Life Insurance✓ Verified · outline & fact-checked · Sep 2026Difficulty 3/5
A policyowner withdraws cash from a life insurance policy's cash value, taking out more than the policy's cost basis. The amount above basis is:
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Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under IRC Section 72, amounts received under a life insurance contract are taxable to the extent they exceed the policyowner's investment in the contract (cost basis). Withdrawals up to basis are a return of premium and are tax-free; amounts above basis represent gain and are taxed as ordinary income. Policy loans, by contrast, are generally not taxable events because they are debt rather than distributions.
Why the other options are wrong
- B) Only withdrawals up to the cost basis are tax-free; the excess is taxable gain.
- C) Gain inside a life insurance policy is taxed as ordinary income, not as a capital gain.
- D) Withdrawals are receipts, not expenses, and are never deductible.
Memory hook
Take out your premium first (free), then the profit is ordinary income. Borrowing, not withdrawing, dodges the tax.