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A client funds a $100,000 single-premium whole life (SPWL) policy. Two years later she takes a $20,000 policy loan at age 50. The most accurate federal tax treatment is:
ALoan proceeds are entirely tax-free because all whole life policy loans are treated as non-taxable distributions of basis
The contract is a MEC under IRC §7702A; the loan is taxed as a distribution to the extent of gain, plus a 10% additional tax under IRC §72(v)
CThe loan becomes taxable only after the policy's accumulated cash value exceeds the total premiums paid into the contract by 200%, under the SPWL accumulation rule
DThe loan is fully taxable as ordinary income, but only after the policy actually lapses or is voluntarily surrendered by the owner for its remaining cash value
Why this is the answer
A single-premium whole life contract by definition collects the entire lifetime premium in year one, vastly exceeding the 7-pay net-level-premium ceiling under IRC §7702A. Once a contract is classified a MEC, ALL pre-death distributions — including loans, partial surrenders, and assignments — are taxed under IRC §72(e) on a LIFO (last-in-first-out / income-first) basis to the extent of gain in the contract, and IRC §72(v) adds a 10% additional tax on the taxable portion unless the owner is 59½ or older, is disabled, or is taking substantially equal periodic payments.
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