Question 59

Taking out a loan under a life insurance policy reduces the amount receivable upon surrender of the contract.

When a loan is taken out against a life insurance policy, it decreases the cash value available to the policyholder, which in turn reduces the amount that can be received if the policy is surrendered.

A) results in a distribution of taxable income to the policy owner

This option is incorrect because taking a loan against a life insurance policy does not result in immediate taxable income. Loans are generally not considered taxable distributions; they are debts that must be repaid.

B) results in loss of the tax exempt status of the death proceeds

This option is also incorrect. Taking a loan against a life insurance policy does not affect the tax-exempt status of the death benefits. The death proceeds remain tax-free as long as the policy is in force.

C) changes the policy into a modified endowment contract

This statement is incorrect as well. A loan taken against a life insurance policy does not automatically convert the policy into a modified endowment contract; this status is determined by the policy's premium payment structure and not by loans.

D) reduces the amount receivable upon surrender of the contract

This is the correct answer. When a loan is taken against a life insurance policy, the outstanding loan balance reduces the cash value of the policy, thereby lowering the amount a policyholder would receive upon surrendering the contract.

Conclusion

In summary, taking out a loan against a life insurance policy primarily impacts the policy's cash value, resulting in a reduced amount that can be received upon surrender. The other options misrepresent the effects of such loans, either implying tax consequences or status changes that do not occur. Thus, the correct answer clearly illustrates the financial implications of borrowing against a life insurance policy.