Which of the following is/are true regarding cash value life insurance? a. The cash value is always taxed when it is withdrawn b. The cash value is always tax free when it is withdrawn c. The cash value cannot be withdrawn until 5 years after policy inception d. B & C e. None of the above
The correct answer and explanation is:
The correct answer is e. None of the above.
Explanation:
Cash value life insurance is a type of permanent life insurance that accumulates a cash value over time, in addition to providing a death benefit. Some key points about the taxation and withdrawal of the cash value in such policies are as follows:
- Cash value is not always taxed when withdrawn (A): Cash value withdrawals are generally not taxed, but the amount withdrawn is subject to certain conditions. If the policyholder withdraws more than they’ve paid in premiums (the “basis”), the excess amount will be taxed as income. In other words, withdrawals are generally tax-free to the extent that they do not exceed the premiums paid.
- Cash value is not always tax-free (B): While cash value withdrawals up to the policy’s basis (amount paid in premiums) are usually not taxed, any amount above this threshold is considered a gain and will be subject to income tax. Therefore, the statement that cash value is always tax-free when withdrawn is incorrect.
- Cash value can be withdrawn at any time (C): There is no specific requirement that cash value cannot be withdrawn until 5 years after policy inception. Policyholders can typically access the cash value at any time, although doing so may impact the death benefit, and there may be surrender charges or fees for early withdrawals.
In summary, none of the provided options accurately reflect how cash value life insurance works in terms of taxation and withdrawals. While withdrawals of the cash value can be made, there are conditions regarding taxability, and there are no mandatory waiting periods such as the 5-year requirement mentioned in option C.