AD Banker Comprehensive Practice Exam

The cost basis of a life insurance policy is __________.

1. Cash values in excess of premiums paid

2. Premiums paid less dividends or withdrawals

3. Dividends left on deposit at interest plus the policy's cash values

4. Cash values plus any outstanding policy loans

The correct answer is: Premiums paid less dividends or withdrawals

The cost basis of a life insurance policy refers specifically to the total premiums that have been paid into the policy, adjusted for any dividends received or withdrawals taken. This approach is essential for determining taxable gain if the policy is surrendered or otherwise matures. By focusing on option B, it accurately reflects the method of calculating the cost basis. The premiums paid represent the initial investment in the policy. When withdrawals or dividends are taken, they reduce the amount of the original investment that remains in the policy, hence adjusting the cost basis downward. The other options involve additional factors that are not directly related to the calculation of the cost basis. For instance, cash values in excess of premiums paid or dividends left on deposit at interest are considerations for the policy's overall value and performance, rather than the basis itself. Additionally, taking into account outstanding policy loans would pertain more to the net value of the policy rather than the original cost basis used for tax purposes. Understanding these distinctions helps clarify the concept of cost basis in the life insurance context.