What is the consequence if the loan against a policy exceeds the adjusted cost basis (ACB)?

When a loan against a life insurance policy exceeds the adjusted cost basis (ACB), the portion of the loan that exceeds the ACB is considered a taxable event. The ACB represents the policyowner's investment in the policy, and any amount of the loan that surpasses this basis is effectively seen as a gain that the policyholder has realized. This gain is subject to taxation because it reflects an excess withdrawal from the policy beyond what the policyholder has paid into it, essentially treating it like a profit.

The tax implications arise because the amount exceeding the ACB can be viewed as an income for tax purposes, making it necessary for the policyholder to account for this amount when filing taxes. Understanding this concept is crucial for policyholders since it affects their overall tax liability and how they manage their life insurance products.

In contrast, options that suggest no consequences or a broader taxable status for the entire policy do not reflect the specific nature of how excess loans are treated with regard to tax liabilities.