L&HNationalhard
A 30-year Return-of-Premium (ROP) term policy reaches the end of its term. The insured is alive; the carrier returns all $42,000 of premiums paid as the ROP benefit. For federal income tax purposes, the $42,000:
AIs fully taxable as ordinary income because the policy reached maturity and paid out a benefit at the end of its 30-year term
BIs taxable as a long-term capital gain because the refunded premium amounts were held within the contract for more than one year
Is generally NOT taxable, because it is a return of the policyowner's own basis (premiums paid) with no gain element
DIs taxable only to the extent the total refund amount exceeds 90% of the cumulative premiums the owner actually paid
Why this is the answer
Return-of-Premium term is level term with a refund-at-end feature: if the insured outlives the term, the carrier returns the cumulative premiums paid (sometimes net of riders). Because the refund equals the investment in the contract (basis), there is no gain to tax under IRC §72(e); the policyowner simply recovers her own money. If the refund ever exceeded total premiums paid (rare; some products include a small interest component), the excess would be taxable as ordinary income. ROP premium is materially higher than plain level term for the same face amount.
Studying for the Life & Health exam?
This question comes from our L&H bank. Take a free practice test — no signup.