Are You Considering Selling Your Life Insurance Policy?
Here’s What You Need to Know
If you are considering selling your policy, you are one of the few Americans that are actually aware that you can. Most seniors who no longer need their policies or find that the premiums are too expensive just stop paying the premiums and let the policy lapse. Some of those seniors who have cash accumulated in their policy, surrender their policy to the life insurance company for the cash value. If you are one of those seniors and are reading this for the first time, don’t surrender your life insurance policy or let it lapse! Your life insurance policy could have significant value. There are companies, such as MRE Finance LLC, that specialize in life settlements that can help you determine if your policy qualifies for a life settlement and can guide you through the process of selling your policy. A life settlement is the sale of your policy for a lump sum cash payment to a licensed buyer known as a life settlement provider. The buyer becomes the owner and is responsible for the premiums going forward.
There are many reasons why seniors or those who are chronically or terminally ill would want to sell their life insurance policy. Maybe they would like the extra cash to travel the world and enjoy their life. Some may need the money for costly medical treatments. Others may have a looming financial burden such as paying for a nursing home or assisted living facility for a loved one. In some cases, seniors that have provided for their families feel there is no longer a need for the insurance policy. However, the most common reason is that seniors living on a fixed income struggle to pay the monthly premiums for their policies and decide that the insurance just isn’t worth it. Whatever your reason for choosing to sell your life insurance policy, you need to know how it works.
If your policy qualifies for a life settlement, it is important to note that your lump sum payout will always be higher than the cash surrender value, if any, in your policy. Since you may receive as much as 25%-40% of the policy coverage as your payout, you may be subject to taxes on a portion of the payment. Here’s what you need to understand about the taxes involved with selling your life insurance policy.
Taxation on the sale of your life insurance policy happens in three tiers:
First, the total amount of premiums you have paid over the life of your policy is known as your “basis”. When you receive your lump sum cash payout, you will not be taxed on the amount of the payout up to your basis or what you have already paid for your policy. Second, the amount of your payout that is greater than your basis up to your cash surrender value is taxed as ordinary income. Third, any portion of your payout that is greater than the cash surrender value is taxed as capital gains.
Here is an example
You are a senior aged 76 and you have a $500,000 life Insurance policy that you have owned for 20 years. You have paid $100,000 in premiums (your cost basis) and your cash surrender value is $120,000.
Congratulations! You have sold your policy for $185,000!
Because you have paid $100,000 in premiums, you will not pay taxes on the first $100,000 of your payout.
Since your cash surrender value is higher than your cost basis, you will be taxed at ordinary income rates on the difference between your cash surrender value and your cost basis.
The remainder of your payout above the cash surrender value will be taxed at a capital gains tax rate. Example: $185,000 (Cash payout) – $120,000 (cash surrender value) = $65,000 (taxed as ordinary income).
In the above example, the seller paid $16,150 in taxes and took home $168,850
The above example does not consider state taxes. Each state has different income taxes, so be sure to check with your tax representative. Each life insurance policy is different, so you would need to contact your life insurance provider for specific details on your cash surrender value.
If you have any further questions about taxes for a Life Settlement, contact your accountant or tax service provider for more information.