Any life insurance policyholder looking to sell their policy for cash is encouraged to first use a life settlement calculator to first see if they qualify. Policyholders in New York state are encouraged to read about life and viatical settlement tax rules specific to their home state.
Many senior citizens own life insurance policies that they no longer need or can no longer afford. Selling an existing life insurance policy, in a transaction known as a “life settlement”, could be an option. However, prior to the recent passage of the Tax Cuts and Job Act (TCJA) of 2017, many seniors were rightfully hesitant to sell these policies because of life settlement taxes. The tax consequences of life settlement transactions often meant life settlements didn’t make the most financial sense. So, policyholders chose to surrender them or continue paying the premiums. With the passage of the new landmark tax bill TCJA, however, some outdated laws regarding tax on life insurance settlements have finally been re-written. The new life settlement tax law now benefits those interested in selling a life insurance policy.
In 2009, the IRS Revenue Ruling 2009-13 was passed. At the time, many complained that the stipulations of this ruling were unfair and poorly reasoned from a life settlement tax standpoint. Specifically, this ruling inexplicably created distinctions between how life settlements and surrendered policies were treated from a taxation standpoint. During this time, life insurance policyholders who wished to sell their existing policies were required to reduce their tax basis. They did this by deducting expenses related to the “cost of insurance” accumulated over the life of the policy.
For example, let’s say a senior with a settlement agreement for $500,000 and a cash value of $350,000 would need to determine the cost basis of the policy (let’s say $250,000). Under the existing life settlement taxes regulation, this person would end up subjected to capital gains taxes on $250,000 worth of their profits ($100,000 at the regular life insurance income tax and another $150,000 at capital gains rates).
Insurance companies simply aren’t able to provide this information because very few kept records of these kinds of charges. This was the main problem. So, policyholders were left in limbo. Many wanted to sell their policy for cash. However, most would end up simply surrendering their policies just to avoid the tax complications.
Recognizing the failures of Revenue Ruling 2009-13, the TCJA of 2017 enacts many changes to the life settlement tax law. The changes make it easier and more favorable for seniors to opt for life settlements. Policyholders selling their life insurance policies are no longer required to reduce their tax basis by “cost of insurance” charges. Instead, the same tax rules and calculations now apply across-the-board. It no longer matters if a person is surrendering their policy or opting for a life settlement.
With this in mind, the same person from the previous example would not be required to factor in the cost of insurance charges. Even if those charges only amounted to about $50,000, this would still mean a significant reduction of profits subjected to capital gains taxes at $100,000 instead of $150,000.
Under new laws, is life insurance tax-free? No, but these changes in life settlement taxes should eliminate a lot of the confusion. A life settlement is almost always more profitable than surrendering a life insurance policy. So, seniors could be in better financial positions.
Many seniors can no longer afford their life insurance premiums. Some need to sell their policy to qualify for Medicaid. Others feel they no longer need their insurance coverage.
Recent changes in tax law can be confusing. However, it’s important for seniors to realize that these changes in the TCJA are working in their favor. Those interested in taking advantage of a life settlement option should still always consult with an experienced life settlement broker before making a decision to ensure it’s the right choice for them.
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