People investigating the opportunity offered by a life insurance settlement want to sell their insurance policy so they can monetize it. Some believe that since the investment vehicle is a life insurance policy it is exempt from taxes. This belief stems from beneficiaries of life insurance that a relative named as a beneficiary on the policy does not pay taxes on the payment from the insurance company.
Life Settlement Sales are Taxable
The rules are different though when a company or individual owns a life insurance policy through a life insurance settlement. In 2009, The United States Internal Revenue Service issued rules on when the proceeds of a life settlement are taxable.
Thanks to the 2009 issuance of rules, life insurance settlements for federal income tax purposes are the same across the country. However, each state, at the state level, handles taxation differently. For this reason, it is important that you arrange a conference with a qualified tax advisor to find out the state tax implications of selling your life insurance policy.
Content presented here is for information only and no one should rely on it or make a decision based on it. Life Settlement sales are complicated financial transactions. Seek the advice of a qualified life settlement tax advisor or your own finance advisor before concluding a sale.
History
The ability to enter in a life settlement agreement has been legal for over 100 years. It was almost a well-guarded secret, as insurance companies would rather pay the insured the cash surrender value of his or her life insurance policy rather than the full face value to an owner not related to the insured. This is a financial decision by the companies. By being silent about life settlements, they encouraged people to either abandon their policies or cash it in for face value only. This is good for an insurance company’s bottom line.
However, during the 1980s, viatical settlements started to become popular. While a viatical settlement is very similar to a life settlement, the sales were from young, terminally ill patients who usually needed the money for health care and end of life care. As the viatical market matured so did the life settlement industry.
Since life settlement transactions were rare, the Internal Revenue Service had no written policies on how to tax them. This lack of direction from the IRS continued for nearly a decade, until May of 2009 when the IRS issued IRS revenue ruling 2009-13 – life settlement taxation guidelines.
IRS Ruling 2009-13
There are two buckets of cash that interest the IRS when a sale of a life settlement occurs. First are capital gains. Second is ordinary income.
Ordinary Income Taxes
The ordinary income portion of the transaction is the cash surrender value of a life insurance policy – it is what the seller receives when surrendering the policy.
Capital Gains Taxes
The amount a seller receives from the life settlement broker less the surrender value is a capital gain under most circumstances. Even if it is a capital gain, the tax rate is usually lower than if treated as ordinary income.
Term Policies
Settlement proceeds up to the total premiums paid beyond the cost of insurance (COI) required to keep the policy in force is the basis. That amount tax-free. Monies paid out over the basis are a capital gain and taxed.
Universal Life Insurance and Whole Life Insurance Policies
These classes of policies have more complicated tax requirements. According to the 209 ruling calculating the basis is the same for these policies as it is for term policies. Settlements up to the amount of the cash surrender value (CSV) less premium payments great than cost of insurance is ordinary income and taxed as such.
Finally, life settlement proceeds that exceed the CSV are capital gains and taxed as such. For Universal Life and Whole Life policies, the taxation is more complex. The revenue ruling says that settlement proceeds up to the total premiums paid over and above the cost of insurance (COI) needed to keep the policy in force is considered basis and is tax free (same as a term policy). Settlement proceeds up to the cash surrender value (CSV) minus premium payments exceeding COI is ordinary and subject to ordinary income tax. Lastly, settlement proceeds above the CSV are capital gain and taxed using the capital gain formula.
Although when you sell your policy for cash, it is not as if you have gotten a tax free life insurance loan. There are tax implications.
The federal government has one set of rules for life insurance settlement taxes that work all over the United States, each state handles life settlement taxation differently. The federal rules need to be followed carefully, as do each state’s regulations making it a good idea to hire an expert in life settlement taxation to advise you.
