Cash value taxable?

[Rich_by_the_Bay]

I have an old NML whole life policy which seemed like a good think to cash out of (no need for the coverage, money can do better elsewhere, etc.). Based on prior policy loans years ago, the cash value is about $28K with a death benefit of $77K.

So, I called to get the forms and was told that the policy had a cash basis of $112, and that almost the entire cash value would be considered as income and generate a 1099. My accountant really questions this, and NML - while reputedly a good company -- is perfectly capable of interpreting the tax code in such a way as to discourage cashing out.

Can anyone shed some light on his? Is cash value of a whole life policy considered taxable income?

 

[2B]

Can anyone shed some light on his? Is cash value of a whole life policy considered taxable income?

Your payments would be return of capital. Everything else is taxable interest. There really isn't much to debate. If you've had a bunch of loans against the policy that confuses the issue but you're ultimately stuck with what's on the 1099.

Any time you deal with an insurance company you will be screwed. Avoid them unless you must "pool" your risk and then get as little as you must have.

 

[renferme]

Here's what I found out:
"Your cash value is tax-deferred, meaning you will not pay taxes on it unless you withdraw funds. Cash value is only taxable when it's worth more than what you have paid into the policy. For example, if you've paid $20,000 in premiums, have $25,000 in cash value, and withdraw $23,000, $3,000 is taxable. If you withdrew less than what you have paid into the policy, you are not going to be hit with taxes."
http://www.insurance.com/Article.aspx/Cash_Value_in_Life_Insurance_Whats_it_Worth_to_You/artid/218

 

[73ss454]

I made the mistake of buying a few of these policies and in the end got screwed.

I currently hold 500K policy that was supposed to be paid up 8 years ago but that's all part of the scam, you just keep paying.
When the agent tells you you'll only have to pay for 10 years it's based on a very large interest rate that the policy never attains.   So you have to keep paying to make up the diff.

At the end of the day they end up in some sort of class action suit and the lawyers make a fortune and the customer gets screwed.

I would cash in the policy I currently hold but it's tied up in another suit so I'll have to pay the vig again this october.  I will cash it in next year one way or the other.

As mentioned above, anytime an insurance company is involved it's a scam, IMHO.  And yes you pay taxes only on any monies that is above what you paid in.

 

[Martha]

I was scammed by an insurance agent into buying an insurance policy in my 401k. I was told the same thing as the prior poster, that it would be paid up in 8 to 10 years. Well 10 years went by and it's cash value was $7800, almost exactly what I had paid into the policy. I bought the policy out of my 401k for the cash value and we probably will cash it in at some point. At least I know my basis.

Back when Greg and I were children parents and grandparents were sometimes sold wholelife policies on their children to help pay for college. My grandpa bought one on me. It was worth about $500 when I went to college and I cashed it in. Greg had one bought by his parents. He took a loan on it when he went to college. That fricking loan is still out there. We ignored it for years. Interest on the loan was added to the prinicipal each year. But the cash value kept going up. A couple of years ago the cash value increases were not keeping up with the loan balance increases. The insurance company sent a letter saying pay the interest on the loan or the policy will be cashed in to pay it off. And oh by the way, we will 1099 you for the cash value.

We have paid the interest the past couple of years. We have no idea what the basis is in the policy. I suppose I could try to get information from the insurance company as to how much was paid in premiums. But what a stinking bad deal.

Anyway, when cashing in a policy the insurance company may give you a 1099 for the amount you receive. However, you likely will not pay taxes on the entire 1099 amount. As others have mentioned, your basis is the amount paid in premiums. Odds are that the 1099 is not reduced by the premiums you paid.

 

[2B]

Anyway, when cashing in a policy the insurance company may give you a 1099 for the amount you receive.  However, you likely will not pay taxes on the entire 1099 amount.  As others have mentioned, your basis is the amount paid in premiums.  Odds are that the 1099 is not reduced by the premiums you paid.

I can't believe I'm coming to the defense of insurance companies. Of the ones I've seen where I also had the ability to recreate the contributions, their 1099s looked like they properly accounted for the contributions and internal financial workings.

You, poor dear Martha and Greg, will be skewred (worse than screwed ). The account interest that has been paying the loan interest is all taxable as ordinary income. The loan interest is not. You could potentially have an income shown on the 1099 that is greater than the amount you receive . Another thing they neglect to tell people.

I guess I didn't come to their defense afterall.

 

[Rich_by_the_Bay]

Anyway, when cashing in a policy the insurance company may give you a 1099 for the amount you receive. However, you likely will not pay taxes on the entire 1099 amount. As others have mentioned, your basis is the amount paid in premiums. Odds are that the 1099 is not reduced by the premiums you paid.

