January 6, 2022
Are you considering selling your life insurance policy in a life settlement transaction? If so, it is important to understand the tax consequences of such a policy sale. Life settlement taxation requires that you make several calculations and gather policy information, but the rules were clarified in the Tax Cut and Jobs Act of 2017. Life settlements are taxed in three different tiers:
- “Return of Basis” / Principal Tier. The first item that needs to be reviewed is what is your “basis” in your life insurance policy. Under current IRS guidelines, your basis in the policy is equal to the total amount of premiums that you have paid into your life insurance policy. Your proceeds in the sale of your policy, up to your basis, are not subject to taxation.
- Ordinary Income Tier. The second calculation covers and proceeds received that are greater than the “basis” up to the cash surrender value of the policy. This amount, if any, is taxed at your ordinary income rate.
- Capital Gains Tier. The final tier is any amount remaining above the basis and cash surrender value. This amount, if any, is taxed at the long-term capital gains rate.
Here is an example to consider:
Life insurance policy death benefit = $100,000
Policy cash surrender value = $7,000
Policy “basis” = $5,000
Life settlement sale amount = $20,000
In this example, of the total amount received in the life settlement transaction ($20,000), the seller would have no taxes due on the amount of the basis ($5,000, explained in #1 above), would owe ordinary income tax to cover #2 above ($7,000 – $5,000 = $2,000 x ordinary tax rate), and would owe capital gains on the remaining amount as per #3 above ($20,000 – $7,000 = $13,000 x capital gains rate).
For more in-depth rules and guidelines, you can refer to the IRS website for additional details on the taxation of life settlement sales proceeds. Keep in mind, if you do sell your policy in a life settlement, you will receive a 1099-LS from the life settlement provider that purchased your policy. The life settlement provider is also required to send notice to the life insurance company that issued your policy, which, in turn, requires your insurance company to send you a statement of your premiums paid (i.e., your policy basis). Remember, you should alway consult with your accountant or tax advisor when making an important financial decision to ensure that you understand the income tax implications.
You can get an instant estimate of the value of your life insurance policy by visiting the Q Life Settlements calculator. You can also call Q Life Settlements at 866-679-9410 or email us firstname.lastname@example.org to discuss your situation. Our team is available and ready to explain to you all that you would want to know about life settlements.
Remember: Never abandon a life insurance policy without looking at the life settlement option first!