Are loans from my life insurance taxable as income?
Also if I cash in my current life insurance policy, is that amount taxable if I have paid the premium?
Answers | 7
If the policy is surrendered or lapsed the amount of loan above your cost basis (essentially your premiums paid) would be taxable as income in the tax year the policy lapses.
Part One, No, as long as 1) it is a non-MEC. I'll define non-MEC if needed. Your original policy illustration probably identifies it as either a MEC or non-MEC 2) You keep the policy until your demise. Often forgotten, you can withdraw an amount equal to the premiums you have paid thereby not incurring a loan. Remember that both loans and withdrawals will reduce the amount of life insurance and may have other negative effects on your policy.
Part Two - If you cash in (surrender) your policy with an outstanding loan and have made no withdrawals other than the loan, only the amount of the loan that exceeds the total premiums you have paid is taxable.
The two exceptions would be if you created a Modified Endowment Contract (MEC 1988) in which you over funded your life insurance (too much money too fast) and turned it into something similar to an IRA for withdrawals.
The other situation would be if you surrender or allow your policy to lapse. At that point all earning above your cost to have the policy or what paid up additions you had, would be subject to capital gains taxes.