The Adjusted Cost Basis (ACB) of a policy is a number used for income tax purposes. The significance of the ACB to most clients is that it quantifies the amount of cash that can be borrowed against the policy (as a policy loan), or withdrawn from the policy (as a withdrawal or possibly a complete surrender of the policy), before you start paying taxes.
It acts very similarly to the ACB of a stock investment or mutual fund, except that it remains relevant even if you leverage your policy through a policy loan.
To keep it simple, this number is calculated by adding all the money that was put into the policy as premiums, Additional Deposits and loan repayments, minus the cost of insurance (called net cost of pure insurance or NCPI) and minus any outstanding policy loans.
The ACB not only affects the tax-efficient access to cash, but it can also limit the size of potentially tax-free policy loans that can be taken to fund major purchases or investment opportunities during the middle years of the policy.
That doesn’t mean that you can’t borrow against your policy or withdraw money if you have the necessary cash value and the ACB is less than the amount of money that you wish to borrow or withdraw, it just means that the portion exceeding the ACB will be taxed.
The ACB usually decreases over the life of the policy, to eventually reach zero. When this happens, any amount withdrawn or borrowed is fully taxable. That is why is it recommended to maintain a good relationship with your bank account manager to set up a line of credit that would use the policy as collateral (see “Collateral Assignment”).