Louisiana Series 101 – Life Insurance Practice Exam

Policy loans are not normally taxed as income while the policy remains in force. A loan against the cash value is simply borrowing your own money from the insurer, so no taxable event occurs at the time you take the loan. The policy can keep growing tax-deferred, and you owe the loan plus interest to the insurer. Tax consequences arise if the policy lapses or is surrendered with an outstanding loan. In that case, the loan is treated as a distribution to the extent the policy’s gains (earnings) exceed the cost basis. Those gains are taxed as ordinary income to the insured. If the policy is a Modified Endowment Contract (MEC), access to cash value through loans or withdrawals is taxed as a distribution of earnings, meaning any amount withdrawn or loaned is taxed to the extent of the policy’s earnings, regardless of the basis.