South Carolina Life Insurance Practice Exam

Regarding taxation, how does the cash value of a universal life policy accumulate?

1. Taxable annually

2. Tax-deferred

3. Fully taxable upon withdrawal

4. Tax-free upon death

The correct answer is: Tax-deferred

The cash value of a universal life policy accumulates on a tax-deferred basis. This means that policyholders do not have to pay taxes on the growth of the cash value as it increases over time. Instead, taxes on this accumulated amount are deferred until the policyholder makes a withdrawal or takes a loan against the cash value; and even then, it can vary depending on the amounts withdrawn compared to premiums paid. When a policyholder eventually accesses the funds through withdrawals or loans, any gain over the total premiums paid may be subject to taxation, but the accumulation itself is not taxed until such actions occur. This tax-deferred status is an important feature that allows for potential growth without the immediate tax implications that would typically come with other types of investments. Thus, the correct choice highlights this significant advantage of universal life policies regarding the treatment of cash value accumulation.