AD Banker Comprehensive Practice Exam

What happens to the cash value of a life insurance policy upon surrendering it?

1. It is automatically taxable

2. It may or may not be taxable depending on premiums paid

3. It is eligible for a loan

4. It is forfeited

The correct answer is: It may or may not be taxable depending on premiums paid

When a life insurance policy is surrendered, the cash value is typically considered to be taxable to the extent that it exceeds the total premiums paid into the policy. This means that if the cash value is greater than the amount of premiums you have contributed, the difference is subject to income tax. Thus, the situation requires careful evaluation of the policy's accumulated cash value against the premiums paid. If a policyholder had paid less in premiums than the cash value at the time of surrender, then the amount over the total premiums would be taxable. In contrast, the other scenarios provided do not accurately reflect what happens to the cash value upon surrendering a policy. For instance, while it may be true that the cash value can be used for a loan, this is not the primary outcome of surrendering the policy; instead, surrendering means the policy is terminated, and the cash value is paid out. The notion of forfeiture implies that no value is received, which does not apply here as cash value is involved upon surrender. Lastly, asserting that surrendering is automatically taxable simplifies the situation without considering the relationship between cash value and paid premiums. Therefore, the most accurate statement regarding the tax implications upon surrender is that it may or may not be taxable based on