Basis in policy is the total amount of after'tax premiums and other contributions paid into a life insurance or nonqualified annuity contract, reduced by any prior tax'free returns of principal. Basis represents the ownerTMs investment in the contract for income'tax purposes. When a policy is surrendered, loans are taken, or modified endowment contract rules apply, basis determines how much of the distribution is taxable gain versus tax'free recovery of principal. For life insurance death benefits, basis is generally irrelevant because properly structured proceeds are income'tax'free, but it becomes critical in partial surrenders, policy sales, and certain business and trust transactions.

Advisors and CPAs track basis in policy when evaluating surrender options, 1035 exchanges, or loan strategies. They review premium histories, prior withdrawals, and cost'basis statements from carriers to confirm accurate numbers. In advanced planning, basis affects outcomes under transfer'for'value rules, corporate or trust ownership structures, and reportable policy sales. When clients are surprised by taxable gains at surrender, advisors often find that basis was lower than assumed due to prior withdrawals or term riders not included in basis. Understanding basis in policy allows advisors to model after'tax consequences accurately and choose strategies"such as exchanges or restructuring"designed to manage taxation over time.