insurance field?

Thank you for your input....I have not cashed out yet.
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Old 05-16-2012, 11:26 AM   #2
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Your UL policy doesn't have any fees for cashing out after 30 years probably. I'm not an expert on taxes, but I suppose that the difference between the cash value and the total of premiums paid will be taxed as your ordinary income (it's passive income like interest on bank savings). Hopefully, the amount you'll need to include on your 1040 will not bump you to the next tax bracket.
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Old 05-16-2012, 11:37 AM   #3
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Originally Posted by aida2003 View Post
Your UL policy doesn't have any fees for cashing out after 30 years probably. I'm not an expert on taxes, but I suppose that the difference between the cash value and the total of premiums paid will be taxed as your ordinary income (it's passive income like interest on bank savings). Hopefully, the amount you'll need to include on your 1040 will not bump you to the next tax bracket.
My understanding (not very strong since I've never owned one of these products) is that any cash value above and beyond "return of paid premiums" would be taxable.

For example: Over a 20 year period someone make $50,000 in payments into a UL or whole life product. The death benefit premium over the course of those 20 years was $35,000. The policy has a cash value of $40,000 currently. My rough understanding is that $15,000 of the cash value would NOT be taxable since that is "return of principal" so to speak in that it's the after-tax cash you already put in. You'd owe taxes on the remaining $25,000.

I'm sure there are going to be more nuances than this but I'm pretty sure that's the *basic* idea. Some of the cash value will be taxable (representing untaxed growth in cash value) and some will be non-taxable (the return premium payments that exceeded the amount needed to supply the death benefit).
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Old 05-16-2012, 11:43 AM   #4
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They will send you a 1099-R. In my case (2011) I had a gross distribution of ~$26k and a taxable amount of ~$4.5k. My contributions totaled ~$21k over 29 years as reported on the 1099-R. My figures showed ~$32.6k in "premiums". I'd two previous withdrawals over the years that removed ~$17k.

They may be confused with the terms "tax" and "taxable amount".

Note: they did not withhold taxes on the distribution.
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Old 05-16-2012, 01:22 PM   #5
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If you paid more than $16k in premiums and never took any withdrawals or loans, there should not be any taxable amount.
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Old 05-16-2012, 02:16 PM   #6
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Quote:
Originally Posted by Dave C. View Post
I was surprised. I am considering cashing out a $75K UL policy I have held for over 30 years. I have roughly $16K in cash value. The UL is getting more expensive, we really don't need it any longer, so I called the office to discuss the process.
I was told my $16K would quickly drop to $12.5K after the tax was paid. Surprise, surprise for me. I expected a little tax, or maybe none, but $3,500 was much more than expected.
I know little about insurance (never liked it, know I need it) but over 20% of the cash value going to tax?? Does that sound correct to some of you folks, much wiser and knowleagable in the insurance field?

Thank you for your input....I have not cashed out yet.
Doesn't sound right to me. Suspect there may be a miscommunication somewhere.

I wouldn't think any of your surrender benefit would be taxable assuming your premiums paid would exceed the surrender benefit. I suspect that the tax they are talking about might be tax withholding and any withholding you would likely get back when you file your return. The only thing that doesn't make sense to me is that the carrier would know that the premiums that you paid exceed the cash value, so why would they proceed to do withholding?

It might be worth a call to ask them whether there would be any taxable gain on a full surrender and if so, how they are computing it and if not, why they would withhold taxes?
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Old 05-16-2012, 02:20 PM   #7
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Quote:
Originally Posted by Dave C. View Post
I was surprised. I am considering cashing out a $75K UL policy I have held for over 30 years. I have roughly $16K in cash value. The UL is getting more expensive, we really don't need it any longer, so I called the office to discuss the process.
I was told my $16K would quickly drop to $12.5K after the tax was paid. Surprise, surprise for me. I expected a little tax, or maybe none, but $3,500 was much more than expected.
I know little about insurance (never liked it, know I need it) but over 20% of the cash value going to tax?? Does that sound correct to some of you folks, much wiser and knowleagable in the insurance field?

Thank you for your input....I have not cashed out yet.
They will ultimately have to send you a 1099 with the true taxable amount. They may also be throwing out a high number to encourage you to stay in the policy. (Have I mentioned I really distrust insurance companies?)

Even if you will have to pay $3,500 in taxes, you might as well cash it out now. You say you don't want the UL policy and the taxes aren't going to go down.
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Old 05-16-2012, 02:31 PM   #8
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For example: Over a 20 year period someone make $50,000 in payments into a UL or whole life product. The death benefit premium over the course of those 20 years was $35,000. The policy has a cash value of $40,000 currently. My rough understanding is that $15,000 of the cash value would NOT be taxable since that is "return of principal" so to speak in that it's the after-tax cash you already put in. You'd owe taxes on the remaining $25,000.
Hmm, yep, I definitely don't understand this product then. Because per your example above I don't see any taxable amount. The insurance sends you a check for $40k, but you paid them $50k. I didn't even think that the death benefit played any role here. So, in my understanding, if the $40K and $50k switched places, then I'd see the difference of $10k as taxable. But as I said I'm missing the whole point.
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Old 05-16-2012, 05:11 PM   #9
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My understanding ,like some of the others ,is that for a "normal" policy,
the excess of your cash balance less the premiums you paid in is the taxable amount. A "normal" policy is not a MEC. Some discussion of a non-MEC
policy in here: from https://www.usaa.com/inet/pages/advi...wment_contract

