Unlike many other tax rules, those governing life settlement proceeds are fairly straightforward. Generally, the taxes you owe—if any—depend on whether you collect the death benefit or sell the policy. If taxes are owed, they typically apply only to a portion of your proceeds. The IRS provides guidance for investors in Revenue Ruling 2009-14, though other IRS rules and regulations help provide a complete picture of the tax implications of life settlement proceeds for you.
Below, we explore when you might owe taxes on money received from a life settlement and what types of taxes could apply. We look at federal taxes in this article, but keep in mind that you may also owe state income or capital gains taxes depending on where you live.
Additionally, high-income investors may be subject to the 3.8% Net Investment Income Tax (NIIT) on certain taxable investment income, including gains from the sale of a life settlement policy.
If you’re unsure what your tax implications may be or want to understand more, consult with a tax professional knowledgeable in life settlements.
Federal Taxation of Life Settlement Proceeds For Investors |
||
|---|---|---|
Situation |
Tax Treatment |
Federal Tax Rates |
| You hold the policy until the policy matures and collect the death benefit. | Ordinary income taxes on profits | 10-37%, depending on your income tax bracket |
| You sell the policy to another investor before the insured passes away. | Capital gains taxes on profits from sale | Long-term capital gains: 0%, 15% or 20% Short-term capital gains: 10-37%, depending on your income tax bracket |
| The policy lapses or expires without a death benefit payout. | No taxes owed. May be a capital loss. | N/A |
YOU RECEIVE THE DEATH BENEFIT
You must pay ordinary income taxes on the profit earned from your life settlement investment, which is the death benefit minus what you paid to purchase and maintain the policy until maturity, such as the premiums paid.
An Example Using a Term Policy
Say you purchase a 15-year term life policy with a death benefit of $100,000. You have no relationship to the person you buy it from, and you didn’t buy the policy for insurance protection. You purchased it purely as an investment.
Here’s how the numbers could look:
- Policy issued: January 1, 2017
- Policy purchased: June 15, 2024
- Purchase price: $20,000
- Time remaining on the policy: About 7.5 years
- Monthly premium: $500
In this example, the insured person passes away in December 2025, and you receive the $100,000 death benefit.
By that point, you had paid:
- Premiums paid:$9,000
- Purchase price:$20,000
- Total invested in the policy: $29,000
Your profit from the investment would be:
- Death benefit received: $100,000
- Subtract Total investment: $29,000
- Profit: $71,000
Because you didn’t sell or exchange the policy—which is generally required for capital gains treatment—the $71,000 is taxed as ordinary income.
For 2025 and 2026, ordinary income tax rates are up to 37%, depending on your total taxable income.
YOU SELL THE POLICY TO AN INVESTOR
Life settlements are typically long-term investments, as there is no easy secondary market for reselling policies. If you do find a buyer and sell the policy, you may owe capital gains tax instead of ordinary income tax on your profit, since the transaction is treated as a sale of a capital asset.
The standard formula for capital gains is:
Gain \= Sale price \- adjusted basis
The adjusted basis is your total tax investment in the life insurance policy. The math is:
Adjusted basis \= Life insurance policy purchase price \+ premiums paid to maintain the policy
To illustrate, let’s use the same scenario as above. Instead of the policyholder passing away in December 2025, you sell the policy to another investor for $30,000 on that same date.
Your total spent on the policy remains the same: $29,000. This is your adjusted basis. If you sell it for $30,000, your capital gain is $1,000 ($30,000 \- $29,000).
You will likely owe long-term capital gains tax on the $1,000 profit, unless your income falls below a certain threshold (see below).
Why Are the Gains Classed as Long-Term Capital Gains?
Because you held the policy for more than a year before selling, the gain qualifies as a long-term capital gain instead of a short-term gain.
If you sell the policy less than a year after purchase, you will likely owe short-term capital gains tax on your profit. Federal tax rates for short-term capital gains match ordinary income tax rates, so you could be taxed between 10% and 37%, depending on your income tax bracket.
When Don’t You Have to Pay Long-Term Capital Gains Taxes?
Federal long-term capital gains tax rates are 0%, 15% or 20%, depending on your taxable income. If you qualify for the 0% rate, you won’t owe taxes on your gains. Here are the IRS thresholds starting in the 2025 tax year:
Filing Status |
Taxable income |
| Single or married filing separately | $48,350 or less |
| Married filing jointly | $96,700 or less |
| Head of household | $64,750 or less |
Many states only allow accredited investors or individuals with higher income or net worth to purchase life insurance policies directly as a life settlement investment. Because of this, many direct investors fall into higher tax brackets and are more likely to pay the 15% or 20% long-term capital gains tax rate rather than qualify for the 0% rate.
THE POLICY LAPSES OR EXPIRES BEFORE IT MATURES
Many life insurance policies purchased by life settlement investors are whole life policies. These don’t expire as long as premiums are paid, and the death benefit is guaranteed, as long as the insurer is still operating when the policy matures.
However, if you buy a term life policy—such as the 15-year term in our example—it will expire 15 years after issuance. If the insured passes away after the term ends, there is no death benefit payout.
Similarly, if a whole or term life policy lapses, the insurer may cancel it, resulting in no death benefit payout.
When a policy lapses or expires, the money you spent to buy and maintain it is treated as a loss. The exact tax treatment can vary depending on how the lapse or expiration is classified for tax purposes, so it’s best to check with a tax professional before reporting it on your return.
If the loss is treated as a capital loss, it may:
- Offset other capital gains you realized during the same tax year
- Reduce up to $3,000 of ordinary income per year if your losses exceed your gains
- Carry forward to future tax years until the remaining loss is used
MANAGING LIFE SETTLEMENT INVESTMENTS FOR LONG-TERM RETURNS
Life settlement taxes are generally easy to understand once you know how the IRS treats different outcomes. Be sure to keep records of the price you paid for the policy and the premiums you continue to pay. Together, these costs make up your adjusted basis, which determines how much of your proceeds may be taxable, whether you sell the policy or collect the death benefit.
Experienced life settlement advisors, such as i2 Advisors, can help you manage your policy and premiums to ensure your policy remains in force. Life settlement investments have average annual returns of 11-13%, and returns as high as 800% are possible when policies mature earlier than expected. However, if the insured lives longer than expected, your returns will diminish as your total investment in the policy increases, while the eventual payout remains the same.
Connect with an i2 Advisors professional to develop a long-term strategy for managing your policies.