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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

When you say present value are you referring to the cash value or the death benefit? When you say estate are you referring to a trust or an individual?

The way life insurance works is that any policy loans and interest due are subtracted from the death benefit when it pays out. For example, If a client had a loan out for $100,000 on a life insurance policy and the death benefit was $500,000 then if the client passed away the insurance company would pay out $400,000 to the beneficiary. This is a general concept but how the life insurane policy is structured with regard to ownership is crucial information with regard to taxation. Always consult a tax professional

I'm not exactly clear on the terminology you are using and so I have to be careful that I don't mislead you. Trust owned life insurance can be complex so you should consult with an attorney but I am not sure if that is what you are referring to in this case.

April 2018