Which statement about policy loans is true?

• A. The loan proceeds are always taxable
• B. The loan proceeds reduce the death benefit
• C. The loan proceeds are not taxable income
• D. The loan must be repaid within one year

Answer: (C)

Policy loans are not taxable income. When you borrow from a life insurance policy’s cash value, you’re taking a loan against your own money, not taking in new income, so there’s no tax due on the loan proceeds as long as the policy remains in force. Interest may accrue on the loan, and if you don’t repay, the outstanding loan balance can reduce the policy’s death benefit payable to beneficiaries. If the policy is surrendered or lapses with an outstanding loan, the loan amount (to the extent it exceeds the premiums paid) can become a taxable distribution. The other statements don’t hold universally: loan proceeds aren’t taxed as income, nor is there a mandatory repayment within one year, and while the death benefit can be reduced by an outstanding loan, the key point being tested is the non-taxable nature of the loan proceeds.