Are Life Settlement Proceeds Taxable?
Life settlements are a great financial option for people who find they no longer need coverage, whose circumstances have changed or who are experiencing financial hardship. This is especially true for senior citizens whose policy premiums have risen beyond what they may be willing to pay. It’s also a way for someone to put extra funds aside for unforeseen expenses, a luxury item they want or a once-in-a-lifetime trip they would like to take. What people may not consider when thinking about selling their life insurance are the tax benefits.
What you will learn:
First Things First: Reasons to Sell a Policy
Before diving into the tax benefits of selling a policy, it’s important to understand why individuals may want – or need – to sell their life insurance policy. Perhaps the policy was purchased to provide for one’s children, but is no longer needed. The policy owner’s children may have attained their own success, are financially well-off and no longer need the money a life insurance policy would provide. Taking a life settlement would provide the policyholder with the funding to meet the rising cost of medical needs as they age, thereby reducing the risk of becoming a financial burden to their children.
Likewise, life insurance policies purchased with a spouse is another leading reason why policyholders sell their life insurance. If life insurance was purchased with a spouse and the couple has since divorced, the policy may no longer be necessary if the couple does not have children. Additionally, someone may want to sell their policy if their spouse has passed away. Taking a life settlement in these instances would provide the funding for relocating closer to family, traveling or ticking items off a “bucket list.”
The High Cost of Premiums and Medical Care
For many seniors, retirement means living on a budget. High life insurance premiums oftentimes become a major financial burden and are no longer affordable. Rather than letting the policy lapse or accepting the cash surrender value, taking a life settlement can actually result in a significant increase in the amount of cash received. Settlement money can be put towards living expenses, paying off debt or offsetting large medical expenses.
As we age, the cost of medical care increases and may become a financial burden to both the person requiring the care and their spouse or family members. A person may decide they would be better off if they had Medicaid but in order to qualify, they need to liquidate their assets. By taking a life settlement, a person would be able to pay off their medical expenses or put aside money for future medical needs. Liquidating their life insurance policy by taking the life settlement would also increase their chance of being able to file for Medicaid – all excellent reasons for taking a life settlement!
Evaluating the Tax Benefits of a Life Settlement
When considering whether or not taking a life settlement is the right course of action, factor in the taxable aspect of the settlement.
According to IRS Publication 554, when a life insurance policy is sold for cash, one must claim as income any proceeds that are more than the cost of the life insurance policy. This is calculated by subtracting the policy’s cash value from the amount paid in premiums. If the policy’s cash value is less than the amount already paid in premiums, no taxes would be owed. Should the cash value be more than the amount paid in premiums, the difference would be taxable income.