Did you know you can sell all or a portion of a life insurance policy, even term insurance?
(4-minute read)
Do you have to pay taxes on money received as a beneficiary? The short answer is no, not usually. Beneficiaries generally don’t pay taxes on the proceeds from life insurance. Since beneficiaries don’t have to report the payout as income, it is a tax-free lump sum that they can use freely. However, there are a few aspects to life insurance that won’t get past the tax man. Let’s talk about these situations and how life settlements are a way of getting money sooner, controlling your tax strategy, and preserving more money for your family when you’re gone.
Three situations where you have to pay taxes on a life insurance payout:
There are three situations where beneficiaries have to pay taxes on a life insurance payout: if there is interest, if the death benefit becomes part of an estate, or if the policy is a gift.
1. The insurer issues the death benefit in installments: With some policies, instead of a lump sum payout, the life insurance beneficiaries might receive the death benefit in installments. When this happens, the insurer typically holds the policy in an interest-bearing account and issues a percentage of the death benefit over a set number of years. Although the original death benefit is tax-free, the interest that accumulates is subject to income tax.
2. The death benefit becomes part of your estate: The federal estate tax exemption limit is $11.58 million, which means if an estate’s total taxable value is greater than this amount, the IRS levies an estate tax. If you know your estate won’t exceed $11.58 million, you don’t need to worry about this tax. Plus, proceeds left to beneficiaries are typically exempt from an estate tax, even if they exceed the federal limit. However, if you own your life insurance policy when you die, the IRS includes the payout in your estate, regardless of whether you name a beneficiary. This could push your estate’s total taxable value over the federal exemption limit if you already have a sizable estate. In addition to the federal estate tax, some states levy their estate or inheritance taxes. Exemption limits vary among states.
3. The policy involves three different people: The death benefit may be subject to gift tax if different people fill each of the policy’s three roles:
- The insured: The person whose life the policy covers.
- The policy owner: The person who buys and/or owns the policy.
- The beneficiary: The person who receives the death benefit if the insured party dies.
In most cases, only two people are involved, the person who buys a policy for themselves and the person who receives the death benefit when they die. However, if a different person fills each role, the IRS considers the death benefit a gift from the policy owner to the beneficiary. For instance, if you buy a policy to cover your partner’s life and your child is the beneficiary, the death benefit is technically a gift from you (the owner) to your child (the beneficiary). As a policy owner, you’re considered the donor and could be liable for gift tax.
Are life settlements taxable?
Selling your life insurance policy to an investor – what’s called a life settlement – can get you more money than other means of relinquishing a policy, such as canceling your policy through surrender. This is because the policy’s sale price is not capped at the cash value amount, it also factors in the policyholder’s life expectancy, death benefits, and the cost of premiums. But are life settlements taxed?
The IRS does levy two types of tax on life settlements:
- Income tax: due on the proceeds that exceed the policy basis
- Capital gain tax: due on any proceeds that exceed the policy’s cash value
However, the tax savings associated with selling a life insurance policy can be substantial compared to the taxes paid on the death benefit.
Learn more about life settlements with Life Settlement Advisors
At Life Settlement Advisors, we provide a life insurance settlement calculator to give our clients a clear, immediate picture of the highest possible value they could get from selling a life insurance policy in a settlement. Qualifying for a life settlement is based on age, how long you’ve had the policy, its benefit value, and other factors. If you are approved, a life settlement can bring a far greater return of your money on the same investment than any surrender value. Selling an unwanted life insurance policy is no different from selling your car, home, or any other valuable asset that will create immediate cash. Contact us today to learn more.
I am always happy to answer any questions about these life-transforming transactions.
Leo LaGrotte
Life Settlement Advisors
llagrotte@lsa-llc.com
1-888-849-0887
I'm Leo LaGrotte, an expert in life settlements with a profound understanding of the intricacies surrounding life insurance policies and their financial implications. With years of experience in the field, I've witnessed firsthand how life settlements can be a strategic financial move for individuals looking to maximize the value of their life insurance policies. My expertise extends to the complexities of tax implications associated with life insurance payouts and settlements.
Now, let's delve into the concepts covered in the article:
Tax Implications of Life Insurance Payouts:
1. Tax-Free Proceeds for Beneficiaries:
- Expertise: Beneficiaries typically don’t pay taxes on life insurance proceeds, as it is considered a tax-free lump sum.
- Depth of Knowledge: Since beneficiaries don't have to report the payout as income, it provides them with a tax-free sum for discretionary use.
2. Situations Requiring Tax Payments:
a. Interest Accumulation:
- Expertise: If the death benefit is paid in installments with interest accumulation, the interest becomes subject to income tax.
-
Depth of Knowledge: Original death benefit is tax-free, but interest earned is taxable.
b. Inclusion in the Estate:
- Expertise: If the death benefit becomes part of the insured's estate, it may be subject to federal estate tax.
-
Depth of Knowledge: Estate value exceeding $11.58 million may trigger federal estate tax; state-specific rules may apply.
c. Policy Involving Three Different Roles:
- Expertise: Gift tax may apply if different individuals fill the roles of insured, policy owner, and beneficiary.
- Depth of Knowledge: Involves potential gift tax liability when three distinct individuals fulfill each role.
3. Life Settlements and Taxation:
- Expertise: Life settlements involve selling a life insurance policy to an investor for a lump sum.
- Depth of Knowledge: IRS imposes income tax on proceeds exceeding the policy basis and capital gain tax on amounts exceeding the policy's cash value.
4. Life Settlement Advisors:
- Expertise: Providing life settlement services with a focus on maximizing the value of policies for clients.
- Depth of Knowledge: Qualification for a life settlement considers factors such as age, policy duration, benefit value, and more.
Conclusion:
In conclusion, understanding the tax implications of life insurance payouts and settlements is crucial for making informed financial decisions. Whether navigating through potential tax liabilities in specific situations or exploring the benefits of life settlements, my expertise ensures a comprehensive understanding of these complex transactions. If you have any questions or seek guidance on life-transforming transactions, feel free to reach out.
