Adjusted Cost Basis (ACB) of a Life Policy: LLQP Tax Exam Basics
The adjusted cost basis (ACB) of a life insurance policy is its tax cost figure — broadly, premiums paid minus the accumulating net cost of pure insurance (NCPI), adjusted for dividends and other items — used to measure the taxable gain when a policy is disposed of.
Why it matters on the LLQP exam
ACB is the bridge between insurance and the Income Tax Act, and the exam tests the direction of the calculation rather than heavy math:
- When a policy is surrendered, the taxable policy gain is the amount by which the proceeds exceed the ACB. That gain is fully taxable as income — it is not a capital gain, so no half-inclusion break.
- The same logic applies to other dispositions, including certain policy loans that exceed the ACB.
- Because NCPI accumulates every year, the ACB trends downward over the life of the policy and often reaches zero in later years — meaning nearly any amount taken out of an old policy is taxable.
- Policy dividends taken in cash also grind the ACB down, which is why they are usually tax-free when received.
The number-one trap: students equate ACB with total premiums paid. Premiums are the starting point, but the annual NCPI deduction drags ACB below premiums — that gap is exactly what creates the taxable gain on surrender.
Example question
Mei surrenders her whole life policy and receives its cash surrender value of $20,000. The policy's ACB is $5,000. What is her taxable policy gain?
- $25,000
- $20,000
- $15,000
- $5,000
Answer: C — the taxable gain is proceeds minus ACB: $20,000 − $5,000 = $15,000, taxed as income.
For how surrender proceeds are calculated before tax enters the picture, see cash surrender value, and keep building in the life insurance and taxation hub.