Taxation of a MEC:
Imposes tax on last-in, first-out (LIFO) method. Withdrawals, borrowings, or use of cash value as collateral from a policy classified as a MEC results in the immediate taxation of all or a portion of policy gains. XXXXXXXX HERE........Unlike distributions from a non-MEC policy, which are treated as a return of premium up to the amount of the policy basis................... TO HERE XXXXXXXXXXXXXXX, distributions from a MEC are treated as coming first from income (earnings) on the policy. The amount of the distribution (to the extent of policy gains) must be included in your gross income and is taxed at the ordinary income-tax rates. Policy gain equals the difference between the cash value and the net investment in the policy (policy basis).
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Old 05-16-2012, 05:57 PM   #10
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Hmm, yep, I definitely don't understand this product then. Because per your example above I don't see any taxable amount. The insurance sends you a check for $40k, but you paid them $50k. I didn't even think that the death benefit played any role here. So, in my understanding, if the $40K and $50k switched places, then I'd see the difference of $10k as taxable. But as I said I'm missing the whole point.
Unless you think the "value" of being insured for the death benefit over the life of the contract was $0, I don't see this. There is some value that gets consumed every month just by being covered with the death benefit.
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Old 05-16-2012, 06:11 PM   #11
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Unless you think the "value" of being insured for the death benefit over the life of the contract was $0, I don't see this. There is some value that gets consumed every month just by being covered with the death benefit.
Yep. My annual statements showed a cost of insurance. It started at $26/month when I was younger and rose to $74/month and increasing exponentially by the time I cashed out.
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Old 05-16-2012, 08:40 PM   #12
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All the responses have been a big help. In fact, I went back to the insurance co and either I didn't hear them correctly or they were talking insuranceSpeak.

My tax is not $3500, I have to pay tax on the $3500! They will withhold $350 if I check the box, or send me the full check and a 1099.

It was the tone of your messages that told me something didn't add up in my first message. Sure enough, because of the replies to my post, I checked back, heard correctly this time, and will cash-out soon.

I started a tempest-in-a-teapot......but your responses helped me figure it out despite myself! Thank you all for your patience.
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Old 05-16-2012, 10:22 PM   #13
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Originally Posted by kaneohe View Post
My understanding ,like some of the others ,is that for a "normal" policy,
the excess of your cash balance less the premiums you paid in is the taxable amount. A "normal" policy is not a MEC. Some discussion of a non-MEC
policy in here: from https://www.usaa.com/inet/pages/advi...wment_contract

Taxation of a MEC:
Imposes tax on last-in, first-out (LIFO) method. Withdrawals, borrowings, or use of cash value as collateral from a policy classified as a MEC results in the immediate taxation of all or a portion of policy gains. XXXXXXXX HERE........Unlike distributions from a non-MEC policy, which are treated as a return of premium up to the amount of the policy basis................... TO HERE XXXXXXXXXXXXXXX, distributions from a MEC are treated as coming first from income (earnings) on the policy. The amount of the distribution (to the extent of policy gains) must be included in your gross income and is taxed at the ordinary income-tax rates. Policy gain equals the difference between the cash value and the net investment in the policy (policy basis).
Most insurance contracts are specifically designed to have enough risk in them that they are NOT MECs. MECs are rare.
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Old 05-16-2012, 11:12 PM   #14
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Originally Posted by pb4uski View Post
Most insurance contracts are specifically designed to have enough risk in them that they are NOT MECs. MECs are rare.
My understanding ,like some of the others ,is that for a "normal" policy,
the excess of your cash balance less the premiums you paid in is the taxable amount. A "normal" policy is NOT a MEC. Some discussion of a NON-MEC
policy in here: from https://www.usaa.com/inet/pages/advi...wment_contract

.UNlike distributions from a NON-MEC policy, which are treated as a return of premium up to the amount of the policy basis..............
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Old 05-17-2012, 08:30 AM   #15
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Unless you think the "value" of being insured for the death benefit over the life of the contract was $0, I don't see this. There is some value that gets consumed every month just by being covered with the death benefit.
Not sure I comprehend your note completely.
But what about those who say or view the UL as an investment or saving account? I know that it's silly in many cases due to the costs paid to the insurance company, but apparently it's fine for some folks. They pay more than the minimum premium (max allowed by the insurance co.) and it seems that the cash value can exceed the death benefit after MANY years. What's the taxable amount for them when they cash out. Paid in less than the death benefit and the cash value is above the death benefit. This is theoretically speaking (I'm curious), because I'm not sure the folks who find UL beneficial use it this way. It's more for their estate taxes, I'm guessing.
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