Federal Tax Considerations — Life & Annuities

Correct

The answer is B: The loan balance is deducted from the death benefit, and the net amount is tax-free.

Any outstanding policy loan, together with unpaid interest, is deducted from the death benefit when the insured dies, and the insurer pays the net amount. The loan is not repaid from the estate, and the insurer does not forgive it. The net death benefit paid by reason of the insured's death remains excluded from the beneficiary's income under IRC §101(a).

Reviewed in our October 2026 California fact-check.

Correct

The answer is B: Loans and withdrawals are taxed gain first (LIFO), not basis first.

The main drawback of a MEC is losing tax-favored access to cash value. Loans and withdrawals are taxed gain first (LIFO), and the taxable part is subject to a 10% additional tax before age 59½ unless an exception applies (IRC §72(e)(10), (v)). Death proceeds are unaffected and stay generally income-tax-free, cash value still grows tax-deferred, and premiums for personal life insurance were never deductible in the first place.

Reviewed in our October 2026 California fact-check.

Correct

The answer is A: As tax-free return of premium until they exceed premiums paid.

Dividends on a participating policy are treated as a return of premium (IRC §72(e)). They are tax-free until the total dividends received exceed the total premiums paid, which is the owner's cost basis. Dividends in excess of basis are taxable. Interest credited on dividends left to accumulate is separate and taxable when credited. Dividends are not interest or capital gain, and they are not tax-free without limit.

Reviewed in our October 2026 California fact-check.

Correct

The answer is A: The employer-paid premiums are taxable income to the employee.

Unlike employer-paid group term life, which has a $50,000 exclusion, employer-paid premiums on a cash value (permanent) policy the employee owns or whose beneficiary the employee names are generally taxable compensation to the employee. The employee gets no deduction. The cash value does not become taxable just because premiums are paid, and the premiums are not tax-free.

Reviewed in our October 2026 California fact-check.