How are life settlements taxed?
Recent landmark cases have brought many Life Settlement tax issues to light as the IRS itself has had issue with defining how life settlements are handled. Below you will find a brief guide covering how Life Settlements are taxed.
What you will learn:
What is a life settlement?
A life settlement is a life insurance policy that is no longer needed. When the owner of the policy decides that they no longer want the policy, they have two options available to them. They can let the policy lapse altogether or they can choose to surrender the policy. The life settlement option presents an opportunity to sell the policy to an investor. The policy is generally sold to another party. These policies don’t involve terminally ill patients.
How do life settlements work?
There are actually life settlement companies that acquire these policies. They hold them until they reach the maturity stage, and then the net value of death benefits is collected. If the policy’s benefits aren’t collected, they can be sold to investors. The owner collects a lump sum payment as a part of the transaction. The amount received depends on your age and other conditions in the marketplace, but you usually end up with more than the cash surrender value. You won’t be able to collect the full death benefit amount.
What are the buyer requirements?
The buyer of your policy will take over the premiums for the remainder of your life. They will also pay you a lump sum at the time of the sales transaction. When you die, the death benefit is collected by the buyer of your insurance policy.
How life settlements are taxed?
The proceeds are treated as ordinary income. Whatever the net proceeds from the transaction is valued will be taxed as ordinary income. The amount paid into the premiums will be treated as capital gains. The remaining net proceeds after taxes from surrendering the policy after should be compared to after-tax proceeds received by surrendering the policy to determine if it makes sense to sell the policy.
In theory, the additional proceeds following a life settlement should cover any tax obligations. It is best to speak to a tax advisor prior to making any serious decisions regarding a life settlement. If the policy is not sold for a higher rate, the seller can lose by having to cash out for a lower sum of money.
Magna Life Settlements, Inc. and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.