Taxation of Life Insurance

Death benefit — received income-tax-free by the beneficiary. This is the most important tax advantage of life insurance.

Cash value growth — grows tax-deferred inside the policy. No annual tax on the investment growth.

Policy loans — not taxable when taken out (the policy owner is borrowing, not withdrawing). However, outstanding loans reduce the death benefit.

Adjusted Cost Basis (ACB) — the ACB of a life insurance policy is calculated as: > Premiums paid − Cumulative Net Cost of Pure Insurance (NCPI)

When a policy is disposed of (surrendered, lapsed, sold, or transferred), any amount received in excess of the ACB is a taxable policy gain — treated as ordinary income.

Disposition events include: surrender, lapse, sale, transfer (other than as collateral to a licensed financial institution), and death of the last life insured.