New Tax Law May Benefit Seniors Interested in Selling a Life Insurance Policy

May 31, 2018 12:00:00 AM / by Darwin Bayston, CFA


The passage late last year of a new law that includes sweeping changes to the tax code — the Tax Cuts and Jobs Act of 2017 — was welcome news to business executives, who saw their corporate tax rates cut significantly, and to many American consumers, most of whom will see more money in their paychecks as they pay lower federal income taxes this year.

A less-publicized component of this new tax law is starting to be appreciated as welcome news by American seniors as well. Before we get to that, here is the back story . . .

For more than 100 years, Americans have had an established legal right to sell a life insurance policy. The courts have consistently held that a life insurance policy is considered your personal property and — as such — you have the right to sell that policy just like any asset that you own, such as a house or a stock. This is an important option for seniors to know they have available to them in the event that they own a life insurance policy they no longer need or can afford. Rather than simply lapsing or surrendering that policy back to the insurance company, you can sell it to a third party for immediate cash (on average, for perhaps seven times more than its cash surrender value) in a life settlement transaction.

In a life settlement, a policy owner receives a cash payment, while the purchaser of the policy assumes all future premium payments and receives the death benefit upon the death of the insured. Candidates for life settlements are typically aged 70 years or older, with a life insurance policy that has a death benefit or at least $100,000. This is a great option for seniors, especially those who are struggling with unexpected health care bills or a shortfall in retirement income needs.

However, for the past several years, many seniors have been hesitant to sell their life insurance policies because of a confusing revenue ruling in 2009 from the IRS. This rule required policy holders to deduct the “Cost of Insurance” charges from their policy in order to determine an accurate tax basis. Unfortunately, since it’s very difficult to obtain that precise data, many seniors simply concluded it was too much of a hassle — and the tax consequences would be too great — to go forward with selling their policy. Instead, they simply surrendered their policies and walked away from an asset of potentially greater value to them.

New Tax Law

Well, after several years of efforts from our association and other concerned parties who sought to fix this outdated revenue ruling with permanent legislation, the new tax law includes just such a solution. The law reverses the effects of that 2009 IRS revenue ruling and eliminates the need for taxpayers to obtain Cost of Insurance charges on their policies if they have opted for a life settlement. This common sense reform takes away an obstacle that stood in the way of many seniors who wished to sell their life insurance policies.

Here is a case comparison provided by LISA member Windsor Life Settlements:

Tax Estimate (Before new tax law went into effect)

  1. Find the Adjusted Cost of Insurance 
    1. Deduct 'Cost of Ins' from 'Premiums Paid' 
    2. ($318,026.00 - $270,271.00 = $47,755.00)
  2. Deduct 'New Adjusted Cost' from 'Settlement Amount' 
    1. ($442,000.00 - $47,755.00= $394,225 )
  3. Calculate Capital Gains Tax
    1. $394,225.00 x 0.25 =  $98,556.25 

This person should expect to pay roughly $98,556.25 in taxes under the previous tax law.

Tax Estimate (After new tax law went into effect)

  1. Find the Adjusted Cost of Insurance 
    1. Deduct 'Premiums Paid' from the 'Net Settlement Amount'
    2. ($442,000.00 - $318,026.00 = $123,974.00)
  2. Calculate Capital Gains Tax
    1. $123,974.00 x 0.25 = $30,993.50 

As you can see, under the new tax law, this person can expect to pay $30,993.50, taking home nearly three times more money the money.  [1]

“The new Tax Cuts and Jobs Act could lead to a new wave of life insurance policy sales, by simplifying the tax calculation rules for policy sellers,” writes Allison Bell, insurance editor for ThinkAdvisor.

At LISA, we are delighted that Congress took this important action to rectify an error in tax policy, which created an unfair burden on seniors who wished to sell their life insurance policies, and we’re pleased to have worked closely with the legislators and regulators who made the change happen.

To be clear, there are still likely to be tax consequences for seniors who sell a life insurance policy, so it’s always a good idea to consult with an accountant or other financial advisor before entering into a life settlement transaction.

But this important change to the tax code regarding life settlements will eliminate a lot of confusion that haunted many seniors in recent years and make it much easier to determine whether it’s in your best interests to sell a life insurance policy you no longer need or can afford.

To learn more about life settlements, call the LISA office today at 407.894.3797. We’ll be happy to answer any questions you have and to steer you in the direction of qualified professionals who can assist with your unique needs.

[1]  This provision of in the new tax law was retroactive back to 2009, For client’s that may have sold their policies and deducted the Cost of Insurance in determining tax basis, those clients may now file an amended return to recoup the over-payment of the tax.

Darwin Bayston, CFA

Written by Darwin Bayston, CFA

Darwin Bayston is President and CEO of the Life Insurance Settlement Association (LISA). His charge is to extend the outreach of the Association to all participants of the life settlement industry from consumers to capital providers, including producers, brokers, providers and service providers who are part of the life settlement market. He was previously Managing Director of Life Settlement Consulting & Management (LSCM), founded in 2004 and specialized in life settlement policy and portfolio valuations, and life expectancy analysis. He has published several articles and participated as speaker at a number of life settlement conferences. Previous to that he operated an investment advisory firm. From 1980 to 1993, he served in several capacities, including President and CEO the CFA Institute (and its predecessor organizations). While at CFA, he founded the continuing education program, was editor of the CFA Digest and supervised research projects funded by the Research Foundation of the ICFA. He began his career as an investment analyst with a Midwest life insurance company. Mr. Bayston has been Chairman of the Martha Jefferson Hospital Foundation ($100 million), a member of the Hospital’s Finance Committee and a past member of the Board of the Institute for Quantitative Research and Finance (Q Group).