How does a larger adjusted cost base (ACB) affect tax implications for a life insurance policy?

A larger adjusted cost base (ACB) for a life insurance policy results in a lower policy gain when the policy is surrendered or transferred. The policy gain is calculated as the difference between the cash surrender value of the policy and its ACB. Therefore, a higher ACB reduces this gain, which in turn leads to lower taxes owed upon the disposition of the policy.

When the ACB increases, the amount that the policyholder must report as income for tax purposes decreases. This tax treatment is important for policyholders who may be considering surrendering their policy or transferring it, as it can significantly impact their overall tax liability. By lowering the gain, the policyholder retains more of their funds, thereby benefiting from a more favorable tax outcome.

In contrast, other options suggest outcomes that do not align with how ACB functions in tax calculations. While some choices imply an increase in taxable gain or suggest that taxes would be eliminated altogether, these scenarios do not accurately reflect the mechanism of how ACB influences taxation on life insurance policies. Understanding this principle can assist individuals in making informed decisions about their life insurance investments.