AD Banker Comprehensive Practice Exam

How much of the cash value received upon surrender of a permanent life insurance policy is taxable if an insured has paid $1,000 in annual premiums for 12 years and is due $15,000?

1. Zero

2. $3,000

3. $15,000

4. $12,000

The correct answer is: $3,000

When a permanent life insurance policy is surrendered, the cash value received is subject to taxation only to the extent that it exceeds the total premiums paid into the policy. In this case, the insured has paid $1,000 in annual premiums for 12 years, which totals $12,000 in total premiums paid. Upon surrender, the insured is due $15,000. To determine the amount subject to tax, you subtract the total premiums paid from the cash value received. Thus, the calculation is as follows: $15,000 (cash value) - $12,000 (premiums paid) = $3,000. This means that $3,000 of the cash value received upon surrender is taxable. The correct understanding of the tax implications hinges on recognizing that only the gain (the amount received over and above the total premiums) is taxed. Therefore, the amount taxable when surrendering the policy is $3,000.