Comparing a Life Insurance Loan to a Viatical Settlement
If you can no longer afford the premium, don’t let the policy lapse. You must get your life insurance policy valued before you just throw it away. Seniors literally throw away Billions of dollars a year.. without ever knowing. Instead, explore your options before you make a decision you may regret. Comparing a Life Insurance Loan to a Viatical Settlement will help you make the smart decision for you and your family.
Life Insurance Loans
When you own a life insurance policy, you can borrow against the cash surrender value and use the money any way you see fit. In general, the longer you own the life insurance policy, the larger amount of money you will be able to borrow. A loan or life insurance advance is a good way for some individuals to get the money they need to pay for medical care or use in other ways while they are still alive.
You can elect to repay the life insurance loan and the accrued interest, or, upon your demise, the balance of the loan plus interest will be deducted from the death benefit. Your beneficiary will receive any remaining balance. If you choose to take a life insurance advance and not pay it back during your lifetime, you should make sure you have made alternate plans for your funeral expenses.
Viatical Settlements
In most states in the United States, laws are in place that allow terminally ill individuals to sell their life insurance policy to a third party viatical settlement company. The National Association of Insurance Commissioners 2009 Viatical Settlements Model Act serves as a guideline for the individual legislation and laws in each state that govern viatical settlements.
An individual with a life expectancy of two years or left can entertain offers from one or more viatical settlement companies and usually receive a greater cash settlement than if he or she took out a life insurance advance. In return for a cash payment, the settlement company continues to make the premium payments and becomes the beneficiary of the policy upon the death of the insured.
What is your best choice?
When comparing a life insurance loan to a viatical settlement, there are many similarities and a few differences. You do not incur any federal tax liability with either option and both methods provide the insured and his or her family with funds that can be used to help provide care.
When you opt for a loan, you can always pay it back. You can also choose to borrow only a portion of the surrender value. You are in control of the amount of how much money will be left to pay out to your beneficiary. With the settlement, you may receive a greater amount of cash, but you no longer own the policy. Once the deal is complete, you can not change your mind.
Can I get an Advance on My Life Insurance Policy?
Did you know that if you own a life insurance policy, you may be sitting on a bundle of cash? You may be able to get an advance on life insurance that you have owned for years and use that money to provide for your current health care needs or use in some other way to make your life more comfortable. Life insurance is an asset just like your home or your car. It has value. As a smart consumer, you must get your life insurance policy valued before you just throw it away. Seniors literally throw away Billions of dollars a year.. without ever knowing.
Using your Accelerated Death Benefit
If your life insurance policy has an accelerated death benefit you may be eligible to take out a tax-free life insurance loan. The intention of this type of provision in a life insurance policy is to provide a benefit to an individual who has been diagnosed with a terminal illness and has a life expectancy of two years or less. In such an instance, a life insurance policy advance or loan against the death benefit of the policy, can be used to provide money to help the individual while he or she is still alive. Upon the death of the insured, the loan is paid off out of the proceeds of the death benefit and any remaining amount is then paid to the beneficiary of the policy.
Using a Life Insurance Advance
In the secondary market for life insurance, you may also be eligible for another type of advance on life insurance policies that you own. If your policy does not contain an accelerated death benefit rider you may qualify under a life insurance advance. Like an accelerated death benefit loan, you can borrow an amount up to $500,000, based on the amount of your death benefit of your life insurance policy. The life insurance loan is repaid, upon your demise, out of the death benefit and any remaining funds are distributed to the beneficiary.
In many ways, this type of life insurance policy advance is better than the much more restrictive accelerated death benefit loan. You do not have to meet the rigid requirements of having a terminal illness that gives you a life expectancy of two years or less. You also have the freedom to spend the money any way you see fit. Many people need the money for current assisted living expenses and this is an excellent way to meet that need.
Once you know how much the current value of your life insurance policy is, you can make an informed decision on whether or not you should apply for a life insurance loan. Although you may not have many years left, you should do what you can to enjoy the time you have remaining. Why not use the value in your life insurance policy to get the money you need?