Hawaii's unique withholding requirement
When a policyholder in Hawaii surrenders the cash value of a life‑insurance contract, the state may require income‑tax withholding at the time of distribution. Unlike many states that rely on the taxpayer's annual return to collect any tax due, Hawaii mandates a flat 7% withholding on the taxable portion of the surrender unless the recipient files a claim for exemption.
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What part of the surrender is taxable?
The taxable amount is the cash value received minus the policy's cost basis, which is the total of premiums paid that were not previously deducted. Any gain above this basis is considered ordinary income for Hawaii tax purposes and is subject to the 7% withholding.
When can the 7% be reduced or avoided?
Hawaii allows a withholding exemption if the recipient files Form N-10, "Request for Exemption from State Income Tax Withholding," and meets one of the following conditions:
- The surrender amount is less than $10,000 and the taxpayer's total Hawaii taxable income for the year is projected to be below the filing threshold.
- The policy is being surrendered as part of a qualified charitable distribution.
- The taxpayer will file a Hawaii tax return and expects a refund that will offset the withheld amount.
If none of these apply, the insurer must withhold 7% and remit it to the Hawaii Department of Taxation.
Reporting the surrender on your Hawaii tax return
On the Hawaii individual income tax return (Form N‑1), the surrender gain is reported on line 9 as "Other income." The amount of tax already withheld is entered on line 22, "Tax withheld." Any excess withholding will be refunded, while a shortfall will increase the tax due.
Comparison of Hawaii withholding with other states
| State | Withholding Rate | Exemption Form Required? |
|---|---|---|
| Hawaii | 7% of taxable gain | Yes, Form N‑10 |
| California | No automatic withholding | None |
| New York | None, but estimated tax may be required | None |
Practical steps for Hawaii policyholders
1. Calculate the cost basis of your policy before surrender.2. Determine the taxable gain and multiply by 7% to estimate withholding.3. If eligible, complete Form N‑10 and submit it to the insurer before the surrender.4. Keep the insurer's Form 1099‑R and the withholding statement for your records.5. Report the gain and any withholding on your Hawaii tax return to reconcile the final tax liability.