Taxation✓ Verified · outline & fact-checked · Sep 2026Difficulty 2/5
For a non-MEC life insurance policy, a partial withdrawal of cash value is taxable to the policyowner:
Select an option to reveal the answer and the full 3-part explanation — free, no signup.
Answer & full 3-part explanation (select an option above, or peek)
Why A is correct
Under IRC §72(e), amounts received from a non-MEC life insurance policy that are not annuities are taxable only to the extent they exceed the policyowner's cost basis, or investment in the contract. Because a life policy uses a first-in-first-out (FIFO) approach for cash-value access, the policyowner first recovers basis tax-free and recognizes taxable gain only after the basis is exhausted. Amounts received that are within the basis are a return of premium, not income. This ordering differs from annuities and MECs, which tax gain first under a last-in-first-out approach.
Why the other options are wrong
- B) The full withdrawal is not taxable; the basis is recovered first under the FIFO rule, so only the amount over basis is included in gross income. The owner's own premiums return tax-free.
- C) Excess distributions over basis from a life policy are ordinary income, not capital gain, and the FIFO rule allows basis recovery before any tax is triggered. Capital gain treatment never applies here.
- D) LIFO, or gain-first taxation, applies to annuities and MECs, not to non-MEC life insurance policies, which use FIFO basis-first ordering. That ordering is the opposite of the life policy's rule.
Memory hook
Life policy cash access is FIFO: your own premiums come out first, tax-free.