Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

Are variable life policies subject to IRS early withdrawal penalties?

1. Yes, always

2. No, never

3. Yes, only on the principal

4. No, only on the earnings

The correct answer is: Yes, always

Variable life policies are not subject to IRS early withdrawal penalties in the same way that qualified retirement accounts are. This stems from the fact that variable life insurance policies are structured differently than retirement accounts, which generally face penalties for early withdrawals prior to the age of 59½. The correct understanding is that while the earnings portion of a variable life policy can be subject to ordinary income tax upon withdrawal, there isn't an automatic early withdrawal penalty applied to the entire policy. In a variable life policy, withdrawals are generally taken first from the premiums paid (the principal), and the earnings are typically only taxed when they exceed the total premiums contributed. Therefore, a policyholder can withdraw the cash value without the fear of the IRS imposing an early withdrawal penalty as long as they adhere to the tax implications. This distinction highlights the flexibility of cash value life insurance products compared to traditional retirement accounts. The option that states there are penalties is not correct as it misrepresents how the tax treatment of withdrawals from variable life insurance works. It’s important for policyholders to be aware of how their withdrawals are taxed and to keep records of their contributions to understand their tax obligations better.