Did you know you can sell all or a portion of your life insurance policy, even term insurance?
(3 minute read)
There are several reasons why you might find yourself looking for information about life settlement taxation today. Whether it’s because you simply no longer have a need for the policy or you need significant funds to materialize for any number of expenses, from a family vacation to a growing pile of medical bills, selling a life insurance policy effectively translates an unneeded policy into spendable cash. Maybe you’re approaching retirement and realizing you haven’t put quite enough away for comfort.
If you’ve done any research on the topic, you’ve probably already discovered that you can get a larger payout by selling your policy (via a life settlement) than simply surrendering the policy back to the insurer.
The overall lapse and surrender rate can be as high as 85%.
Some of this is to be expected since term-life policies are designed for short-term use and then lapse. Among universal life insurance policies, which are meant to stay with a person as long as needed, nearly 90% of policies don’t materialize into claims.
This goes to show why life settlements make so much sense for so many people. This data really shows the astounding rate at which people simply forget about their policies, letting them lapse and reaping no benefit.
So let’s get into the big questions that might be running through your head about life settlements, starting with the basics of how they’re taxed.
When Are Settlements Taxable, and How Much Are They Taxed?
Any time you sell your life insurance policy as part of a life settlement, there may be tax implications. Fortunately for you, working with a broker makes the process simple—not that the taxation is particularly hard to understand once you know the basics.
If you had thought about selling your policy prior to the introduction of the Tax Cuts and Jobs Act of 2017 (TCJA), you may have felt overwhelmed by the complexity of the answer. Now, though, the taxation is much more straightforward, making it easier for you to understand whether selling your policy makes sense for your situation.
In a nutshell, whatever net proceeds you receive from the settlement is taxed as a long term capital gain.
If you’ve held the asset (your policy) for a year or less, it counts as short-term capital gains; over a year, and you’re talking long-term capital gains. Short-term capital gains are taxed at your personal income tax rate; long-term gains are taxed at a rate that considers your taxable income and filing status.
Here’s an example of what this looks like: Let’s say you receive a $100,000 settlement,– but you paid $75,000 in premiums. There’s no taxation up to the $75,000 base, but the remaining $25,000 is then taxed as a long-term capital gain. There can be no tax if you paid more in premiums than you sell it for.
It’s also worth briefly clarifying the difference between a viatical settlement and a standard life settlement. The difference is that a viatical settlement is specific to policyholders who are terminally ill, and the rules are a little different. The reason for pointing this out in this post? Because life insurance viatical settlement taxation works differently. The biggest distinction is that the IRS doesn’t consider viatical settlements taxable.
- Note: We are not CPAs, and we encourage you to talk to your tax professional before making any decisions.
How Can I Avoid Paying Taxes on a Settlement?
Legally, the answer is that you cannot avoid paying taxes on a life settlement. Running afoul of the IRS is an absolutely terrible idea—don’t do it!
What Is a Life Settlement Contract? What Is the Primary Purpose of a Life Settlement Contract?
Like any high-value transaction you might be involved with, a contract’s purpose is simply to document the financial terms of the transaction. Basically, it’s just putting everything in writing, so it’s clear exactly what is happening with the policy’s funds and what portion of the settlement sum will be yours to keep.
Reviewing the terms of a settlement contract, and asking questions any time you don’t understand what something means, allows you to make the best decision possible for your financial present and future.
What Factors Impact the Terms of the Contract?
The main factors that impact the terms of a life settlement contract include the following:
- The original size of the policy being sold
- The policyholder’s current age and life expectancy
- The policy’s annual premium cost
- The market rate of return (of interest to the entity that’s buying your policy)
- The policy’s total cash value
The number of different variables makes the idea of a universal settlement tax calculator a tricky proposition. That being said, speaking to the buyer is the best way to start getting the important questions answered and begin the settlement process.
It’s also important to note that proceeds of the life settlement contract could be subject to the claims of creditors, so you’ll want to make sure that you’ve got all your ducks in a row.
We’re Here To Answer Your Questions
While we’ve attempted to offer some quick answers to common tax-related questions, we expect you to have a few more. Life Settlement Advisors want to help you understand if you qualify for a life settlement, and to make sure you understand the tax implications of your decision.
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.
Get in touch with Life Settlement Advisors today to take the first step toward converting your policy into cash.
Life Settlement Advisors