Taxes are complicated. That is why there are experts whose sole position is to determine your taxes. It is a part of any significant transaction made in life, including a life settlement. How a cash settlement is taxed is not a simple question.

Taxation depends on each individual’s placement in the tax bracket, the amount that their policy is valued at, and how much they have paid in premiums to the policy over the years. Evidently, it is a very personalized process; that is why it is important to involve your financial advisor and consult a tax expert. So, where do you start, and what do you need to know?

Start with an appraisal. 

An appraisal costs little to nothing and opens up options. In order to make any changes to your life insurance policy it is wise to get it appraised. An appraisal will tell you anything you need to know about your policy and its potential in the case of a life settlement.

An appraisal will tell you the value of your policy and give you an estimate of how much you may be receiving for your life insurance policy before any fees or taxes are taken. The value on your policy is crucial to understand. 

How much of your policy is taxable?

The amount on the policy that is considered profit is taxable. That amount is based on the difference between the premiums paid into the policy, and the cash that the policyholder receives. A settlement is also taxed as both ordinary income and capital gains. The two greatly contrast, which is why you also want to know your tax basis. 

Any settlement amount that is received up to the tax basis is not taxed. Any amount that is received over the tax basis is taxed as ordinary income: the amount that is up to the policy’s surrender value. Any amount of the settlement that surpasses the policy’s cash surrender value is taxed as capital gains. 

Being aware of where you stand on the tax spectrum and having a current appraisal gives you an idea of how much will go straight to Uncle Sam. You can be better prepared for what to expect in an actual amount from your settlement. The last thing you want to do is find out you are not getting the actual amount you expected due to taxes and fees. 

It is always recommended to do a thorough amount of your own research. Your financial advisor and a tax consultant are reliable resources you should confide in before your transaction is finalized. There is a reason that it is some people’s sole position to prepare taxes; it is a lot of work. Don’t let the vague guidelines of taxes deter you from a life settlement. There is much more potential for cash and your benefit from a sold life insurance policy. 

Rob HaynieFebruary 18, 2021

Rob Haynie

Mr. Haynie has been a major influence on the evolution of the life settlement industry during his almost twenty-seven year career of proactive involvement. Not only has he been directly involved in negotiating and settling several thousand contracts, he also presently serves on the board of directors of the Life Insurance Settlement Association (LISA) and is a charter member of the Association’s PPC committee, which is charged with the regulatory and legislative activities of the industry. Additionally, he has served on both the Customer Advisory Board (CAB) of ITM/TwentyFirst Services and the Advisory Board of the Insurance Studies Institute (ISI). He was named one of the top 10 most influential people in the life settlement industry worldwide. Mr. Haynie, an Alumnus of Florida State University, currently holds a Life Agent License with Viatical Settlement Broker Appointment for LIS and has spoken at almost every life settlement industry meeting or conference, published articles on the subject and has given many educational webinars as well.

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