Selling a Term Life Insurance Policy Creates Thorny Tax Issues

Are you considering cashing out your term life insurance policy? Unfortunately, selling a term life policy to investors is nearly impossible unless you are terminally ill and unlikely to outlive the policy.

You do have one potential option: you could name a relative as the beneficiary in exchange for a payment and their agreement to take over all future premium payments.

This type of arrangement creates significant tax consequences:

• Taxable transfer. The IRS will likely treat the transaction as a “transfer for value.” You, as the transferor, must recognize taxable income if the payment you receive exceeds your basis in the policy. Your basis equals the total premiums you paid before the transfer. If you owned the policy for more than one year, you’ll pay tax at long-term capital gains rates.

• Taxable death benefit. If you die while the policy is still in effect, the beneficiary will be required to pay tax on the death benefit. Typically, life insurance proceeds are tax-free. However, in this situation, the beneficiary can exclude only the amount equal to what they paid for the policy, plus any premiums paid after the transfer. The IRS taxes the rest at ordinary income rates.

• No deductible loss. If you outlive the policy and the beneficiary receives nothing, the IRS will not allow a deductible loss.

If you want to discuss the sale of a life insurance policy, please give us a call.