How are life insurance cash values and death proceeds generally taxed?

• The cash value growth in a life insurance policy generally enjoys deferral of taxation while the policy remains in force.
  
  
• Policy loans, except those made from Modified Endowment Contracts, are generally NOT treated as taxable distributions.
  
  
• If the entire life insurance policy is surrendered for its cash value, the difference between the gross cash value and the taxpayer's basis in the policy, is generally subject to income tax.
  
  
• Partial surrenders from life insurance policies are taxable to the extent funds received exceed the taxpayer's basis in the policy.
  
  
• Funds coming out of a life insurance policy (other than as death proceeds) classified as a Modified Endowment Contract (MEC), are taxed differently than those not classified as a MEC. Under a MEC, distributions, including policy loans, are subject to income tax to the extent the gross cash value of the policy exceeds the taxpayer's basis in the contract. In addition, a 10% penalty tax may apply if the distribution was made prior to owner's age 59½.
  
  
• In general, life insurance death proceeds are not subject to income taxation. This income tax exclusion makes life insurance a very attractive financial planning tool.

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