Expert: Willard R. Brumbaugh, LUTCF, CSFP - 9/9/2008

Question
Hello,
I currently own a Prudential variable appreciable life insurance policy(bought in 1987) that I want to surrender.  The contract fund amount is $11073.27 with a loan debt of $3979.84 leaving a net cash value of $7093.43.  There is no surrender charge according to the statement.  When I contacted prudential about surrendering this policy I got a verbal tongue lashing of why I needed to keep this policy and that there would be heavy tax implications involved.  I no longer wish to continue this policy however but would like to know exactly how this money will be taxed, and how much of the net cash value of $7093.27 I will in fact end up with. I am 50 years old, widower, no dependents, and no longer feel the need for life insurance. Thank you for any information you can offer.  

Charles

Answer
Dear Charles,

I don't blame you for wanting to make a change. While it is good to maintain enough insurance to not leave your heirs with the responsibility for paying your last expenses, it is likely that this policy is not suitable for this purpose.

I would only suggest that you should keep a Variable Life policy, which is what this is, if you were not eligible for something better.

To determine what the tax bite would be you would subtract the actual premiums that you paid from the contract value. If the total premiums are greater than the contract value, you will owe no income tax on the surrender of the policy.

As I believe you are aware, the contract value changes from day to day. Therefore the net surrender value after paying off the loan will also change from day to day. Whatever the contract value is the day that you surrender your policy minus the outstanding loan will determine how much you will receive.

The tax will not be based on what you receive, but rather on what the difference between the premiums paid and the contract value is at the time of termination. For example: if you had been paying $400 per year for the 21 years you have had the policy, you would subtract $8,400 from the contract value of say $11,074, and be taxed on $2,674. If you had been paying $600 per year, your premium total would be $12,600, and your taxable gain would be zero. Thus, no tax.

In the unlikely case that your policy's face amount is so low that you have created a Modified Endowment Contract, due to your age there would be a Federal premature penalty of 10% on the gain over premiums paid. Again, if your premiums paid exceed the contract value, there will be no tax or penalty.

Willard R. Brumbaugh, LUTCF
CA License 0374776
(888) 792-2379