Life Settelement

Depending on specific financial and estate planning circumstances, sometimes selling your life insurance policy makes the most sense. Life insurance also comes with favorable taxation on “Life Settlements”.

A life settlement is where the policy owner sells the contract to a third party. But do you know how life settlement proceeds are taxed?

If you are unsure whether keeping or selling a policy is right for you, it’s important to first understand why you need life insurance and how it fits into your overall financial plan.

A life settlement is where the policy owner sells the contract to a third party. But do you know how life settlement proceeds are taxed?

Understanding how life settlement taxation works can help you and your clients determine whether a life settlement supports your broader estate planning goals for your family’s future.

How Life Settlement Taxation Works:

1.  Sales proceeds up to the amount of the cost basis are tax free.
2. Sales proceeds above the cost basis and up to the policy’s surrender value are taxed as ordinary income.
3. Any remaining sale proceeds above the surrender value are only taxed as long-term capital gains.

Life Settlement Case Example:

• Policy Type: $1,000,000 UL
• Premiums: $70,000 (Cost Basis)
• Cash Value: $80,000 (Surrender Value)

Case Example Tax Breakdown:

• Policy Sale Price: $300,000 (Settlement Amount Paid to Policy Owner)
• Tax Free: $70,000 (Cost Basis/Amount Paid in Premiums)
• Taxed as Ordinary Income: $10,000 (Sale Proceeds Above Cost Basis and up to Surrender Value)
• Taxed as Long-Term Capital Gains: $220,000 (Remaining Sale Proceeds)

• Tax Cuts and Jobs Act of 2017 (TCJA)

EXAMPLES: CASE STUDIES

Business Expansion:

a 78 year old entrepreneur, and primary shareholder of a closely held family business finally gets around to developing his Estate Plan. Son and daughter-in-law have been in the business for 20 years, but are only now the heir apparent. The 78 year old suffers a few TIAs, forcing the issue of the business transition. He owns a life insurance policy worth $1,000,000 with cash value of approximately $73,000. He sells the policy for approximately

$310,000. The proceeds make the purchase of the business more palatable for the son and daughter-in-law to afford the business and the 78 year old now has the liquidity he didn’t have to sustain a long-term care stay in senior housing. So what started out as a business transition consult, turned into a succession plan for a child and a long term care plan. Without the knowledge of ‘LIFE SETTLEMENTS’ this family wouldn’t have been able to do either.

Policy Rescue:

A 75-year-old woman purchased a term life insurance policy 10 years ago when she refinanced her home and took cash out. She spent her deceased husband’s estate and retired early from the school system. Soon, she realized she had too much free time and spent much of it shopping.

As reality set in, she became concerned about her financial future. Observing her friends facing medical issues, she was referred to us to evaluate her budget and determine whether her assets could sustain her over time.

We reviewed her $500,000 term policy. She no longer needed it, especially since her home was upside down. Term policies typically do not have cash value and often end without paying a death benefit.

Fortunately, her policy was convertible. We found a buyer and converted the term policy to permanent coverage with a new premium. This allowed the buyer to have a predictable return on investment.

She received $117,000 from the transaction. This gave her financial flexibility to sustain herself while growing her other nest eggs, preparing for the future with greater security.