New York Child Abuse Identification and Reporting Practice Exam

Which advantage does a policy loan have over a withdrawal?

1. The loan must be repaid within a year

2. The loan is not taxed, while a withdrawal is taxed above the contract cost basis

3. The loan option has lower interest rates

4. The loan can be used for any purpose

The correct answer is: The loan is not taxed, while a withdrawal is taxed above the contract cost basis

The correct answer highlights a significant advantage of taking a policy loan rather than making a withdrawal from a life insurance policy. When a policyholder takes a loan against the cash value of their life insurance, the amount borrowed is not considered income, which means it is not subject to income tax. This is beneficial because it allows access to funds without incurring tax liabilities at the time the loan is taken. In contrast, a withdrawal from the policy's cash value can have tax implications if it exceeds the amount of premiums paid into the policy, or the cost basis. Fundamentally, this encourages policyholders to consider loans as a more favorable option for accessing cash, as they can avoid the immediate tax consequences associated with withdrawals, thus preserving the value of the policy for future needs. The other aspects of the answer choices do not encapsulate the same level of financial advantage. For instance, loans do not necessarily need to be repaid within a specific time frame and can accrue interest over time, unlike the specified one-year repayment requirement. Interest rates on policy loans can vary and may not always be lower than those of withdrawals or other forms of credit. Additionally, while loans can typically be used for any purpose, this characteristic is not unique to loans, as withdrawals can