Financial Planning Matters: Tax Policy Impacts to Life Settlements and After-Tax Profitability


Steve Kohler, CFP®, CPFA and Nancy Kunz, CFP®, ChFC®, CLU®


Insurance policy holders must be aware of shifts in regulations and legislation as part of the Biden Administration’s proposed tax policy. Under the policy, a shift in government regulation will almost certainly affect many individual life insurance policy holders, particularly wealthier individuals.

Life Settlements


One area the Biden Administration is likely to address will be life settlements. A life settlement is the legal sale of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit. Life settlements can make a policy holder’s life insurance more valuable when a policy is no longer needed, wanted, or affordable.

When the Trump administration passed the Tax Cuts and Jobs Act (TCJA) in 2017, life policy holders choosing life settlements profited. Section 13521 of the TCJA states that “in determining the basis of a life insurance contract or an annuity contract, no adjustment is made for mortality, expense, or other reasonable charges incurred under the contract.” The Act effectively changed the rule stating that a life insurance policy seller’s basis is reduced by the cost of insurance (COI) for mortality, expense or other reasonable charges incurred. So, whether a policyholder surrenders their policy to the insurer for a gain or sells it outright, the basis is calculated as the full premium. This arrangement ultimately benefits policyholders.

Addressing the Tax Benefits of Life Settlements

The Biden administration said it intends to repeal parts of the TCJA which reduces the tax on the cost of insurance inside a policy by counting as cost basis. The Act also increased transparency regarding COI figures from the carrier to separate them from the premium, making it easier to calculate taxes on a life settlement transaction.

If these elements of the TCJA are repealed, the cost basis and tax ramifications for life insurance policies surrendered for cash value or sold as a life settlement could be negatively impacted. Potentially leading to higher taxes and difficulty calculating cost basis.


Impacts on Wealthier Individuals

For wealthier individuals, the Biden tax plan intends to remove favorable capital gains treatment for anyone with an income greater than $1 million. This means their taxes could almost double from 20% to 39.6% for gains, such as those arising from the sale of life insurance policies. All of these changes could be unfavorable regarding policy-holder’s options for exiting a policy.

In terms of after-tax profitability, one will need to determine if it is best to surrender the policy now, or to wait and see what the final Biden legislation contains. As in any important financial decision, you should consult with your financial advisor and a tax consultant on the tax ramifications before making a final decision. If you are a policy owner or trustee considering surrendering or selling a policy, we recommend a policy review as soon as you are able.


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Steven Kohler, CFP®, CPFA

Senior Financial Advisor

Financial Planning Chair

skohler@dbroot.com


Nancy Kunz, CFP®, ChFC®, CLU®

Financial Advisor

nkunz@dbroot.com


This material has been provided for general, informational purposes only, represents only a summary of the topics discussed, and is not suitable for everyone. The information contained herein should not be construed as personalized investment advice or recommendations. Rather, they simply reflect the opinions and views of the author. D. B. Root & Company, LLC. does not provide legal, tax, or accounting advice. Before making decisions with legal, tax, or accounting ramifications, you should consult appropriate professionals for advice that is specific to your situation. There can be no assurance that any particular strategy or investment will prove profitable. This document contains information derived from third party sources. Although we believe these third-party sources to be reliable, we make no representations as to the accuracy or completeness of any information derived from such sources, and take no responsibility therefore. This document contains certain forward-looking statements signaled by words such as "anticipate," "expect", or "believe" that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward-looking statements. As such, there is no guarantee that the expectations, beliefs, views

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