Betty purchased a universal life insurance policy when she was 61. Upon her 66th birthday, she received sizable inheritance, paid an exceptionally large annual premium and, in doing so, violated the 7-pay test. The following year, hoping to correct the situation, she made no premium payment so that the average premiums paid were less than the 7-pay test average. Today the policy's cash value stands at $45,000, and her basis in the contract is $28,000. If she were to withdraw $30,000 from the policy's cash value, which of the following best describes the tax treatment this transaction would receive?
A) $28,000 of the distribution is tax-free, but $2,000 is subject to income taxation.
B) The entire distribution is income tax-free.
C) The entire $30,000 distribution is subject to income taxation.
D) $13,000 of the distribution is tax-free, but $17,000 is subject to income taxation.
Ans: D) $13,000 of the distribution is tax-free, but $17,000 is subject to income taxation.
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