Your client, Jacob, turned 66 years old this year. Jacob has no heirs and has decided that he would like to sell a life insurance policy to fund a trip to Africa that he has wanted to take.
Jacob knew that he could surrender the policy (a whole-life policy) back to the insurance company, but a friend told him he could get more for the policy if he sold it to a life settlement company. A life settlement company buys life insurance policies from policyholders who are not ill and who generally have a life expectancy of between 2 and 15 years. In return, the seller of the policy receives a lump-sum payment. The life settlement company either holds the policy to or resells the policy to an investor.
The lump sum received depends on factors such as age, health, and the terms and conditions of the policy, but is generally more than the policy’s cash surrender value (which would be received from the life insurance company upon surrender of the policy).
In November 2015, Jacob (who was not terminally or chronically ill) sold his policy to a life settlement company for $160,000. During the time he owned the policy, Jacob did not borrow against the policy or receive any distributions. Jacob also had paid premiums totaling $122,000 (of which $32,000 was paid for the provision of insurance before the sale of the policy).
How should Jacob calculate his basis in the life insurance policy to determine if he has a realized gain or loss on the surrender of the policy?
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