Most calls we have fielded from CPAs and Accountants over the past 15 years have been around cost basis. Accountants -many for the first time- were trying to calculate the cost basis of a life insurance policy. There was a next to impossible computation to interpolate the cost basis, which relied on cost of insurance information from the insurance company and many insurance companies wouldn’t disclose the information and some didn’t even track it. It became much easier to determine life insurance cost basis in 2017 with the passage of the Tax Cuts and Jobs Act.
Accountants, CPAs Discovering Hidden Value in Life Insurance
Today things are very different, most of the calls we get from Accountants are around assisting or facilitating the sale of their client’s life insurance policy. Many of the CPAs and Accountants are navigating a life settlement for the first time, because their client’s insurance agent or advisor is restrained from mentioning a life settlement, even though it is in their shared client’s best interest.
The Reverse Life Insurance platform digitally and compliantly garners all of your clients insurance information directly from the carrier and gathers all the appropriate medical information inside of HIPPA guidelines. Once the information is mustered, third party Life Expectancy estimates are obtained by licensed buyers utilizing our platform. There is no cost and no obligation to the seller. Accountants and CPAs discovering hidden value in life insurance can help their clients without taking an active part in the process.
Life Settlement Taxation
The Tax Cuts and Jobs Act of 2017 (TCJA) made a big impact on the taxation of life settlements. The law has two provisions favorable to life settlements. One makes the tax treatment to the seller more favorable by changing the treatment of proceeds from a settlement. The other provision is an increase in the estate tax exclusion amount, diminishing the need for a large policy to cover estate taxes.
Prior to the Tax Cuts and Jobs Act of 2017
Currently, the tax treatment of life settlement proceeds is the same as the treatment of funds received from surrendering your policy. Prior to TCJA, the tax treatment of funds received after policy surrender was more favorable than the tax treatment of funds received in a life settlement.
When surrendering a policy, the proceeds were taxed on the amount received minus the total cumulative investment (premiums paid in minus withdrawals and dividends.)
When selling a policy as a life insurance settlement, the basis was reduced by the cumulative cost of insurance (COI) charges. You could not deduct the full premiums paid into the policy and it was usually difficult to obtain a correct COI charge or any explanation for those charges from your insurance company. Now, the premiums paid are the cost basis, regardless of the amount utilized towards the cost of insurance. This is huge, and brings Term Life Insurance policies into play.
Prior to TCJA, the estate tax exemption was $5.49 million for a single taxpayer and $11.2 million for a couple filing jointly. There were many Estate Tax policies sold that have not only underperformed, but they often are no longer necessary. Universal Life and Flexible Premium Life policies with no cash value often have a hidden value as a life settlement. Many people hedged their insurance by purchasing large term insurance policies as the Federal Government discussed the potential estate tax threshold. If the term life insurance policies are convertible, which they typically are, there may very well be a hidden value, dependent upon the insured’s age, current health and policy specifics.
After the Tax Cuts and Jobs Act of 2017
As a result of TCJA, taxation of life settlements changed dramatically.
Amounts received up to the tax basis are income tax free. Anything in excess of the tax basis (up to the surrender value) is taxed at ordinary income rates. Amounts received in excess of the cash value get favorable capital gains treatment. This applies to both funds received in a life settlement and those received after surrendering a policy.
Whatever your client paid into the life insurance policy minus anything taken out in the form of dividends, cash, or loans is now the tax basis. Money taken out of the policy or any proceeds from a life settlement up to this tax basis should incur no income taxes. For example, if a client paid premiums for 20 years at $3000 per year, the tax basis would be $60,000 regardless of the type of life insurance policy. Any amount received over the tax basis up to the surrender value of their policy will be taxed as ordinary income. Anything in excess of the surrender value is still considered a capital gain.
Estate Tax Exemptions Changes
The amount excludable from estate tax is now $11.2 million per person and $22.4 million per couple. People with large estates used to purchase policies for the sole purpose of paying for estate taxes. Now that the exemption amounts have been raised, many of these policies are no longer necessary. A life settlement is a great option to access the hidden value of an unneeded policy. Someone in this scenario could be able to stop paying premiums and receive cash money now.
Viatical Settlement Taxation
Viatical settlement proceeds are taxed differently than life settlement proceeds, but only if they meet specific requirements. The taxation of the proceeds was not affected by recent tax law changes.
