On May 29, 1:05*pm, se...[at]panix.com (Seth) wrote:
- quote -

First, and for clarification, the interest isn't really forgiven
(that's why I used the quotation marks). The situation is akin to
taking out loan1 at bank A and then in 1 year, when the annual accrued
interest comes due, taking loan2 at the same bank A to pay the
interest due on loan1. And then in another year taking loan3 at bank A
to pay the interest on loan1 and loan2. Rinse and repeat ad nauseum.
That's why $9400 (taken out over many years) snowballed into a $24k
loan balance. She simply took out consecutive loans to pay the
previous loans and the insurance company aggregated them. This whole
process was likely automated.

As to why the interest can't be deducted as investment expense: I
can't say with certainty. I suspect it is because a) TEFRA, DEFRA, and
TAMRA all aim to ensure that insurance products are clearly defined
and separated from investments (so it's not _investment_ interest) and/
or b) I don't believe the investment expense deduction applies to tax
qualified accounts. The dividends and interest of an insurance policy
grow tax deferred.

Someone else may be better suited to answer your questions, but my
experience assures me that the answers are "no" and "no".

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In article <5321fe2a-69eb-4e65-8d0b-9740033a428a[at]m36g2000hse.googlegroups.com> ,
kastnna <kastnna[at]auburnalum.org> wrote:

- quote -

Why isn't the $14.6k of interest deductible?

Seth

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In article <a739bc72-6741-415c-a8dd-f41c0188afda[at]l64g2000hse.googlegroups.com> ,
kastnna <kastnna[at]auburnalum.org> wrote:
- quote -

Was the forgiven interest tax-deductible as investment interest?
Shouldn't it be carried forward and deducted this year?

Seth

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On May 28, 10:29*pm, Arthur <art...[at]yahoo.com> wrote:

- quote -

As I originally expected, she will have a $26k gain. By the way, it's
taxed at ordinary income tax rates.

Your mother's $10k investment grew to $36k. She withdrew $9400 in
cash. She "withdrew" $14.6k to pay the interest on the $9400. She then
received $12k at surrender. All of that, minus her $10k investment, is
about $26k in gains.

The rule change you referred to is for policies that were intended to
act like investments more so than insurance. They were retitled as
"modified endowment contracts" (MECs). While this could have
potentially applied to your mother, it doesn't seem to be the case.
Regardless, the primary difference between a MEC and a normal life
insurance contract is how the cash values are taxed while the policy
is inforce. Once surrendered, the end result is the same.

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On May 28, 11:43 am, kastnna <kast...[at]auburnalum.org> wrote:
- quote -

I am not sure I can add anything except that the rules on such Single
Premium Insurance changed sometime during the life of the loan.
Apparently, there were some questionable practices involving these
accounts so some regulations got added (IIRC).

I think it was not made very clear to my mother how the policy worked.
She also got a letter which she understood to mean that she owed 26K.
We took this to a financial adviser who straightened this out and my
mother decided after talking to him that it would be best just to cash
in the policy. At the time, we didn't ask about the tax situtation.
Thanks

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On May 27, 5:55 pm, kastnna <kast...[at]auburnalum.org> wrote:
- quote -

The $9400 is the sum of all the checks she received.

- quote -

I have the following
Cash value 36K
Loan Payoff 24K
Surrender value 12k
Taxable Gain 26K
I am not sure which once of these =the outstanding loan balance
(probably the 24K?)
- quote -

It does not appear to me that the $9400 includes the "forgiven
interest".

Thank you very much again for your help

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On May 27, 4:55*pm, kastnna <kast...[at]auburnalum.org> wrote:
- quote -

Another thought occurs to me, but it may only further confuse the
matter.

The typical protocol for using life insurance policies to generate
income is "withdrawals to basis, then loans". In other words, the
insured makes out-of-pocket contributions, which add to basis (in our
case $10k). When the insured begins taking income from the policy, the
first $10k is a return of basis, not a loan (hence, no tax due). Once
basis is zero, loans are accrued from the accumulated cash value and
those amounts plus any capitalized loan interest are taxable when the
policy is surrendered.

