What is the cost basis in a life insurance policy?

The cost basis in a life insurance policy refers to the sum of the premiums paid into the policy. This amount is crucial for determining the policy's tax implications, particularly when it comes to cash value and death benefit payouts. The cost basis represents the total investment made by the policyholder into the policy and is important because it establishes the non-taxable portion of any eventual cash value distributions or death benefits.

When the insured individual passes away, the death benefit paid out to beneficiaries is typically tax-free. However, if there’s any cash value accumulation, the portion that exceeds the cost basis may be subject to taxation. Understanding this concept helps policyholders make informed decisions regarding their life insurance and potential tax liabilities.

The other options do not accurately reflect what the cost basis is. The face value of the policy is the amount paid out upon the insured's death, while the sum of the death benefits refers to total payouts that beneficiaries would receive, neither of which assists in calculating the tax basis. The cost of administering the policy is an operational expense and does not contribute to the policyholder's investment in the policy. Thus, the sum of the premiums paid is the correct assessment of the cost basis in a life insurance policy.