Ask Terry Questions

By Terry Savage on October 13, 2018 | Insurance & Annuities

I am 68 year old and in very good health. I have had a life insurance policy I’ve been paying premiums on since 1980. I will not need the death benefit at the end of my life as I have other funds that will cover funeral expenses and take care of my heirs. I want to cash this policy in, knowing that I will probably only get a little close to half of what the death benefit would be. My accountant and attorney seem to feel this is a good idea. I do, too. What I would like to know what the tax ramifications will be. I can request that a certain percentage be taken out prior to distribution, but how much should it be? I want to pay the tax upfront so I don’t have to worry about any more taxable income next April 15. I have the forms to cash the policy in but am confused as to how much I should request be taken out for tax. Can you help me figure this out? Thank you.

Terry Says

You must ask your insurance company what portion of the amount you will receive represents premiums you paid into the policy over the years, and what amount represents investment earnings and dividends that accumulated inside the policy. You get the return of premiums paid on a tax-free basis. But you must pay ordinary income taxes on those earnings. They are likely to be a much smaller portion of the money you receive. And then you can ask the insurance company to withhold 20 percent on the taxable portion only.

Please do one thing before you cash in this policy. Check to see if the additional income you will receive from this taxable portion will not only put you in a higher tax bracket — but in a higher bracket for Medicare Part B premiums.

I’m surprised that your accountant did not know the answer to this simple question! So be sure to check on the impact of receiving the taxable cash portion.



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