This is apparently not the case, because the OP states there _are_
interest capitalizations and a loan balance yet her total withdrawals
were less than basis. Very strange, indeed, given what little facts we
have. I will be interested to see clarification from the OP.

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On May 24, 11:09*am, se...[at]panix.com (Seth) wrote:
- quote -

Was that the sum of the checks that she actually received or the
amount that the insurance company considers to have given to her? It's
the latter that the IRS cares about. As I said previously, every year
the interest she capitalized was considered a "withdrawal" even though
she likely never received a penny. What was the outstanding loan
balance on the policy at the time of surrender? This likely represents
the reportable "profit".

- quote -

And unless I am incorrect (which has been known to happen), you left
out the "forgiven" interest she didn't pay on the loan. If the $9400
includes the forgiven interest, then you are likely correct that she
only owes taxes on the $10.4k

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In article <1a95affd-c7a0-4d1e-8e5f-7a54cae66f15[at]s50g2000hsb.googlegroups.com> ,
Arthur <artyw2[at]yahoo.com> wrote:
- quote -

So she deposited $10K, and withdrew $9.4K and $11K, totalling $20.4K,
and is now supposed to pay taxes on $26K of her $10.4K profit? If
this contract were sold as "tax-advantaged" I'd consider that fraud.

Seth

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On May 24, 2:07 am, se...[at]panix.com (Seth) wrote:
- quote -

Her total withdrawals were about $9400

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In article <57418780-7aad-4187-b81e-c26d6a87a481[at]34g2000hsf.googlegroups.com> ,
kastnna <kastnna[at]auburnalum.org> wrote:

- quote -

She originally invested $10K. She withdrew interest over 15 years
(how much, in total? Say, 14K?) Now she's getting a final $12K. So
her total withdrawals are $26K. So she should owe tax on the net,
$16K.

Or were her total withdrawals over the years more like $24K?

Seth

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On May 22, 5:34 pm, kastnna <kast...[at]auburnalum.org> wrote:
- quote -


Thank you very much. I suspected something like that, but I was not
sure.

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On May 21, 7:51*pm, Arthur <art...[at]yahoo.com> wrote:
- quote -

She did "touch" the interest capitalizations, just not directly. It
sounds as though every year she took a small withdrawal in the form of
a loan. The insurance carrier charges interest on that loan balance
because that treat the withdrawal as if it is still in the policy
earning interest (even though it's really in her pocketbook). However,
instead of paying the loan interest annually, she took another loan to
pay the interest on the former loan. She likely did not actually
engage in any action as this process is automatic unless the interest
payment is remitted to the insurer by other means (i.e. she writes a
check).

Unfortunately, it's time to pay the piper. She invested $10k, withdrew
some of the earnings, continued to receive interest on those earnings,
did not pay out of pocket interest for that priviledge, enjoyed tax
deferred growth, and then cancelled the policy (for which she received
$10k-12k). She almost assuredly owes taxes on the $26k. At 20%
automatic withholding, that's about $6500 in taxes. Although it's easy
to feel bitter, you shouldn't. Had the insurance company reduced her
cash value instead of charging interest she would likely have gotten
much less in the long run.

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In 1989 my mother spent 10,000 dollars on a single premium insurance
policy. Every year, until 2004 she took out some amount which was (As
far as I can tell from the records) slightly less than the interest
amount she accrued. She decided to cash the whole thing in this year.
She received (before taxes) a little over 12K. However, the insurance
company is reporting her taxable gains as about 26K. looking at the
records the 26K = the total she took out, (+ 12K-10K) + the sum of
"Interest Capitalizations"* which total about 14.5K. As far as I can
tell, she never touched the "Interest Capitalizations" but they are
part of her "Loan Balance". Can anyone explain this? Will she have to
pay taxes on 26K worth of income? According to the records, they gave
her about 7K of the 5K and took the rest out for taxes already which
seems rather steep.

*The "Interest Capitalizations" are a series of figures which goes
approximately like this: (dollar figures)
60, 129, 200, 277. 356, 432, 507, 587, 674, 768, 869, 857, 950, 1053,
1,156, 1275, 1271, 1467. This looks like a running total of interest,
but it is the sum of these values that is used to determine the "loan
balance".

Very confused.
Thanks in advance for any insight.

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