Cashing in on Life Insurance? You are Still Subject to Taxation

            The 2017 Tax Cuts and Job Act included revisions designed to create financial options for millions of Americans with life insurance policies. The changes specifically benefit those individuals who may need to “cash in” on the value of their policy prior to their death.

            A life settlement allows a policyholder to sell their life insurance policy to a third party for a sum of money, typically for a sum less than the death benefit that would otherwise be paid to a policyholder’s survivors. The purchaser of the policy takes on the responsibility for future premium payments (if applicable) and receives the death benefit upon the insured person’s death.

            Historically, life settlements contained tax disadvantages. However, with the 2017 passage of the Tax Cuts and Job Act, many of the disadvantages that came with a policyholder opting for a life settlement are no longer in effect.

            Prior to this, in 2009, the IRS passed Revenue Ruling 2009-13, which created a seemingly arbitrary distinction and unequal tax burden between taxpayers who surrendered their policies and taxpayers who sold them. Those who opted to sell their policies were forced to reduce their tax basis by deducting their cumulative “cost of insurance” expenses related to the policy.

            Many life settlement proponents objected to the ruling, calling it unfair, unreasonable, and unduly punitive to policyholders who often relied on a life settlement to provide funds for urgent needs or expenses.

            2017’s tax reform brought an end to this. The changes written into the current tax code now mean that taxpayers who surrender their policy or who elect to sell it are treated equally, with the latter group no longer penalized for their choice.

            Though life insurance policy transactions are still subject to taxation, it no longer means unequal treatment when an owner opts for a life settlement instead of surrendering a life insurance policy.

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