Do you have a life insurance policy that you no longer need? Do you have a parent with an old policy who needs more income? In such situations, selling the policy to a third party who will keep it in force is a possibility. Even after you pay the tax on the sale, there might be more money remaining than would be the case if the policy were surrendered to the insurance company. What you need to know…


Today, there is an active market in “life settlements,” purchases of insurance policies from individuals.

Seller: Typically, the seller will be age 65 or older with a health condition, such as cancer, heart disease or diabetes. The illness need not be terminal, but there must be a shortened life expectancy.

Buyer: Several life insurance policies will be bought by companies known as life settlement providers, packaged as securities and sold to investors. As the insured individuals die, investors will receive shares of the death benefits.

tax treatment

For most life settlements, the tax consequences will depend on the amount paid and the seller’s cost basis in the policy.

Determining cost basis: This usually will be the total amount of premiums paid for the coverage. If any withdrawals or cash dividends have been received, they will be subtracted from the basis.

Example: John Jones, age 67, is covered by a $1 million permanent life insurance policy (one that has an investment account known as the cash value — explained below). Over the years, he has paid $150,000 in premiums and has taken a $10,000 withdrawal.

John is widowed, and his children are financially comfortable, so this policy is no longer necessary.

An investor group evaluates John’s medical history and estimates his life expectancy. Based on this estimate, it offers John $140,000 for the policy.

Result: John’s basis in the policy is $140,000 — $150,000 paid in premiums minus a $10,000 withdrawal. With a $140,000 basis and a $140,000 selling price, no taxes will be due. If John had paid only $100,000 in premiums and taken a $10,000 withdrawal, giving him a $90,000 basis, there would be tax due on $50,000 of income, assuming a sale for $140,000.

Settling up: The tax rate that applies to that $50,000 of income will depend on the type of life insurance policy…

  • Permanent life insurance. These are whole life, universal life and variable life policies. They have an investment account known as the cash value.
  • When a policy is sold, the buyers become the owners. The owners name a new beneficiary. The insurance company has no say. Premiums are paid by the new owners on the existing schedule. When such a policy is sold by the original owner at a gain, the difference between the basis and the cash value will be ordinary income, taxed at a rate as high as 35%. Although the IRS has not issued a definitive pronouncement, any excess received in the sale most likely will qualify for the bargain 15% rate on capital gains.

    Example: Suppose the policy’s basis is $90,000, the cash value is $110,000, and the purchase price is $140,000. Of the $50,000 gain, the first $20,000 ($110,000 cash value minus the $90,000 basis) will be taxed as ordinary income while the remaining $30,000 will probably be a long-term capital gain.

  • Term life insurance. There is no law or IRS pronouncement that gives a clear ruling on the taxation of gain when a term life policy is sold. When a term life policy is sold, the taxable income is most likely a long-term capital gain. The gain is the sales price over basis.
  • Loophole: Purchases of life insurance policies from terminally ill individuals are known as “viatical” settlements. There is no federal income tax on these transactions.

    Required: To get the tax exclusion, the seller must have a physician’s certification that the insured individual’s death is reasonably expected within 24 months. The payment must come from a “viatical settlement provider,” who will report the amounts received by the insured individual to the IRS on Form 1099-LTC, Long-Term Care and Accelerated Death Benefits. Viatical settlement providers generally need licenses in the states where they do business.


    A life insurance policy will have the most appeal to buyers if it was bought when you were considerably younger, and healthier, than you are now. If so, it will have premiums that are low in relation to the death benefit.

    If the insured individual’s health has deteriorated, those low premiums will be a good deal for the buyer — who will pay premiums based on the insured individual’s previous good health and who will stand to benefit from the insured individual’s shortened life expectancy. Thus, as your health declines, the resale value of your life insurance policy rises.

    Price points: The shorter the seller’s life expectancy, the greater the purchase price as a percentage of the policy’s face value.

    Example: Wendy Brown has a life expectancy between three and four years. An investor group might offer 40% of her policy’s face value.

    Say Wendy has a $300,000 life insurance policy. She might get $120,000 (40%) because the investors hope to collect $300,000 in a relatively short time.

    On the other hand, suppose Victor Green has a 12-year life expectancy. He might be offered only $45,000 (15%) for a $300,000 policy.

    The type of policy you hold also may affect the price you receive. Universal life (permanent life insurance that gives the owner flexibility in paying premiums) and convertible term life (term life insurance that can be switched to permanent life, at the owner’s request, without a medical exam) are the most attractive policies to potential buyers. Buyers like these types of policies because they generally require relatively low premiums, compared with the death benefit.

    Safety first: If you want to put your insurance policy up for sale, work with an experienced life settlement broker, one who will offer the policy to at least 20 potential institutional buyers. Your own life insurance agent, your attorney or your accountant may provide a referral.

    To protect yourself, request that an unrelated third party, such as an attorney or bank, hold the buyer’s funds in escrow. Then your insurance policy can be placed in escrow and the sale can be concluded.

    This process can make sure that the money really is available and, since you are not dealing directly with the buyer, that your privacy is not unduly compromised.

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