Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What is the tax status of loans taken against variable life insurance policies?

1. They are always taxable

2. They are tax-exempt

3. Only if the policy is surrendered

4. They may be taxable if not repaid

The correct answer is: They are tax-exempt

Loans taken against variable life insurance policies are typically considered to be tax-exempt. This is because life insurance policies generally allow policyholders to borrow against the cash value without triggering an immediate tax liability. The cash value grows on a tax-deferred basis, and when a loan is taken, it does not count as income. Therefore, as long as the policy remains in force and is not surrendered, the loan itself will not incur taxes. However, it's essential to note that if the policy is surrendered or lapses with an outstanding loan, it could result in a taxable event, as the loan amount may be treated as a distribution, and tax would then apply to any gain. This understanding illustrates why the other options do not accurately capture the nature of loans against variable life insurance policies. Overall, the favorable tax treatment of these loans is a crucial feature that policyholders should understand when managing their variable life insurance products.