Understanding The Tax Implications Of Life Settlements

Understanding the​ Tax Implications Of Life Settlements
Understanding the​ tax implications of​ replacing or​ selling existing life insurance coverage will help shed some light on​ the​ options available to​ financial advisors and policy holders looking to​ capitalize on​ the​ hidden value in​ their life insurance plans .​
Policy holders need to​ know what the​ tax implications are for coverage payments in​ advance of​ death .​
They need to​ know whether viatical agreements will be taxed,​ and they need options when it​ comes to​ replacing expensive or​ undesirable life insurance policies with more favorable policies .​
Following are some ideas to​ help consider taxation of​ life insurance proceeds both as​ pre-payment advances for viatical purposes and in​ the​ case of​ life insurance settlements.
Viatical or​ Advance Payment Coverage
Viatical payments and accelerated payment of​ coverage in​ advance of​ death remain tax-exempt .​
Congress continues to​ favor the​ tax-exempt status of​ these policies and therefore,​ will probably remain tax free .​
To be sure,​ viatical and advanced payment plans cover medical bills and allow terminally or​ chronically ill policy holders with a​ life expectancy of​ two years or​ less to​ use insurance coverage now instead of​ later .​
Some states also exempt viatical settlements from taxation.
IRS 1035 Exchange Rule
Under the​ 1035 Exchange rule,​ the​ IRS allows policy holders a​ way to​ defer taxes .​
David Friedman explains in​ a​ Street Talk article that the​ 1035 rule allows the​ cash value in​ an​ existing life insurance contract [to be transferred] into another life insurance contract without creating a​ taxable event at​ the​ time of​ the​ transfer .​
Any taxable gain in​ the​ existing life insurance contract is​ deferred as​ the​ new contract assumes the​ basis that had been established in​ the​ original contract .​
While replacing expensive or​ unneeded life insurance policies with new ones is​ a​ financially savvy idea,​ there is​ an​ after-tax alternative that can meet and significantly exceed the​ advantages of​ a​ 1035 Exchange.
An LIS could sell in​ a​ tremendously robust secondary marketplace for proceeds as​ high as​ 200 or​ 300 percent of​ its cash surrender value (CSV) .​
It’s not uncommon for investors to​ purchase policies from policy owners who are 65 years old,​ have a​ life expectancy between three and 12 years,​ and whose policy is​ cost-effective to​ enforce .​
The concept is​ simple .​
Individual policy holders sell their life insurance coverage to​ the​ highest bidder .​
When this happens,​ the​ investor is​ named as​ the​ beneficiary and the​ seller receives a​ cash payment .​
The buyer assumes the​ yearly premium payments and collects the​ coverage proceeds when the​ policy is​ executed upon the​ demise of​ the​ seller.
The life insurance settlement can trigger ordinary taxable income and a​ capital gains tax .​
If the​ cash surrender value equals less than the​ premium contributions to​ date,​ the​ difference between the​ premium contributions and the​ settlement amount is​ a​ taxable capital gains .​
If however,​ the​ cash surrender value equals more than the​ premium contributions to​ date,​ two things happen: the​ difference between the​ premiums paid to​ date and the​ cash surrender value are taxed as​ ordinary income; and the​ difference between the​ cash surrender value and the​ settlement amount is​ taxed as​ capital gains.
Policy holders wishing to​ replace their existing coverage with less expensive coverage can do so more profitably in​ many cases than using the​ tax deferred portion of​ the​ IRS 1035 Exchange rule .​
Of course the​ after-tax proceeds of​ a​ life insurance settlement could be gifted to​ a​ charitable non-profit organization or​ a​ charitable trust .​
These basic tax implications regarding life insurance proceeds should prove useful in​ opening up further dialogue with financial professionals and advisors.
Understanding The Tax Implications Of Life Settlements Understanding The Tax Implications Of Life Settlements Reviewed by Henda Yesti on July 05, 2018 Rating: 5

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