Life Settlement Taxation for U.S. Seniors

Selling a life insurance policy can have tax implications for the policy seller. The tax considerations that should be taken into account when selling a life insurance policy may include the following:

  1. Taxable Income:
  2. The proceeds from selling a life insurance policy may be subject to income tax. The amount of tax that is due will depend on the seller’s tax bracket, and it may be necessary to report the proceeds as taxable income on the seller’s tax return.

  3. Capital Gains:
  4. If the seller of the life insurance policy receives more than the policy’s cash surrender value, the additional amount may be considered a capital gain. Capital gains are generally subject to a lower tax rate than ordinary income, but the exact rate will depend on the seller’s tax bracket and the length of time they owned the policy.

  5. Basis:
  6. The basis of the life insurance policy is the amount the policy owner paid in premiums, less any dividends or other returns received from the policy. If the seller sells the policy for more than their basis, the excess amount may be considered a capital gain.

  7. Cost Basis:
  8. If the policy was transferred to a trust, then the cost basis for tax purposes could be determined by the date of transfer.

  9. Estate Tax:
  10. The sale of a life insurance policy may impact the estate tax liability of the policy seller’s estate. The proceeds from the sale may be included in the seller’s estate for estate tax purposes, which may result in a higher estate tax liability.

  11. State Taxes:
  12. Depending on the state in which the policy seller resides, state taxes may also apply to the sale of a life insurance policy. It is important to consult with a tax professional to determine the specific tax implications of the sale of a life insurance policy.

While selling a life insurance policy is not the right decision for everyone, there are certain situations in which it can be a smart financial move. For example, if the policy is no longer needed, if the premiums have become too expensive, or if the policy owner is in need of funds for other expenses, selling the policy may be a good idea. By selling the policy, the owner can receive a lump sum payment that can be used for other financial goals, such as paying off debt or investing in a new business venture. Additionally, selling a life insurance policy can provide greater financial flexibility and reduce the ongoing financial burden of paying premiums. Ultimately, the decision to sell a life insurance policy should be made after careful consideration of the financial implications and with the advice of a financial professional.

Are Viatical Settlements Tax Free?

In addition to the potential tax advantages, viatical settlements can also offer financial relief for individuals with terminal or critical illnesses or in need of long-term care. By selling their life insurance policy through a viatical settlement, the seller can receive a lump sum payment to help cover medical bills, long-term care expenses, or other costs associated with their illness. This can provide a much-needed financial cushion during a difficult time. Additionally, the seller may be able to use the proceeds from the sale tax-free if they are used to pay for qualified medical expenses. Overall, a viatical settlement can offer both tax and financial benefits for individuals facing serious health challenges.

Basic Tax Pros & Cons for Sellers

Pros:

  • Selling a life insurance policy may result in capital gains tax savings.
  • Proceeds from a life insurance policy sale may not be subject to federal income tax.
  • Estate taxes may be reduced by selling a life insurance policy.

Cons:

  • The sale of a life insurance policy may trigger income tax if the policy has a higher surrender value than the cost basis.
  • The proceeds from a life insurance policy sale may disqualify the seller from certain means-tested government benefits.
  • The tax implications of a life insurance policy sale can be complex and depend on the specific circumstances of the seller, so it’s important to consult with a tax professional before making any decisions.

Quick Tax Facts

  1. The Tax Cuts and Job Act of 2017 confirmed favorable income tax treatment for the sellers
  2. The tax basis: of a life insurance policycan be determined by calculating cumulative premiums less any surrenders, withdrawals, or dividends taken in cash.
  3. If a policy is sold for less than its tax basis, the proceeds are not taxed.
  4. Policyholders usually receive two 1099s: A 1099-LS from the company that bought the policy and 1099-SB from the insurance company that shows the basis in the policy at the time of the ownership transfer.
  5. Capital gains tax rates may apply: When selling a life insurance policy, the excess of the sale price over the cost basis may be considered a capital gain. The capital gains tax rate may be lower than the ordinary income tax rate, resulting in potential tax savings. This can be especially advantageous for seniors who no longer need the life insurance policy and are looking to increase their cash flow. [Source: Investopedia – “How to Avoid Taxes on Life Insurance Proceeds”]
  6. May not be subject to federal income tax: In some cases, the proceeds from a life insurance policy sale may not be subject to federal income tax. This can occur if the sale is structured as a viatical settlement or a life settlement, and the seller is considered to be selling their interest in the policy as an investment rather than a life insurance benefit. However, the tax implications of a policy sale will depend on the specific circumstances and should be reviewed with a tax professional. [Source: Internal Revenue Service – “Publication 525: Taxable and Nontaxable Income”]
  7. Estate taxes may be reduced: Life insurance policies are generally included in the value of the policy owner’s estate for estate tax purposes. By selling a life insurance policy, the proceeds from the sale may be removed from the estate and, therefore, may reduce the estate tax liability. This can be an advantage for individuals who have a high net worth and are looking for ways to minimize their estate tax liability. [Source: Forbes – “How to Reduce Estate Taxes with Life Insurance”]

Note: This is not tax advice. Consult your local tax professional