What Are the Tax Consequences of Cashing Out a Variable Universal Life Policy?

Variable universal life policies are a combination life insurance and investment product with the potential to earn a profit. These policies take a portion of your paid premium and put in your choice of investment vehicles. Over time, depending on the performance of the policy's investments, the gains from the contributions can create a cash value for the policy. However, if you make a profit on a variable universal life policy, you will owe income taxes on that profit when you withdraw the money.

Basis of the Policy

Taxes are due on any gains that you withdraw over and above the policy basis. The basis of the policy is the total insurance premiums paid on the policy. If you cash out a universal life policy worth $30,000, and you have paid a total of $25,000 in premiums, you will pay taxes on the gain of $5,000.

Partial Withdrawals

If you make a partial withdrawal from a universal life policy, you incur no tax liability until you have withdrawn more from the policy than you have paid in premiums. If you paid a total of $25,000 in premiums, and your policy has a cash value of $30,000, and you withdraw $25,000 in cash value over two years, you have no tax liability. If you withdraw the additional $5,000, and have paid no more in premiums, the $5,000 is subject to taxes.

How is it Taxed?

The IRS collects taxes on taxable life insurance proceeds at your normal income tax rate. If you are married filing jointly, and your income is $100,000 per year, you are in the 25 percent tax bracket, as of 2015. If you withdrew $5,000 from your variable life insurance policy that is taxable, you would owe 25 percent of that amount, or $1,125 in taxes.

Tips

    • If you have a large tax bill from a large withdrawal from a variable life insurance policy, you may need to pre-pay on your taxes to avoid tax penalties.
    • If you have a high taxable gain that you are cashing out, it could have significant impact on your total tax liability due to an increase in your tax bracket. Structure large, taxable withdrawals over multiple years to lessen this impact.

Death Benefit

The death benefit of any type of life insurance policy, including variable life, is not subject to income taxes. If the death benefit is $300,000, the beneficiary collects $300,000 income tax-free. Depending on the ownership of the policy, the amount of the death benefit may be included in the deceased's estate, and used as part of the estate tax calculation.

Tips

  • As of 2015, your estate must be valued at more than $5.43 million for an individual, or $10.86 million for a couple, before estate taxes are levied.

Loans

Loan proceeds against cash value on life insurance are not taxable. You also don't have to pay the loan back. The insurer deducts the balance of the loan from the death benefit of the policy. You do need to pay the interest on the loan, either from the cash value of the policy, or by paying it yourself.

About the Author

Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.