Payment of a death benefit is not a disposition of a life insurance policy (includes the early death benefit available on a Joint Last To Die policy).

Upon disposition any gain is fully taxed as income regardless of how earned.

Taxable Policy Gain = Proceeds of Disposition - Adjusted Cost Basis

• Proceeds of Disposition = cash surrender value received (i.e., the money withdrawn)
• Adjusted Cost Basis = the cost of the policy
• applies even for exempt policies

Causes of Disposition

1. Surrender: full or partial (withdrawal)
2. Transfer of ownership (aka "absolute assignment")
   • exceptions (i.e., no disposition for)
     1. loan collateral
     2. tax-free rollover to
        • spouse
        • child, where the child is the life insured (as in "cascading")
3. Maturity
4. Conversion to an annuity
   • exceptions (i.e., no disposition for)
     • life insured is totally and permanently disabled, or
     • policy is grandfathered and gains are spread over the annuity period
5. Policy loans (after Mar 31, 1978)
6. Lapse
   • and not reinstated with 60 days after the calendar year of lapse
7. Void policy
   • e.g., if facts misrepresented
8. Dividend payment
9. Death benefit of a nonexempt policy
   • tax on the untaxed accrued income
     • death of a life insured under an exempt of grandparented policy is not a disposition
10. Upon becoming nonexempt

Note nonexempt life insurance policies are very rare.

Exemptions

The following are not causes of disposition for a life insurance policy

1. payment of a death benefit
2. assignment of the policy as collateral for a loan (other than a policy loan)
3. transfer of ownership ("absolute assignment") to
   • • • spouse
       • child, where the child is the life insured (as in "cascading")
4. payment of a disability benefit
5. use of a nonforfeiture option in a whole life policy contract

Articles

• Tax implications of a life insurance policy transfer (Sun Life, Aug 2003)
• Transfers of Personally-owned Life Insurance (Manulife)