13 Apr Will I owe tax on the cash value from my life insurance policy?

Q. I have been paying the premium on a $10,000 whole life policy for close to 50 years that now has a cash-in value of $16,000. I have been adding the interest I receive from the 1099 form to my gross income. Will the $16,000 be tax-free and will this money affect the $100,000 ceiling to qualify for the New Jersey 2020 pension income exclusion?
— Retired guy

A. It seems you’re receiving taxable dividends from your cash value life policy.

This is because the dividends exceed the amount of premium you paid for the policy.

Otherwise, life insurance policy dividends are usually not taxable, said Altair Gobo, a certified financial planner with U.S. Financial Services in Fairfield.

If you decide to cash in the policy for the $16,000 cash value, there may be a tax consequence to do so, he said.

It all depends on your cost basis, which is what you paid into the policy over the last 50 years, less any dividends received and not reinvested back into the policy or unpaid loans, Gobo said.

For example, Gobo said, if you paid premiums totaling $10,000 and received dividends of $1,000, your cost basis is $9,000. If you cash the policy in for $16,000, the difference of $7,000 is taxable to you.

“As far as this impacting your $100,000 pension income exclusion amount, one of the many items that determine if you exceed the $100,000 threshold for New Jersey pension exclusion purposes includes all taxable New Jersey income, which would include the taxable gains in a life insurance policy.”

That being said, in the example above, it would not be the full $16,000.

You can call the insurance company and request a policy gain statement before you cash it in so you will know how much of the $16,000 is taxable, Gobo said.

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This story was originally published on April 13, 2020.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.