LLQP Life Insurance · Component 2.1 · 30% of the exam
A policy loan taken from a whole life policy is taxable to the extent that:
- AIt is never taxable, since a loan is a debt that must be repaid rather than income received by the policyholder
- BIt exceeds the death benefit, since a loan above that amount leaves the insurer with no security
- It exceeds the policy's adjusted cost basis at the time the loan is taken
- DIt is used for personal purposes rather than to earn income, since the interest is then not deductible
Correct answer: C) It exceeds the policy's adjusted cost basis at the time the loan is taken
A policy loan is a disposition; the amount by which the loan exceeds the policy's ACB is a policy gain included in income. Repaying the loan later creates a deduction. Collateral loans from a third-party lender are not dispositions.
Why the other options are wrong
- APolicy loans can be taxable to the extent they exceed the ACB.
- BLoans cannot exceed the death benefit; the comparison is with the ACB.
- DThe purpose of the loan is irrelevant to whether a policy gain arises.
Exam tip
Policy loan above ACB = policy gain. Repayment later creates a deduction. Collateral bank loans avoid this.
Common mistake
Assuming policy loans are always tax-free because they are 'loans'.
What this tests
CISRO competency component 2.1 — Analyze the available products that meet the client's needs — which is weighted at 30% of the Life Insurance module. Written against the published curriculum.
More from component 2
- A client has a need lasting about twenty years and compares a ten-year and a twenty-year term policy. The main point to explain is that:
- A client exercises the conversion privilege on his term policy. The permanent premium will be based on:
- A client notices that a small policy costs proportionately more per unit of coverage than a larger one. The explanation is that:
- A client wants to pay monthly rather than annually. The agent should explain that monthly payment:
- A client asks why dividends from her participating policy are not taxed like interest from a bank. The reason is that a dividend is:
- A universal life policyholder is choosing among the investment options inside her policy. She should understand that:
Practice the whole Life Insurance module
Timed sets weighted like the exam, and review of every question you miss. Free to start.