Life Insurance proceeds help please

[joanmcq]

Client (now deceased) had insurance policy mature in 2014.  1099-R has $17,332 gross proceeds and $9314 as the taxable amount.  His daughter (long time client that took over his affairs in 2013) says he only received a check for about $5k.  It might have been the $5509.50

 

Paperwork from insurance company states the following:

 

Face value of insurance                                 $5,000

   Dividend Accumulation balance                         $0

   Interest on accumulation                                    $0

2013 Dividend                                              $334.50

Termination dividend                                   $175.00

 

Subtotal                                                     $5,509.50

 

Less    Loan balance                                            $0

            Loan interest due                                      $0

 

Net policy balance                                       $5,509.50

 

Another page of 'important tax information' has the net distribution as $5509.50, gross distribution as $17,332.75 (cash value plus dividends allowed over life of plan)

 

Gross premiums paid: $8.018.59

Dividends allowed       $12,332.75

Net cost                        ($4814.16)

 

amount taxable 'in our opinion' $9,314.16

 

I am not familiar with life insurance contracts at all, but in the last two years, I haven't seen any 'dividend' income from this policy, and although the dividends for 2013 and termination dividend were added to the cash received over the contract value, I have a hard time seeing why he would pay income tax when the amount of premiums was more than what he received.  Does this type of contract pay actual monies out over the years, ie. the dividends allowed figure?  My client's brother was handling his dad's affairs before 2013 (badly), so I have no idea if he received cash dividends over the years.

 

I know there are some insurance agents on here; can you explain to me so that I can explain to my clients?

[Lee B]

From The Tax Book:

 

Dividends paid on Insurance

 

" Dividends paid on insurance policies are a partial return of the premiums paid.

 

Do not report them as dividends. Include them in income only if they exceed

 

the total of all net premiums paid for the contract."

[jklcpa]

Those dividends could have been being used to pay the premiums each year too.  Sometimes they don't exceed the premium and so no cash is received.

 

What you posted does make sense.  All of the accumulated dividends and cash value of the contract exceeds the basis in the contract (total of prems paid). Your client should have received that cash, and I wonder if it was paid to him before the daughter took over.

 

http://www.themadisongroup.com/Resources/Taxation%20at%20Maturity%20-%20Cash%20Value%20Life%20Ins%20bulletin.pdf

[B. Jani]

The best I can explain is:

(1) Your client had option to use dividend to pay the premium and if more then premium, then balance in cash. That is why dividend balance is 0

(2) The taxable amount is more then death benefit paid means policy made profit (earning) hence 1099R is issued for that. Yes it is taxable.

Hope this helps.

[Randall]

Not sure what's going on here.  If dividends received each year, he should have received a 1099R showing zero taxable amount until basis ran out.  After that, 1099R showing amount as taxable.  But then the insurance company would have tracked that and would not be showing so much as taxable.  So I'm not sure what's going on here.  Check to see if you have past records to track this.  Dividends inside a policy aren't really dividends as in a 1099-DIV.  Like credit unions calling interest 'dividends' (they issue a 1099-INT).

[joanmcq]

what are dividends received inside a policy then? 

[jklcpa]

Some policies, like whole life and universal life, combine insurance and savings in one product.  Cash value in these builds up and dividends are paid on the savings, and like B Jani said, these policies have the option to apply the dividends to the premium that is due.  Your client's policy came to maturity (reached a certain age) and it had a build up of cash value that is shown in box 1 of the 1099R.  Box 2, the taxable portion, is the amount of cash value in excess of basis. Basis is the total premiums paid over the life of the policy.

 

The maturing of the policy might have occurred earlier in the year before his death and that is why the daughter doesn't know he received these funds. Does the 1099R or paperwork indicate a date that this payout occurred?  The company could tell you that so that daughter could find out where the money went, and the age when the policy matured. Might be age 95.

 

Then your client died and the face value plus terminating dividend was paid out.  The payout at maturity and the payout at death might be two separate events.  I think you might be confused by the daughter's statement about the $5500 payout being all they received and trying to match that up with the 1099R you are looking at.    The 1099R you have seems to combine the maturity and the death benefit of $5000 (face value of the policy) into one form.

 

If your client had died prior to reaching the age specified in the insurance contract, the beneficiary would have received only the death benefit, and the accumulated cash value and dividends would not have been paid out, the insurance co would have kept that.  That is why these types of policies are not great investments.