That's what I assumed, but apparently with whole life, a portion of your premium goes to cash value, and a portion goes to "real" insurance. Sorting that out with an ins comp that is not cooperative just may have to await an audit

 

[2B]

That's what I assumed, but apparently with whole life, a portion of your premium goes to cash value, and a portion goes to "real" insurance. Sorting that out with an ins comp that is not cooperative just may have to await an audit 

The comedy is that the "real" insurance is a tiny fraction of the actual payment. For the kiddy policies it approaches zero.

 

[Martha]

The comedy is that the "real" insurance is a tiny fraction of the actual payment. For the kiddy policies it approaches zero.

But how do you figure it out?

You, poor dear Martha and Greg, will be skewred (worse than screwed ). The account interest that has been paying the loan interest is all taxable as ordinary income. The loan interest is not. You could potentially have an income shown on the 1099 that is greater than the amount you receive . Another thing they neglect to tell people.

I guess I didn't come to their defense afterall.

No kidding. That is why we have been treading water, paying the loan interest out of pocket for the time being. There is only one solution, but I don't think Greg would appreciate it.

(He says use a small bullet )

 

[astromeria]

Who among us had never made a poor financial decision? The difference between us and the hoi polloi is that with our above-average intelligence, incomes, and often good luck (health, mentors, right job at right time, reliable spouse), we were able to make up for them. My ex's parents had bought a child policy for each of their children. When we got married, we got the hard sell to convert to a "better" policy. We were saved only by my skeptical nature, inability to understand the mumbo-jumbo or even the tables, and procrastination--he was ready to sign on the dotted line.

 

[73ss454]

That's what I assumed, but apparently with whole life, a portion of your premium goes to cash value, and a portion goes to "real" insurance. Sorting that out with an ins comp that is not cooperative just may have to await an audit 

After spending many hours on the phone trying to find out where my money was going I finally gave up. It's impossible to get any answers that make any sense. As mentioned above complete Mumbo-Jumbo.

I wish I would have figured all this out before I bought any. Oh Well!

 

[mickeyd]

Whole  Life = Whole Death

The way that WL works is like this:

Say the face amount of the LI policy is $50,000, say the annual premium is $500. Year one your $500 goes to pay the agent's commission and costs of issueing the policy. Your cash value (CV) after year one = $0. If you die beneficiary gets $50k.

Time moves on....say ten years later you are still paying the $500 premium however the CV has increased to $3000. If you die $50k is still paid to the beneficiary. What about the $3000 CV? What you have is really a Decreasing Term (DT) policy with a CV benefit that causes the DT to decrease at the same rate that the CV increases. In the example given, the policy will pay $47k plus $3k = $50k. If you have a policy that pays dividends that is a seperate deal. Most Mutual insurance companies pay dividends, which is really a return of your overpaid premium, so it is not taxed.

Time moves on...say 20 years later you are still have the policy but you are using the dividends to pay the $500 annual premium (free insurance some would say).  After paying 31 years of premium ($15,500) but some of those years using the dividends to pay,  you decide to cash in the policy for the CV of $20,500.  The way that the IRS decides what part of that CV is taxable is : Total premium paid by you - Dividends paid (returned to you) = your cost amount.  Deduct that from the CV and that is what you pay tax on.

For example, say you received $5,500 in dividends during the 31 years of owning the policy, since that was your own overpaid money being returned to you, the cost basis is not what you paid ($15,500) but $15,500-$5500=10,000. CV $20,500 - cost Basis $10,000 = $10,500 taxable income.

Thus the Form1099 that would be issued to the policyowner would be for $10,500 as that was the net gain over 31 years.,

 

[Gumby]

..

 

[2B]

I am about halfway into a very large 15-year paid up universal life policy, which I plan to cash out when it is paid up, which should occur just after I retire.*

Please let me know if I have overlooked anything or made any errors in my reasoning.

All I can say is that you got a great deal. I have personally never seen anyone get a "great deal" from any insurance product. I hope for your sake you did. I have seen lots of people "told" they were getting a really great interest rate but after a year it readjusted lower. Seven years ago a 7.4% insurance based product was not available to mere mortals except as a teaser rate. Insurance companies also give themselves outs to stop paying the high "guaranteed" rate if "market conditions warrant."

Again, I hope you're the first person that actually gets what the insurance salesman "promised."

 

[saluki9]

Rich

I'd think twice before surrendering an NML policy that is more than a few years old. While it probably wasn't a good financial idea at the time, once they are seasoned they can actually be a good deal.

Look at the dividends your policy is earning compared to the annual premium. You may be able to stop paying the premiums and have the policy run on dividends alone.

 

[Gumby]

..

 

[Rich_by_the_Bay]

I'd think twice before surrendering an NML policy that is more than a few years old. While it probably wasn't a good financial idea at the time, once they are seasoned they can actually be a good deal.

