Tax Laws and Life Settlements: What Policyholders Need to Know

Green Settlements Staff

Unless you earn a living as a CPA or bookkeeper, you probably find taxes to be a complex, even mystifying part of managing your finances. Survey data indicate that most American adults receive an “F” when it comes to understanding standard income tax information, with the average adult scoring about 50 percent on personal finance-related questions. Another study reveals the majority of Americans (57 percent) are not confident in their understanding of the tax code.

For older adults planning to sell their life insurance policy in pursuit of a life settlement, an extra layer of complexity enters the tax equation. Fortunately, there’s good news for policyholders: Thanks to a recent piece of legislation proposed by the IRS, those who engage in a life settlement transaction stand to benefit from a significantly streamlined filing process.

Before diving into the details of this updated legislation, it helps to first understand the basic tax consequences of selling your policy.

How Will Your Life Settlement Be Taxed?

After selling your life insurance, you will be taxed on a three-tiered basis:

1.Amounts received up to the tax basis (the total you paid in premiums) are free of income tax.

2.Amounts received that are larger than the tax basis up to the amount of the cash surrender value—the amount of cash that you can withdraw if you surrender your policy and let it lapse—are taxed at standard income rates.

3.Amounts received that exceed the amount from tier two are taxed as long-term capital gains.

Before legislation known as the Tax Cuts and Jobs Act of 2017 (TCJA) was enacted, some seniors were wary of life settlements due to tax concerns. In December of 2017, however, TCJA came along and simplified the tax implications for selling a life policy. The legislation overturned an IRS ruling that required sellers to reduce their tax basis by the cumulative cost of insurance charges, resulting in an increased taxable gain. This old ruling meant only a small portion of the proceeds was considered tax-free.

In the end, the TCJA works in policyholders’ favor by lowering the capital gains tax that life settlement recipients have to pay and expanding the portion of tax-free proceeds. Pre-TCJA legislation dictated that those surrendering their policy were able to recoup more than those selling their policies; however, now the same tax rules and calculations apply to both groups evenly.

Whenever changes occur or updates are made to tax laws, things are bound to get a little confusing. But with the right guidance and educational resources, seniors are able to make better decisions about their financial futures.

If you are at least 65 years old and own a term, whole or universal life insurance policy with a face value of $100,000 or more, you may benefit from a life settlement. Get a free, no-hassle quote today to see if you qualify.

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