[Randall]

If your client had died prior to reaching the age specified in the insurance contract, the beneficiary would have received only the death benefit, and the accumulated cash value and dividends would not have been paid out, the insurance co would have kept that.  That is why these types of policies are not great investments.

 

Judy, not sure I agree with this last part.  Assuming no loans or withdrawals, the death benefit should be higher than cash surrender value.  But since the policy was terminated or surrendered before death, something has happened.  There must have been payments to him.  Joan, don't get confused by the word dividend.  It's just build up inside the policy (interest, dividends).

[Burke]

Dividends on life insurance policies are considered a return of premium and are not generally taxable until such time as they exceed the premiums (less cost of insurance and other calculations).  He could have used them to pay the premium, as others have said, but he also could have gotten a check every year if he elected a cash option.  Apparently they were paid or used over the years, as there were no dividends left to include in the distribution.  I say distribution, because if it was received as a death benefit, it would not be taxable.   This type of calculation (now required by the IRS) happens when a policy matures or is surrendered by the insured.  It is considered a gain and taxable.   The 1099R is reportable on the (now deceased's) final tax return since I am assuming it was paid out while he was still living. 

[Burke]

 

f your client had died prior to reaching the age specified in the insurance contract, the beneficiary would have received only the death benefit, and the accumulated cash value and dividends would not have been paid out, the insurance co would have kept that.  That is why these types of policies are not great investments.

 

If this had been a regular whole life policy, the dividends (if still credited to the policy and not previously withdrawn) would have been paid out at death as part of the benefit.

[Randall]

Burke, I agree.  But I would have thought once the dividends paid to him exceeded basis, he would have received a 1099R showing taxable income each year.  In the original post, it seems this is reported all at the end.

Joan, the only thing I think you can do is get the annual statements if available.  This would give you a complete history.  Otherwise, your client is stuck with reporting the 1099R as is.  Insurance companies don't always get this right.  So if you have the annual statements and he's shown taxable income thru the years on his returns, you may be able to get a corrected 1099R or report it as corrected on the 1040.  Another thing 'funny' in the original post is the ins company stating the taxable amount 'in their opinion'.

[jklcpa]

Randall and Burke, you are correct!  I started to change my post right after I made it and didn't change it all, then interrupted by appointments.

 

One of my clients had the exact same thing this year, and just talked to him about this about an hour ago! He had a policy that he rolled about $42K into something else with a 1035 exchange, 1099R with a code 6 for the exchange.  Then he also had the nasty surprise of a second 1099R of over 18K of accumulated dividends in excess of basis that were used to pay the premiums over the years.  Normal distribution and no cash received. He thought the 1099R was in error and called the company to find out what it was all about.

 

Of course, he didn't tell me about the 18K when I did his tax planning for a sale of investment property, and with the 18K and him reaching a higher level of a large bonus last year, he is now subject to AMT, the NII and the additional Medicare tax too, none of which I had in the planning. Even after the estimates I'd set up, he owes over $11K on the Federal return alone. 

[joanmcq]

The policy matured and was paid out while he was still alive - age 97.  The final dividend and the termination dividend were added to the cash value of 5k, he received $5509.  My client took over his finances from her brother in 2013, and is now executor/trustee since all his assets were in a living trust.  She doesn't know if he's been receiving the 'dividends' or not, and her brother made a bloody mess of his accounts before she took over, so we'll probably never know.

 

however, then I got his medical expenses and there's no taxable income anyways, so I'm going to consider it a moot point.

 

Definitely learning new stuff this year!

[Randall]

Good outcome for you Joan.  Advice for all clients, KEEP the policy annual statements FOREVER.  The annual statements come out on the policy anniversary date (not Dec 31).

Edited March 20, 2015 by Randall

[BulldogTom]

The policy matured and was paid out while he was still alive - age 97.  The final dividend and the termination dividend were added to the cash value of 5k, he received $5509.  My client took over his finances from her brother in 2013, and is now executor/trustee since all his assets were in a living trust.  She doesn't know if he's been receiving the 'dividends' or not, and her brother made a bloody mess of his accounts before she took over, so we'll probably never know.

 

however, then I got his medical expenses and there's no taxable income anyways, so I'm going to consider it a moot point.

 

Definitely learning new stuff this year!

Thanks for this post all, I learned a lot from it.

 

Tom

Newark, CA

[kcjenkins]

Yes, almost all of us can learn something about insurance that we did not know, since it's a whole different set of rules.  Most of what I know about how insurance works I learned on here.