What must be considered concerning tax implications when a partial withdrawal is made from a policy?

When a partial withdrawal is made from a life insurance policy, the tax implications depend on how much has been paid into the policy versus how much is being withdrawn. Specifically, any amount withdrawn that exceeds the total premiums paid into the policy (the cost basis) is subject to taxation. This is often referred to as the “last in, first out” (LIFO) principle, where the cash value is considered to include both the principal (premiums contributed) and any accumulated earnings (interest).

Therefore, when a policyholder makes a partial withdrawal, the distribution is viewed in light of these contributions. The key point is that while the amount withdrawn up to the total premiums paid is generally not taxed (as it is considered a return of the policyholder’s own money), any amount taken out above the total premiums represents earnings or gains, which may be taxable.

Recognizing this principle is crucial for policyholders to accurately understand potential tax liabilities associated with withdrawals from their life insurance policies.