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Ask the Experts: Are life insurance proceeds taxable?

By Claudia Buck, McClatchy Newspapers –

Is there tax owed when cashing out a life insurance policy? IRS expert Jesse Weller has the answer:

QUESTION: I have a whole life insurance policy that has been building up a cash value based on the premiums paid. I no longer need the policy. If I cancel the policy and take out the cash value, is that money subject to income taxes, both state and federal? Or is it my money, since I’ve already paid taxes on the income used to pay the monthly premium?

ANSWER: Life insurance proceeds paid to a taxpayer because of the death of the insured person are usually not taxable.

But when a policyholder surrenders a life insurance policy for cash, the taxpayer must report and pay tax on any proceeds that are more than the cost of the life insurance policy.

Generally, a taxpayer’s cost, also called “investment in the contract,” is the total of premiums paid for the life insurance policy, minus any refunded premiums, rebates, dividends or unpaid loans.

Taxpayers should receive from their insurance company a Form 1099-R (Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.), showing the total surrender proceeds and the taxable portion. It usually arrives in January following the year of surrender.

More information is available in IRS Publication 525 (Taxable and Nontaxable Income). You can view it online at IRS.gov or receive a mailed paper copy by calling 800-TAX-FORM (829-3676).

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