Capital Gains Tax on a Life Insurance Payout

Did you know you can sell all or a portion of a life insurance policy, even term insurance?

(4 minute read)

Whether you are already in the process of getting a life insurance payout or were unaware that this was even an option for you, we have you covered when it comes to selling your life insurance policy. One of the  first questions that come to mind for those choosing a life settlement to sell an insurance policy is likely “What is a capital gains tax?” Capital gains are the profits from the sale of an asset (life insurance is considered an asset), meaning that the profit you make from selling your life insurance policy would be taxed. How much you are taxed depends on how long you hold onto this asset.

There are two main types of capital gains tax, short-term and long-term. 

  • Short-term capital gains tax is a tax on profits from the sale of an asset held for one year or less (this is equal to your personal income tax rate).
  • Long-term capital gains tax is a tax on profits from the sale of an asset held for more than a year (this tax rate is 0%, 15%, or 20% depending on your taxable income and filing status).

While deciding on whether or not to cash in your life insurance policy, it would be helpful to figure out how to maximize the amount of money you will receive in return. The tax consequences of cashing in a life insurance policy can result in a smaller return. For example, if you are under the age of 59½ there is a possibility you will be hit with a 10% early withdrawal penalty.

Do you have to pay tax on a cash surrender value?

The cash surrender value is the cash you have leftover after the fees are taken out when you cancel a life insurance policy. It is also important to know that not all life insurance policies provide a cash value, and this is something you can find out by checking the type of policy you currently have. The short and most simple answer to this question is yes. Although, the better question would be: when is the cash surrender value taxable?

Any money that you receive from a cash surrender that is over the policy’s cost basis can be taxed as income. The cost basis (the sum of all your insurance premium payments) is not the only item that can be taxed in a cash surrender. Dividends earned or interest can be taxed as well, this will vary depending on your specific policy. 

The good news is that a cash surrender value is determined by deducting any fees you owe the insurer from your policy’s cash value. Therefore, if you do not have any fees left when you perform a cash surrender, then you will be left with more cash after being taxed.

Can the IRS take my life insurance cash value?

Deciding to turn in your life insurance policy early is an important decision as the cash payout can alleviate some of the financial pressures currently present in your life. In a typical life insurance payout, the IRS is not allowed to tax the money given to a beneficiary. However, if you choose to sell your life insurance policy, the IRS no longer views that money under the same circumstances. As a rule of thumb, as the cash value grows inside the policy, it cannot be taxed on the interest or dividends. Although, as mentioned above, this is only the case if the money stays inside the policy. A final piece of advice, it is always recommended that you check with your current financial advisor as well to get their opinion on your options.  

Turn your unneeded life insurance policy into cash with Life Settlement Advisors

Take out the confusion and frustrations of converting a life insurance policy you longer need into money you can use today. Head over to our online form to find out if you are eligible to sell your life insurance policy. 

Did you know you can sell all or a portion of a life insurance policy, even term insurance? Selling an unwanted life insurance policy is no different than selling your car, home, or any other valuable asset that will create immediate cash. Contact us today to learn more.

I am always happy to answer any and all questions about these life-transforming transactions.

Leo LaGrotte
Life Settlement Advisors

Get in touch with Life Settlement Advisors today to take the first step toward converting your policy into cash.
Life Settlement Advisors
Leo LaGrotte
At Life Settlement Advisors, we strive to be a voice of confidence and assurance for our clients. Our goal is to educate you about the life settlement process so you can make an educated decision about whether it is right for you.

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