Disposition of a Life Insurance Policy

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  • Proceeds of Disposition = cash surrender value received (i.e., the money withdrawn)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

Exempt policies are not taxed at death: the death benefit —> beneficiary tax-free

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.


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


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