How Can Taxes Affect Life Settlements?

A life settlement is when a person sells his or her life insurance policy to a life settlement provider in order to obtain extra money. The provider in turn will become responsible for paying the premiums but will later enjoy the benefits of the policy when the original policyholder passes away. If a retiree has no dependents, the cash he or she will get from the life settlement can be used to pay for emergency expenses. This also applies to seniors whose dependents have a steady source of income and have no need for the benefits that come with the insurance policy. Nevertheless, knowing how much an individual can receive from a settlement is important. This means that several factors such as taxes must be accounted for.

A Summary on How Taxes Affect Life Settlements

Life insurance policies are products that come with tax advantages. When the planholder passes on, heirs or the estate may have to pay considerable amounts towards estate taxes, although h a beneficiary receives the benefits without the burden of taxes. When the plan is exchanged for money in a life settlement, the income tax exemption is cancelled because of the involvement of a third-party investor (such as a life settlement provider, for example).

The investor then has to pay income taxes on the difference of the face value of the insurance policy and the overall amount of the premiums made and the tag price of the plan. Exemptions to this tax rule can be made if the provider of the life settlement is in partnership with the original policy holder or if the life settlement company has the insured as a shareholder. However, if the provider is in the business or trade of purchasing insurance policies or facilitating life settlements (and the seller is neither a shareholder nor partner), gains are taxed as ordinary income. Here are other particulars concerning life settlement taxes:

Previously Paid Premiums

As this is counted as the returned capital, the sum of all the premiums made by a policyholder will not be taxed.

Income Tax

The difference between cash surrender value of the policy and all premiums paid for coverage is taxed as ordinary income. If the planholder chooses to return the policy to the insurance company that issued it in exchange for the cash surrender value, he or she would have the same tax obligations.

Capital Gains and Taxes

Taxes on capital gains are implemented upon receipt of an amount that goes beyond the cash surrender value of the policy. A policy involved in a life settlement can be considered a capital asset because ownership of the plan went beyond twelve months.

Although tax treatments for providers of life settlements can be heavy, planholders can still obtain decent amounts for their policies through these procedures. Statistics say that the average client of a life settlement can receive a lump sum payment that can be anywhere from twice to five times the surrender value of the policy. Despite the numbers, you will have to think about numerous considerations when selling your insurance policy to make the most out of your life settlement, with taxes being one of them.