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What are the tax implications of a life insurance policy loan that is still outstanding when the insured passes away?

A life insurance policy on the life of the insured was purchased in 1978 for $100,000 in a single payment. The present value of the policy is approximately $425,000. A loan of $400,000 was taken out by the estate on policy intended for long-term care expenses of the insured. The insured appears to be in fine health, but then unexpectedly dies. The residual value of the life insurance policy goes to the beneficiary or beneficiaries as a nontaxable event to them. But does the outstanding $400,000 loan become a taxable event to the estate?

Debt, Estate Planning, Taxes, Insurance, Life Insurance, End of Life
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April 2018

It's hard to answer this question definitively with your description.  You don't say what the death benefit of the original $100,000 purchase was. It's also unclear to me what value you're referring to when you say the present value of the policy is $425,000.

Another confusing piece of this is the reference to the estate taking out a loan on the policy intended for long-term care expenses. The owner of the policy is the only person who can make changes, take out loans, name beneficiaries, etc. An estate is established after someone dies. How can an estate own a policy on someone? Unless by estate you mean a trustee of a trust owned life insurance policy. That would be possible, but not an estate.

In general, here's how life insurance loans work. Whatever unpaid loan amounts outstanding when an insured dies get deducted from the life insurance proceeds. If you're saying the death benefit of the policy was $425,000 and the loan was $400,000, then the beneficiaries would get $25,000 in death benefits. In general, life insurance death benefits are tax-free. However, that depends on several factors like who owns the policy, who paid the premiums, etc. 

The beneficiaries should consult a tax attorney or CPA to discuss the tax implications. Not sure if you're asking on their behalf, or if you are the/one of the beneficiaries. Either way, seek professional advice.,

April 2018