Cash Surrender of Life Insurance

[BulldogTom]

Client is 81 years old.   His father bought him an insurance policy when he was 12.   Has paid the $126 per year until last year when he cashed out the policy.   1099R shows distribution fully taxable.   Shouldn't the premiums paid over that 68 years be deducted from the taxable amount?   Or am I missing something.

Tom
Longview, TX

[Lee B]

It may depend upon the type of life insurance policy.

[DANRVAN]

2 hours ago, BulldogTom said:

 1099R shows distribution fully taxable

Box 1 should show the total distribution = amount received.

Box 2a should show the taxable amount, box 1 less basis (premiums).

If

[BulldogTom]

10 hours ago, DANRVAN said:

Box 1 should show the total distribution = amount received.

Box 2a should show the taxable amount, box 1 less basis (premiums).

If

But the box 1 & box 2 amounts are the same

Tom
Longview, TX

[Randall]

Insurance companies should provide an annual statement showing the activity.  People should save these annual statements.  It's doubtful your client has that saved.  You'll probably have to estimate his cost basis.

[Lee B]

2 hours ago, BulldogTom said:

But the box 1 & box 2 amounts are the same

Tom
Longview, TX

Check and see if he had a Universal Life Policy that generated Dividends and Interest

[BulldogTom]

1 hour ago, Lee B said:

Check and see if he had a Universal Life Policy that generated Dividends and Interest

I am thinking that is the case.   Client tells me that a couple of years ago (? how many) the Insurer told him to stop making payments because the earnings took care of the premiums.   I am inclined to believe the calculation of the Insurance company on the surrender.

Tom
Longview, TX

[DANRVAN]

4 hours ago, Lee B said:

a Universal Life Policy that generated Dividends

 

3 hours ago, BulldogTom said:

stop making payments because the earnings took care of the premiums. 

The dividends are considered a tax free return of dividends; any excess is taxable.

But in this case did the dividends offset all the past premiums paid?  If he has been receiving taxable dividends that would be an indication. 

[BulldogTom]

No taxable dividends since I have been doing his returns (5 years).   1099INT from the insurer this year in addition to the 1099R.   Cash value was a little higher than the face value of the policy.

Tom
Longview, TX

[DANRVAN]

6 hours ago, BulldogTom said:

1099INT from the insurer this year in addition to the 1099R

Interest taxable for sure.  

 

10 hours ago, BulldogTom said:

 I am inclined to believe the calculation of the Insurance company on the surrender.

I would check it out to be sure they are not overlooking any premiums that were not paid back as dividends.

[Catherine]

Sounds like you should talk to an insurance agent who sells whole life, term life, and variable life (including universal) policies. See if they can point you to any information sources.

I do have one contact who sells insurance; not sure if he sells life policies. If you have no one you already know, I could ask him. 

[Sara EA]

On 2/7/2024 at 7:23 AM, BulldogTom said:

Box 2a should show the taxable amount, box 1 less basis (premiums).

The premiums paid are not the cost basis.  The policy holder is paying for insurance, don't forget, plus some administrative costs.  In other words, he bought something with a portion of those annual payments.

[BulldogTom]

26 minutes ago, Sara EA said:

The premiums paid are not the cost basis.  The policy holder is paying for insurance, don't forget, plus some administrative costs.  In other words, he bought something with a portion of those annual payments.

I am aware that there are commissions and admin fees included in the cost he paid that are not premiums for insurance and do not increase the cash value of the policy.  

The thing that has me stumped is this client is pretty meticulous in his recordkeeping, especially for someone 81.   He does not have any records of anything coming back to him as dividends.   He remembers they sent him a letter telling him he did not need to make payments anymore, but he says he never got a dividend check.   As soon as he decides to cash out the surrender value of the policy is nearly equal to the face value of the policy and 100% of all contributions have been returned as non-taxed distributions of premium.   Something does not add up.  Or maybe it does and I just see conspiracies everywhere I look.

Tom
Longview, TX

[jklcpa]

7 minutes ago, BulldogTom said:

The thing that has me stumped is this client is pretty meticulous in his recordkeeping, especially for someone 81.   He does not have any records of anything coming back to him as dividends.   He remembers they sent him a letter telling him he did not need to make payments anymore, but he says he never got a dividend check.   As soon as he decides to cash out the surrender value of the policy is nearly equal to the face value of the policy and 100% of all contributions have been returned as non-taxed distributions of premium.

It does make sense if you think of a whole life policy's surrender in a different way. When the policy is surrendered and CSV is received, that is a return of premiums and the excess that is  being reported as taxable is that which has grown beyond the premium, and that is why it's said that the premiums paid over the life of the policy is considered basis.

[jklcpa]

Does the 1099R received by the client show the entire cash amount that was received, or is it just the excess amount over premiums returned to him?

[jklcpa]

As an aside, and I don't believe this is the type of policy your client had, but there is a type of policy called return of premium term life insurance. That type of policy is term insurance where the insured can have all of the premiums returned if he/she outlives the policy's maturity date. 

I've never known anyone that has this type of policy and have only read about it.

[Lee B]

Has your client called the insurance company and asked why?

[jklcpa]

13 hours ago, BulldogTom said:

He does not have any records of anything coming back to him as dividends.   He remembers they sent him a letter telling him he did not need to make payments anymore, but he says he never got a dividend check.

Dividends in whole life policies aren't always paid to policy owners. In your clients case they were left in, and that's why they were available to pay premiums.  Besides being paid to owners in cash, dividends can be left in and used to pay premiums, left on deposit that accumulate with interest, or to purchase paid-up additional whole life insurance.

If there no paperwork explaining the payout and its components, the client's insurance agent or company should be able to provide the explanation and breakdown.  The business clients I've had over the years with whole life-type policies received annual statements that showed the face value, CSV, termination dividends, any outstanding loans, accrued interest on loan, net value, and any potential taxable gain on surrender.  Does your client have any statement from a prior year that may provide clues as to how the 1099R amount was determined?

 

14 hours ago, BulldogTom said:

As soon as he decides to cash out the surrender value of the policy is nearly equal to the face value of the policy and 100% of all contributions have been returned as non-taxed distributions of premium.   Something does not add up.  Or maybe it does and I just see conspiracies everywhere I look.

 

Maybe the amount isn't that farfetched. This policy is almost 70 years old, and that's a lot of time to accumulate value that's never been taxed.

[Catherine]

21 hours ago, BulldogTom said:

As soon as he decides to cash out the surrender value of the policy is nearly equal to the face value of the policy and 100% of all contributions have been returned as non-taxed distributions of premium.   Something does not add up.

I agree that it sounds odd indeed. Talk to an insurance person not connected with the client or his insurer, and ask how these things can work. See if you can get anything that says the type of policy that it is.

[jasdlm]

Seems like the dividends and interest paid inside the policy exceeded the basis of the premiums, which could definitely happen, and the former would be taxed when surrendered.