insurance's surrender value
I cashed in an insurance policy. Is the amount
I received from it considered earned income, dividends or interest?
When you surrender an insurance policy, generally most of what you
receive is a return of the premiums you paid for the policy. Since
premiums paid for the policy were never deductible, the return of
the premiums is not taxable.
If the policy performed well, then you may have received
more than the premiums upon its surrender. This is considered ordinary
income and is reported on line 7 of your 2003 Form 1040. The insurance
company will issue you a Form 1099 reporting the gross amount that
you received and, provided they have sufficient information, the
amount that may be taxable, if any.
If the insurance company is unable to tell you the
taxable amount, you need to compile a record of what you paid in
premiums. Sometimes an insurer cannot tell you what you paid as
it may have acquired the policy in a merger or the policy may be
quite old. However, you should not hesitate to reduce the amount
you received by your actual premiums. Depending on how long you
have had the policy, it would not be surprising to find that none
or only 10 percent to 20 percent of what you received is actually
taxable. If you paid more premiums than you received in return,
the loss is not deductible.
The older that an insured gets, the more sense it
may make to cash in an insurance policy. As the insured ages, the
cost of the insurance gets expensive and begins to eat into the
value of the policy or makes the annual costs of maintaining the
policy quite expensive. Additionally, as you age, the need for the
face value of the policy may not exist as sufficient other assets
may be available. A professional accountant or trusted insurance
adviser can help you make a determination as to whether to maintain
the policy or surrender it.
If the cash value in the policy is needed, you can
also consider borrowing from the policy, which would not be taxable.