In 1996, the Health Insurance Portability and Accountability Act (HIPAA) was signed into law. This act specified that proceeds received either from a viatical settlement or as accelerated death benefits on a policy in which the insured was chronically or terminally ill would be tax free as long as the policy was purchased by a viatical settlement company who is licensed in the seller’s state. To qualify for this tax treatment, the insured must have less than two years to live. Although most states follow this federal law, some still impose taxes on viatical settlements. As a tax advisor, you need to be prepared to advise your clients of the laws affecting them.
The proceeds from a viatical settlement in which the insured is considered chronically ill are taxed differently. In order for money received by a chronically ill person to be tax free, the proceeds must be used for the costs of long-term care services that are not covered by insurance. Otherwise, benefits not used for long-term care received in excess of an annually-adjusted limit are subject to taxation.
Considering the recent tax law changes, a life settlement may be a better option now than ever before.
- Funds received as a result of a life settlement no longer receive unfavorable tax treatment when compared to those received after a policy surrender.
- Viatical settlement taxation has remained unchanged and funds received in this type of settlement are in most cases tax-free.
- The estate tax exemption has been doubled, so many policies taken out for the sole purpose of paying taxes are no longer needed. These policies can be sold for cash now, eliminating premium payments.
Why Don’t More CPAs and Financial Advisors Mention Life Settlements?
Many accountants and financial advisors often wrongly assume that their client’s insurance agent or advisor has educated them about life settlements and has already helped them to have their policy appraised. Most seniors purchased their policy years ago and are no longer in contact with their original insurance agent. Insurance companies certainly don’t reach out to clients to make them aware of any potential value in a life settlement or discuss how a policy is performing. If no one else is assisting your clients in understanding the value of one of their biggest assets, the duty may fall to you. Accountants and CPAs can help clients with discovering the hidden value in their life insurance policies by telling them about life settlements.
Most Accountants, when asked, simply do not feel qualified to discuss life settlements, have a bad taste in their mouth from something they have heard or just don’t feel that it is their responsibility. Any advisor knowledgeable about life settlements and other reverse life insurance options is more prepared to help their clients discover the hidden value in their life insurance policy, but you don’t have to be an expert to simply tell your client to have a life insurance policy appraised prior to any surrender or lapse.
Life settlements are legal and heavily regulated in most states. Only 5 states, Alabama, Missouri, South Carolina, South Dakota, and Wyoming are without life settlement regulation.
Several states actually have laws in place to protect consumers. In those jurisdictions with disclosure laws, insurance companies must make consumers aware of the possibility of a life settlement as an alternative to a policy lapse or surrender. Agents and advisors have already been sued for neglecting to educate their clients.
Appraisals Necessary for Discovering the True Hidden Value in Life Insurance
If you are selling real estate, a business, or any other valuable asset, you would hopefully have the item evaluated by a qualified appraiser if you could. A life insurance policy is no different. A life insurance policy is an asset and unfortunately, all too often, we hear of someone surrendering a policy and unwittingly throwing away hundreds of thousands of dollars. The fact is, their life insurance policy may be the most or one of the most valuable of your client’s assets, and they are often completely unaware.
Term insurance and policies with zero cash value often qualify as a life settlement. Your client’s life insurance policy may have an exponentially higher hidden value than the obvious cash surrender value offered by the insurance company.
How to Talk to a Client About Life Settlements
When considering a surrender or lapse of an unneeded or too expensive life insurance policy, your client may not even think to ask for your input. If life insurance is not something you discuss regularly, consider adding it to your client checklist. An accountant or advisor can help prevent clients from lapsing or surrendering policies before exploring all of their options.
Your clients may see advertisements about life settlements on television or social media. You should tell them to always get more than one offer, and if they can get a direct offer from a licensed Reverse Life Insurance buyer and save the 30% or more commissions most brokers charge, they will thank you and so will we.
Anyone can make a referral to Reverse Life Insurance for a possible life settlement. You do not have to have an insurance license or any licensing for that matter. Should your client qualify and accept and receive their cash offer, you or your designate is eligible for a referral fee in all but a few states. This fee is paid by the licensed buyer above and beyond the sales proceeds your client receives.
With the current and more favorable treatment of life settlement proceeds as well as the diminished need for estate tax policies, it is a great time for your clients to explore the hidden value in their policy before they cancel it. Accountants and CPAs discovering hidden value in life insurance can often make a big difference in the lives of their clients.