Tax Policy:

Tax Treatment of Life Insurance and Annuity Accrued Interest

GGD-90-31: Published: Jan 29, 1990. Publicly Released: Feb 6, 1990.

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Pursuant to a legislative requirement, GAO assessed the Technical and Miscellaneous Revenue Act of 1988, focusing on the: (1) effectiveness of the revised tax treatment of life insurance products in preventing the sale of life insurance primarily for investment purposes; and (2) policy justification for, and the practical implications of, the present treatment of earnings on the cash surrender value of life insurance and annuity contracts.

GAO found that: (1) taxing interest on life insurance contracts could reduce the amount of insurance coverage purchased and the amount of income available to retirees and beneficiaries and could be less costly than direct government provision of consumer protection; (2) tax preferences create incentives to construct products that take advantage of them; (3) since repayment of amounts borrowed against insurance benefits restores the death benefit, any amount taxed as income when borrowed should be deductible when repaid; and (4) the effect of recent tax law changes has been to reduce the number of single-premium policies sold, but other changes are more difficult to evaluate.

Matters for Congressional Consideration

  1. Status: Closed - Not Implemented

    Comments: Congress, at least for the time being, has decided not to tax life insurance inside buildup.

    Matter: Because the pattern of policy usage as well as the type of products offered can change, Congress may wish to periodically reconsider its policy decision to grant preferential tax treatment to inside buildup, weighing the social benefits against the revenue foregone.

  2. Status: Closed - Not Implemented

    Comments: Congress, at least for the time being, has decided not to tax life insurance inside buildup.

    Matter: If Congress decides not to tax inside buildup, it should eliminate tax-free borrowing of life insurance proceeds. Any borrowing of those proceeds should be considered a distribution of interest income. To offset the advantages of accruing interest income without tax, a penalty provision needs to be added to the regular tax. Since repayment of the amount borrowed restores the death benefits, any amount that is taxed when it is borrowed should be tax deductible if subsequently repaid.

 

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