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The situation: My mother bought a life insurance policy and has been paying the premiums using after-tax dollars. The policy is held within a trust she set up with me and my siblings as beneficiaries. For reasons I won't go into, it didn't make any sense to continue paying the premiums for the policy. So we all (Mom and siblings) agreed to cancel the policy and evenly distribute the cash out value after surrendering the policy among the trustees. In the end I got a check for about $20k from the trust after the insurance company cancelled the policy.

Obviously I will seek professional guidance when filing my taxes, but for now I mostly need to understand if I need to stash away some of this cash for a tax liability.

The insurance company asserts that this does not generate any tax liability because it is simply a return of our after-tax premium payments (minus a penalty). However, given that the money was paid to a trust and then disbursed to my siblings from the trust I am not so sure.

Does anything in this scenario sound like I will likely incur a tax liability?

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It is a little difficult to understand what you are saying. It appears that the owner of the policy is the Trust and your mother was the one paying premiums? Normally those two would be the same - your mother - and the Beneficiary - would be the trust.

That a policy could be cancelled with return of premiums after anything but the shortest of times is also uncommon. Are you sure the money you received was not actually the cash value of the policy after surrendering it? (NOT a return of premium).

In either case - I believe there would be no tax consequence. The payout of a life insurance policy - or cash in for cash surrender value is never taxable (in the US) - that it was funneled through a trust is unimportant.

Alternatively - if it is somehow a cancellation of a policy and return of premium it is a simple return and cancelled transaction and can't have any tax effect (regardless of what route the refund took). But again - that could only really be possible if no coverage was ever in effect - that there was no claim is unimportant - there was coverage and risk by the company. Clearly, if she died before you said cancel...you would have (had a right) and taken the face value....because protection was in effect. I think your going to find it was a cash in of an inforce policy with a cash value....NOT a refund.

  • You are correct, it was the cash out value. Not the return of premiums. I was confused. Also, my siblings and I are the beneficiaries. I've updated my question. So the question remains, is this a taxable event? – JohnFx Jan 5 '18 at 22:53
  • Payouts of whole life insurance of any type are not taxable. It is one of the few benefits of life insurance. There are many ways to use a policy of the age and values you indicate rather than cashing it in, most providing cash and better results. Acting without knowing what your doing frequently has that result. Just returning the premium you said would be much much less than you received but illegal. – Teflon2Insults Jan 7 '18 at 3:39

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