Question

Betty owns a $150,000 whole life participating insurance policy that she purchased ten years ago. She has paid premiums of $4,000 each year since she bought the policy, and the current cash surrender value is $60,000. Betty has received $10,000 in paid dividends since the policy inception. Which of the following statements is/are correct regarding Betty's policy?

A. If Betty surrenders the policy now, she will have a taxable gain of $30,000 taxed as ordinary income
B. The dividends that were paid on Betty's policy were subject to ordinary income tax treatment
A) 1 only
B) 2 only
C) Both 1 and 2
D) Neither 1 nor 2

Answer 1

Betty will have a taxable gain of $30,000 if she surrenders the policy now. Dividends on the policy are not subject to ordinary income tax.

Step-by-step explanation:

The correct statement regarding Betty's policy is A. If Betty surrenders the policy now, she will have a taxable gain of $30,000 taxed as ordinary income. When Betty surrenders the policy, she will receive the cash surrender value of $60,000, which is $30,000 more than the total premiums she has paid ($4,000/year x 10 years = $40,000). This $30,000 gain will be taxed as ordinary income since it represents the difference between the surrender value and the total premiums paid.

The statement B. The dividends that were paid on Betty's policy were subject to ordinary income tax treatment is incorrect. Dividends on participating whole life insurance policies are generally not subject to ordinary income tax. They are considered to be a return of premium and are not taxable.