Before you cash in your policy, you might have questions about how the IRS will...
Yes — in most cases you pay taxes on life insurance settlements. However, since 2017, taxes on selling your life insurance policy have eased, allowing policyholders to keep more of their settlement amount.
But the how much and what portion depends on the type of policy, your cost basis, and how the IRS categorizes the gain. Here’s the breakdown in plain English:
Before 2017, tax law treated policyholders unfairly — often excluding part of the premiums from cost basis, which inflated taxable income. The Tax Cuts and Jobs Act of 2017 changed that. Now, policyholders can include all premiums paid as part of their cost basis, lowering taxable income in most cases.
So in this scenario, the seller would likely owe tax on $50,000 of capital gains.
Before you cash in your policy, you might have questions about how the IRS will...
For decades, the tax treatment of life settlement transactions discouraged people from selling their policies....
A Policyholder’s Guide To Viatical Settlements Understanding how taxes apply to a viatical settlement is...
If the policyholder is terminally or chronically ill and the transaction qualifies as a viatical settlement, proceeds may be exempt from federal taxes. To qualify, the settlement must be completed through a licensed viatical settlement provider.
Life settlement proceeds can affect eligibility for Medicaid. Because they are counted as income or assets, a settlement may disqualify someone from benefits unless carefully structured with professional guidance.
If your policy has an outstanding loan, the settlement may first be applied toward repayment. This can reduce net proceeds and affect taxable gain calculations.
Life settlement providers typically issue a Form 1099-B to the policyholder, showing gross proceeds. It’s then up to the policyholder and their tax advisor to report the correct breakdown between basis, ordinary income, and capital gains.
While federal tax law applies across the country, states may have their own rules and rates. Here are some highlights that matter most in 2025.
New York recognizes viatical settlements as tax-free when the insured is terminally ill. For standard life settlements, proceeds are treated as income under New York State tax law and taxed at the state’s progressive rates. Policyholders should expect to pay both federal and state taxes unless the settlement qualifies as viatical.
California conforms to federal rules for determining taxable amounts but applies its own state income tax rates, which range as high as 13.3%. For higher-value settlements, the state-level impact can be significant. Policyholders often work with tax advisors to plan carefully and avoid surprises at filing time.
Texas does not levy a state income tax. That means policyholders only pay federal taxes on life settlement proceeds. This creates a more favorable after-tax outcome for residents compared to states with higher tax rates.
Florida, like Texas, has no state income tax. For retirees considering life settlements, this can be a deciding factor in keeping more of their proceeds. Federal tax rules still apply, but the absence of state-level taxation is a clear advantage.
Illinois taxes life settlement proceeds at a flat state income tax rate of 4.95%. Combined with federal obligations, this can modestly reduce the net payout for policyholders.
Pennsylvania does not tax retirement income such as pensions and Social Security, but it does treat life settlement proceeds as taxable income. Seniors here should factor in both state and federal implications when weighing a settlement offer.
Ohio conforms to federal rules for determining taxable amounts and applies its own state tax rates ranging up to about 3.99%. Policyholders with large settlements may feel a noticeable difference compared to states with no income tax.
Washington has no state income tax, but residents should be aware of the state’s estate tax when planning their finances. For those considering a settlement late in life, this may be relevant to estate planning alongside federal rules.
These state examples illustrate the importance of looking beyond federal law. Where you live can directly impact how much of your settlement you keep.
Reporting a life settlement correctly is essential to avoid IRS scrutiny. While providers issue Form 1099-B, you’ll also need to determine the correct breakdown:
Common mistakes include overstating taxable income by not including the tax-free basis or misclassifying capital gains.
Taxes only apply to the proceeds you receive. That means the higher your settlement offer, the better your after-tax outcome. An independent life settlement broker introduces your policy to multiple institutional buyers, creating competition and driving up offers. Direct buyers, by contrast, represent only themselves — limiting your options and potentially reducing your net gain.
Before 2017, complex and unfair tax rules discouraged many seniors from selling their life insurance policies. The Tax Cuts and Jobs Act changed that, simplifying the system and allowing more people to benefit from settlements.
In 2025, life settlement taxes are clearer, more predictable, and far more favorable than they were just a decade ago. For policyholders, that means a chance to unlock hidden value while still managing tax obligations responsibly.
Every case is unique. To ensure the best possible outcome, consult with both a qualified tax professional and an independent broker who can maximize your policy’s value. Windsor Life Settlements is here to help you navigate the process and secure the strongest offers available.
Sources:
Yes, the portion of the settlement up to your policy’s cash surrender value is taxed as ordinary income.
Yes, any amount you receive above the policy’s cash surrender value is taxed as capital gains.
Yes, if the insured qualifies as terminally ill under IRS rules. These proceeds are treated as accelerated death benefits, not taxable income.
No. States like Texas and Florida impose no state income tax, while California and New York apply higher state rates. Where you live can significantly affect your after-tax proceeds.
Yes, because proceeds are typically counted as income or assets. This can disqualify you unless the settlement is planned carefully with professional help.
Most policyholders receive Form 1099-B, which shows gross proceeds. Depending on the situation, you may also receive Form 1099-LTC for viatical settlements.
You cannot avoid federal rules, but you can minimize taxes by working with a broker to maximize your gross offer and with a tax advisor to ensure proper reporting and explore state-specific strategies.
No, taxes are reported on your annual return for the year in which you receive the proceeds. However, some policyholders make estimated payments to avoid underpayment penalties.