Look at the dividends your policy is earning compared to the annual premium. You may be able to stop paying the premiums and have the policy run on dividends alone.

The dividends are set to pay premiums and then increase cash value. Are you saying that I can stop paying premiums, forego the death benefit, and just leave the cash value to accumulate like a "real" investment? That might work well since the dividends are sheltered until withdrawn, if the rate of return is good.

I thought that if you don't keep up with premiums, they automatically deduct them from dividends, no choice, but I'll call. As others have said, this is damage control, and fortunately not a huge sum (though big enough to get my attention .

 

[Martha]

According the Fairmark forum, the taxable amount = the amount by which surrender proceeds exceed (premiums paid in less refunded premiums, rebates, dividends, and unpaid loans.) The 1099R should have the calculation when you cash the policy in.

We like Rich will continue with damage control. I have no desire to pay taxes on an unpaid loan and all the accumulated dividends. So, we pay the interest.

 

[Rich_by_the_Bay]

According the Fairmark forum, the taxable amount = the amount by which surrender proceeds exceed (premiums paid in less refunded premiums, rebates, dividends, and unpaid loans.) The 1099R should have the calculation when you cash the policy in...I have no desire to pay taxes on an unpaid loan and all the accumulated dividends. So, we pay the interest.

Course the other strategy is to take the cash value out, and get your accountant to jusfity not paying taxes on the full 1099 amt. Just because the ins company thinks this is taxable (and it's to their advantage to discourage cash-outs), doesn't mean that this is the only or best interpretation.

And even if you take it out as income, you will probably come out ahead by investing these after-tax dollars elsewhere. I don't know -- got some calls to make Monday.

 

[Nords]

Course the other strategy is to take the cash value out, and get your accountant to jusfity not paying taxes on the full 1099 amt.

Anything different than the 1099 will immediately be snapped up by the IRS's computers and subject to a long discussion.

I'm not sure it's worth the effort, to say nothing of the taxes, interest, & penalties....

 

[2B]

So far, the annual reports on the policy match my expectations.  I guess the acid test comes in another eight years when I try to pull the money out.

You may have been protected by the military affiliation. If so, great.

My first experience with insurance products was right after my first child was born I rushed off to buy life insurance. I didn't want to "throw away my premiums" into term life plus I would get "great returns" with my whole life policy.

Being anal-retentive, I took their high and low "projections" for the interest rates and I plotted out where my cash value would be far off into the future. The agent was really impressed.

Three years later when I checked my statement my cash value was less than half of my "low end" projection. I called the company and found out that the interest rate had fallen below their "low end" interest rate even though every other interest rate in the country had gone way up.

That was the first of many times that I've seen the "ol' switcheroo" done on an insurance product. I've just never been personally taken in as badly.

 

[saluki9]

The dividends are set to pay premiums and then increase cash value. Are you saying that I can stop paying premiums, forego the death benefit, and just leave the cash value to accumulate like a "real" investment? That might work well since the dividends are sheltered until withdrawn, if the rate of return is good.

Not quite... Look at your last year's statement. What were the dividends for the last 12 months compared to the annual premium? In many cases the dividends on older whole life policies can far exceed the annual premium. If you leave the policy in place you have no choice but to keep the insurance part. That being said you can stop your out of pocket costs, keep the insurance, and possibly still grow the cash value.

 

[Rich_by_the_Bay]

If you leave the policy in place you have no choice but to keep the insurance part. That being said you can stop your out of pocket costs, keep the insurance, and possibly still grow the cash value.

Oh, that.. yep, the dividends have exceeded the premiums for years; the remaining balance is used to increase cash value.

More I think about it, and the more I realize just how opaque the insurance company is about just how much money is going where, and what the real returns are, I am inclined to cash out, bite the bullet and invest it wisely.

 

[2B]

More I think about it, and the more I realize just how opaque the insurance company is about just how much money is going where, and what the real returns are, I am inclined to cash out, bite the bullet and invest it wisely.

Weren't you the guy defending annuities a while back? The same people you are dealing with now will let you put your life insurance cash value into an annuity. They will be just as opaque.

 

[Rich_by_the_Bay]

Weren't you the guy defending annuities a while back? The same people you are dealing with now will let you put your life insurance cash value into an annuity. They will be just as opaque.

Uh.. nice troll, but no, I wasn't defending annuities; I was pointing out that in selected situations there may be a place for immediate annuities only as a small part of a FIRE plan, depending on circumstances.

Anyway, back to topic, there seems to be an interest by the ins companies in discouraging cash outs; by taking the most conservative stance re: 1099s, they keep the IRS happy, accomplish their goal regarding impeding cash-outs, and have no risk.

Seems like you either go against their 1099 calculation (with the risk of flagging your income tax return for audit), or else just eat it, pay the tax, and move on.

Not sure which I'll do. May be worth a call to the accountant.