What are tax implications on life settlement proceeds?

June 2, 2016
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Consider the taxes

Life insurance policies are an asset, just like real estate or any other possession. So, when a individual goes to sell an unwanted life insurance policy in the secondary insurance market, he or she must consider if taxes will need to be paid on the sale.

Because when an unwanted policy is sold, the Internal Revenue Service may see the sale as an income, policyholders must consider this fact before they decide to sell. Only in the last decade because of the extreme momentum in the secondary insurance market did the IRS establish guidelines regarding life settlements.

Policyholders should most definitely seek the advice of their financial advisor before deciding to sell an unwanted life insurance policy.

Taxes vary according to the policy type

For each type of policy that is eligible for sale in the secondary insurance market, the way the taxes are figured is different.

Policies that are typically eligible for sale include term life insurance policies, whole life insurance, cash value insurance, and several others.

A financial advisor and tax attorney can better help individual policyholders understand the taxation for their specific policy. Because these taxes vary vastly, considering them on a case by case basis is advised; afterwards, you and your advisor can determine the best financial decisions.

IRS rulings

The IRS has established guidelines regarding the taxes from a life settlement transaction.

The first IRS guideline states that no tax will be collected on the amount equal to the policyholder’s adjusted basis in the policy. To determine this number, deduct the cost of the life insurance from the total of premiums paid.

The second IRS guideline states that the difference between total premium amounts and the policy’s cash surrender value would be taxed as ordinary income. Therefore, traditional tax guidelines would apply. This would apply to surrendering the policy as well.

The third IRS guideline states that the proceeds received from the sale of a life insurance policy over the cash surrender value (CSV), is taxed as long term capital gain money. The policy would be considered a capital asset and would be taxed like one, with a 15% maximum tax rate.

Some tax experts feel these guidelines are difficult to decipher, so speak with your financial advisor for specifics in regard to your policy.

Professional assistance

Contact your tax advisor before making any financial decisions. He or she can help you better determine the tax costs, if any, associated with selling your unwanted policy.

After you are aware of the specific tax implications of selling your policy, contact us. We are happy to discuss the life settlement process.

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