Video Tips: Tax Implications of Selling a Life Insurance Policy
In times past, an individual who no longer needed a life insurance policy had few options. In general, he could surrender the policy to the issuing insurance company for its cash surrender value, or he could stop paying the premiums and let the policy lapse. For a term insurance or other policy without a cash surrender value, the only choice was to let the policy lapse.
Now, for some individuals, there is a secondary insurance market in which they may be able to sell a policy for more than its cash surrender value or even sell a policy without cash surrender value, such as a term policy. These transactions are called life settlements.
How Life Settlements Work
A life settlement involves selling your life insurance policy to a third party for more than the cash surrender value. The buyer takes over premium payments and receives the death benefit when the insured passes away.
Tax Implications
The tax treatment of a life settlement depends on how the proceeds compare to your basis in the policy:
- Amount up to your basis (premiums paid): Not taxable — this is a return of your investment.
- Amount between basis and cash surrender value: Taxed as ordinary income.
- Amount above cash surrender value: Taxed as capital gains.
Key Considerations
- Selling a policy may have gift tax implications if the proceeds are gifted.
- The sale could affect Medicaid eligibility.
- Once sold, the policy cannot be reinstated.
- Proceeds may be subject to creditor claims.
Before selling a life insurance policy, consult with your tax advisor to understand the full tax implications and explore all available alternatives. This is a significant financial decision that should be made with professional guidance.
