7.25 When You Convert Your Endowment Policy

When an endowment policy matures, you may elect to receive a lump sum, an annuity, an interest option, or a paid-up life insurance policy. If you elect—

A lump sum.

You report the difference between your cost (premium payments less dividends) and what you receive.

An annuity before the policy matures or within 60 days after maturity.

You report income in the years you receive your annuity (7.23). Use as your investment in the annuity contract the cost of the endowment policy less premiums paid for other benefits such as double indemnity or disability income. If you elect the annuity option more than 60 days after maturity, you report income on the matured policy as if you received the lump sum; see above rule. The lump sum is treated as the cost investment in the annuity contract.

An interest option before the policy matures.

You report only the interest as it is received, provided you do not have the right to withdraw the policy proceeds. If you have the right to withdraw the proceeds, you are treated as in constructive receipt; the difference between your cost and what you receive would be taxed as if you had received a lump sum.

Paid-up insurance.

You report the difference between the present value of the paid-up life insurance policy and the premium paid for the endowment policy. In figuring the value of the insurance policy, you do not use its cash surrender value, but the amount you would have to pay for a similar policy with the company at the date of exchange. Your insurance company can give you this figure. The difference is taxed at ordinary income tax rates.

Tax-free exchange rules apply to the policy exchanges listed in 6.12.

Gain on the sale of a life insurance policy is partly ordinary income and partly capital gain; see 11.20.

The proceeds of a veteran’s endowment policy paid before the veteran’s death are not taxable.