Glossary

Cost basis

For life insurance and annuities, the after-tax money put in (premiums minus tax-free amounts taken out), which sets how much of a payout is taxed.

Also called: basis, investment in the contract, tax basis

Cost basis, called "investment in the contract" in the tax code, is the after-tax money you have put into a life insurance policy or non-qualified annuity that has not yet come back to you tax-free. It is the dividing line between money returned tax-free and gain taxed as ordinary income.

For a life insurance policy, basis generally equals total premiums paid minus tax-free amounts received, such as dividends taken in cash and earlier withdrawals. Hypothetical example: you paid $60,000 in premiums and received $5,000 in cash dividends, so your basis is $55,000. If you surrender the policy for $80,000, $25,000 is taxable income. Under the usual first-in, first-out rule for policies that are not modified endowment contracts, withdrawals up to $55,000 would come out tax-free.

Basis matters for surrenders, withdrawals, policy sales and annuity payouts, where the exclusion ratio applies it. It does not normally matter for death benefits, which are generally income-tax-free to beneficiaries. Modified endowment contracts and deferred annuities reverse the order and tax gains first. A 1035 exchange carries the old policy's basis into the new one. Keep records of premiums paid, or ask the insurer for a basis statement. See how cash value is taxed: withdrawals, loans and surrenders and how annuities are taxed.

Last reviewed October 4, 2026

In the index now

Related terms

Cash surrender value What a permanent policy pays the owner on cancellation: the accumulated savings minus surrender charges and any outstanding loans. Cash value The savings component that builds inside whole life, universal life and other permanent policies, which the owner can borrow against or withdraw. Exclusion ratio The fraction of each annuity payment treated as a tax-free return of the buyer's own money, found by dividing cost basis by expected total payments. Policy dividend A non-guaranteed annual payment a participating whole life policy may receive when the insurer's mortality, investment and expense results beat its assumptions. Policy loan Money borrowed from an insurer using a permanent policy's cash value as collateral, with no credit check and no required repayment schedule. Non-qualified annuity An annuity bought with after-tax money outside an IRA or employer plan; earnings grow tax-deferred, and only the gains are taxed when withdrawn.

Related guides

1035 exchanges: swapping policies without tax Section 1035 lets you swap a life policy for another policy or an annuity without taxing the gain. What qualifies, what you can lose and how to do one right. Annuity beneficiaries and inherited annuity options What a beneficiary can do with an inherited annuity: lump sum, spousal continuation, 5-year or stretch payouts for non-qualified, 10-year rule for qualified. Should you put an annuity in an IRA? An IRA already defers tax, so an annuity inside one adds guarantees, not tax savings. When it can make sense, what it costs, and how RMDs and QLACs work. Withdrawing cash value from a life insurance policy How partial withdrawals from permanent policies work, what they do to the death benefit, when they are taxed, and how they differ from loans and surrender. Cross-purchase vs entity-redemption buy-sell plans Compare cross-purchase and entity-redemption buy-sell plans on policies, cost, basis step-up, creditors and estate tax, including the 2024 Connelly ruling. How annuities are taxed Annuity earnings grow tax-deferred and are taxed as ordinary income at payout; rules differ for qualified, non-qualified, early and inherited annuities.

Related tools

Keep, surrender or sell your policy? Compares cashing in a policy, selling it in a life settlement, and keeping it, using the return your beneficiaries earn on what you keep putting in.