Selling your life insurance policy enables you to get a lump sum of cash, and you won’t have to pay your premiums anymore. However, you will need to pay taxes on your life settlement. Luckily, the Tax Cuts and Job Act of 2017 includes two provisions to help simplify the process of paying taxes on a life settlement. This law can help you understand the tax consequences of selling your life insurance policy.
What are the Tax Cuts and Job Act of 2017?
The Tax Cuts and Job Act of 2017 expanded the exemption for estate taxes. Initially, the estate tax exemption for one person was $11,400,000 in 2019, which increased from $11,180,000 in the previous year. The estate tax exemption also went up to $22,800,00 for married couples, as these tax increases made some unnecessary policies that were bought for estate tax purposes.
Additionally, the TCJA changes how the IRS taxes any cash you gain from selling your life insurance policy. Before this law was implemented, the taxation of a life settlement policy was complex and challenging to follow. For example, the policy seller had to decrease the basis of their approach by calculating the cumulative cost of the insurance charges from the insurance provider, which always resulted in even more taxable gains.
This process also forced sellers to determine the cumulative cost of their life insurance, as life insurance providers sometimes provided this amount. Fortunately, the TCJA made this entire life settlement process much more manageable. You are no longer required to find out the cumulative cost of insurance, which results in lower taxable gains. It also allows policy sellers to be treated the same as individuals that surrender their life insurance policies to the carrier.
How Are Life Settlement Proceeds Taxed?
Life settlement proceeds are taxed in various ways, which include:
- Tax-Free – Any proceeds you obtain up to your tax basis aren’t taxable, such as the premiums you paid on your life insurance policy.
- Ordinary Income – All the proceeds you received above your tax basis and up to the cash surrender value are taxed as ordinary income.
- Capital Gains – Any remaining proceeds are taxed as a capital gain.
Do You Pay Taxes on Life Insurance Cash Out?
Life insurance taxability depends on the type of settlement. For example, a viatical payment allows you to sell a life insurance policy if you are chronically or even terminally ill. This cash can be obtained without paying any income tax. Life settlement companies can purchase a policy from someone terminally ill, as the proceeds from the sale price are taxed as if the life insurance provider pays the death benefit. Typically, you don’t have to worry about paying income tax on a death benefit or accelerated death benefits.
Who is Considered a Terminally Ill Individual?
A terminally ill individual is any person certified by a doctor as having any physical condition or severe illness that will most likely lead to death in two years or less on the certification date. On the other hand, a chronically ill individual is any person that’s unable to complete at least two daily activities for at least ninety days due to a disability or a loss of functional capacity. Because of substantial cognitive impairment, these individuals also require significant supervision to protect their health and safety. A healthcare practitioner must also certify these conditions for it to be official. Any activities of daily living can include eating, getting dressed, bathing, or going to the bathroom.
Learning about the tax consequences of selling your life insurance policy is essential if you are considering this option. The Tax Cuts and Jobs Act of 2017 made the process easier by making everything more straightforward. Reaching out to life settlement companies is always a good idea if you are interested in selling your policy or if you have any questions. These professionals can work with you to discuss life insurance taxability while helping you determine if you are eligible for a viable settlement. Ultimately, trying to do everything alone can feel overwhelming, as working with life settlement companies is an excellent choice for many people.