Policy Loan vs Withdrawal
A policy loan borrows against cash value at interest while the policy stays intact with full face amount (reduced at death by the loan). A withdrawal permanently removes basis and value, reducing the death benefit and possibly creating MEC taxation.
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Practice This Concept
A policyowner takes a cash withdrawal from a non-MEC life insurance policy that exceeds the total premiums paid into the policy. The excess amount withdrawn is:
Taxable as ordinary income to the extent it exceeds the policy's cost basis — Under IRC Section 72(e), amounts withdrawn from a life insurance policy's cash value are taxable to the extent they exceed the policyowner's cost basis, generally the total premiums paid. Under the cost recovery method, withdrawals first return the basis tax-free; once basis is fully recovered, further withdrawals are taxable as ordinary income. A policy loan, by contrast, is a borrowing and is not a taxable distribution. If the policy is a MEC, withdrawals are taxed on a LIFO basis with a possible 10% penalty before age 59 and a half.
National insurance concept