Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

Which of the following is true regarding the taxation of a life insurance policy loan?

1. The loan amount is taxable if it exceeds the policy basis

2. The loan is added to the policy's cash value as taxable income

3. The policyholder must pay taxes on the loan amount

4. The loan is not considered taxable income during the life of the insured

The correct answer is: The loan is not considered taxable income during the life of the insured

The correct statement is that the loan is not considered taxable income during the life of the insured. This principle is rooted in the tax treatment of life insurance policies, which treats policy loans as non-taxable cash value withdrawals as long as the policy remains in force. When an individual takes out a loan against their life insurance policy, it does not trigger a tax event because they are borrowing against their own capital. The loans must eventually be repaid, but until that point, the amounts borrowed do not count as taxable income. Tax implications may arise when the policy is surrendered, lapses, or upon the death of the insured if there is an outstanding loan; however, these scenarios do not affect the tax treatment of the loan while the policyholder is alive. This understanding is pivotal for policyholders as it allows them to access funds without immediate tax consequences, making life insurance loans a potentially valuable resource for liquidity.