A policyowner has a cost basis of $50,000 in a non-MEC life insurance policy. The policyowner takes a partial cash withdrawal of $60,000. How much of the withdrawal is taxable as ordinary income for federal tax purposes?

Why B is correct

Under the FIFO rule for non-MEC life insurance, partial withdrawals first recover the policyowner's cost basis tax-free. Here the basis is $50,000, so the first $50,000 of the $60,000 withdrawal is a nontaxable return of premium. The remaining $10,000 exceeds the basis and is includable in gross income as ordinary income under IRC §72(e). The $10,000 gain is not capital gain, and no penalty applies because the policy is not a MEC and the owner is withdrawing from a non-qualified contract rather than a retirement account.

Why the other options are wrong

• A) $0 would be correct only if the entire withdrawal were within the basis; here the $60,000 withdrawal exceeds the $50,000 basis by $10,000, which is taxable. Part of the withdrawal is therefore income.
• C) $60,000 treats the entire withdrawal as income and ignores the tax-free recovery of the $50,000 basis that the FIFO rule provides. The basis is excluded, not taxed. So $60,000 is far too high.
• D) $50,000 confuses the basis amount with the taxable amount; basis is excluded from income, not taxed, so the correct taxable figure is the $10,000 excess. Basis is never a taxable figure.

Memory hook

Withdraw over your basis and only the excess is income — here $60k minus $50k = $10k.