Did you know you can sell all or a portion of a life insurance policy, even term insurance?
Do you have to pay taxes on money received as a beneficiary? The short answer is no, not usually. Beneficiaries generally don’t pay taxes on the proceeds from life insurance. Since beneficiaries don’t have to report the payout as income, it is a tax-free lump sum that they can use freely. However, there are a few aspects to life insurance that won’t get past the tax man. Let’s talk about these situations and how life settlements are a way of getting money sooner, controlling your tax strategy, and preserving more money for your family when you’re gone.
Three situations where you have to pay taxes on a life insurance payout:
There are three situations where beneficiaries have to pay taxes on a life insurance payout: if there is interest, if the death benefit becomes part of an estate, or if the policy is a gift.
1. The insurer issues the death benefit in installments: With some policies, instead of a lump sum payout, the life insurance beneficiaries might receive the death benefit in installments. When this happens, the insurer typically holds the policy in an interest-bearing account and issues a percentage of the death benefit over a set number of years. Although the original death benefit is tax-free, the interest that accumulates is subject to income tax.
2. The death benefit becomes part of your estate: The federal estate tax exemption limit is $11.58 million, which means if an estate’s total taxable value is greater than this amount, the IRS levies an estate tax. If you know your estate won’t exceed $11.58 million, you don’t need to worry about this tax. Plus, proceeds left to beneficiaries are typically exempt from an estate tax, even if they exceed the federal limit. However, if you own your life insurance policy when you die, the IRS includes the payout in your estate, regardless of whether you name a beneficiary. This could push your estate’s total taxable value over the federal exemption limit if you already have a sizable estate. In addition to the federal estate tax, some states levy their estate or inheritance taxes. Exemption limits vary among states.
3. The policy involves three different people: The death benefit may be subject to gift tax if different people fill each of the policy’s three roles:
- The insured: The person whose life the policy covers.
- The policy owner: The person who buys and/or owns the policy.
- The beneficiary: The person who receives the death benefit if the insured party dies.
In most cases, only two people are involved, the person who buys a policy for themselves and the person who receives the death benefit when they die. However, if a different person fills each role, the IRS considers the death benefit a gift from the policy owner to the beneficiary. For instance, if you buy a policy to cover your partner’s life and your child is the beneficiary, the death benefit is technically a gift from you (the owner) to your child (the beneficiary). As a policy owner, you’re considered the donor and could be liable for gift tax.
Are life settlements taxable?
Selling your life insurance policy to an investor – what’s called a life settlement – can get you more money than other means of relinquishing a policy, such as canceling your policy through surrender. This is because the policy’s sale price is not capped at the cash value amount, it also factors in the policyholder’s life expectancy, death benefits, and the cost of premiums. But are life settlements taxed?
- Income tax: due on the proceeds that exceed the policy basis
- Capital gain tax: due on any proceeds that exceed the policy’s cash value
However, the tax savings associated with selling a life insurance policy can be substantial compared to the taxes paid on the death benefit.
Learn more about life settlements with Life Settlement Advisors
At Life Settlement Advisors, we provide a life insurance settlement calculator to give our clients a clear, immediate picture of the highest possible value they could get from selling a life insurance policy in a settlement. Qualifying for a life settlement is based on age, how long you’ve had the policy, its benefit value, and other factors. If you are approved, a life settlement can bring a far greater return of your money on the same investment than any surrender value. Selling an unwanted life insurance policy is no different from 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 questions about these life-transforming transactions.
Life Settlement Advisors