The estate planning question is rarely whether a client should keep a policy — it is whether the policy still serves the purpose it was bought for, and whether anyone has priced it before it gets surrendered. A policy bought in 1994 to cover a federal estate tax exposure that no longer exists is a common finding in a routine review, and surrender is usually the reflex answer.
Washington makes this a live issue for a structural reason: it is one of the few states with its own estate tax, so estate liquidity planning did not disappear here when the federal exemption climbed. That means more old policies, more trust-owned coverage, and more instruments drafted around a tax picture that has since changed. Verify current Washington estate tax thresholds and rates with the Department of Revenue before relying on them in a plan.
A redacted cover page starts the analysis. With the client’s permission, one page supports a free preliminary read, typically returned within one to two business days, with no fee and no obligation to you or the client. Call (305) 209-7183.
In This Article
- Three Tiers of Tax the Drafting Attorney Should Know
- IRC Section 6050Y Reporting and Transfer for Value
- Where Estate-Adjacent Policies Have Outlived Their Purpose
- Trust-Owned Coverage and the Trustee’s Monitoring Duty
- Washington’s Statutory Framework
- Screening a Policy in Under a Minute
- How a Referral Works
- Frequently Asked Questions
Three Tiers of Tax the Drafting Attorney Should Know
The taxation of a policy sale is layered. Proceeds up to the seller’s basis are a tax-free return of premium. Proceeds between basis and cash surrender value are ordinary income. Proceeds above cash surrender value are generally long-term capital gain. That structure is what makes the arithmetic of a sale different from a surrender, where all gain over basis is ordinary income.
Rev. Rul. 2020-05 conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change: seller basis is no longer reduced by cost-of-insurance charges, so basis is generally total premiums paid. That is a material improvement over the earlier Rev. Rul. 2009-13 treatment and it changes the after-tax comparison on older, heavily funded policies. Route the specific computation to tax counsel or the client’s CPA. Overview: Washington life settlement tax treatment.
IRC Section 6050Y Reporting and Transfer for Value
A reportable policy sale triggers information reporting under IRC § 6050Y by the acquirer and, in some cases, by the issuer, and the client will receive corresponding forms. Building that expectation into the closing memo prevents a January surprise and a mismatched return.
The transfer-for-value rule is the other trap, and it bites in the opposite direction: where a policy is transferred for consideration, the death benefit can lose its income-tax-free character for the transferee unless an exception applies. That matters most when a plan contemplates a trust or business entity acquiring an existing policy from a related party, not when a client sells to an unrelated purchaser. Confirm the current exceptions and their post-2017 interaction before drafting around them.
Where Estate-Adjacent Policies Have Outlived Their Purpose
Four fact patterns account for most of what a review turns up. Split-dollar unwinds where the arrangement is being terminated and nobody has priced the underlying policy. Buy-sell coverage on a partner who retired or was bought out years ago, with the entity still paying premiums out of habit. Key-person coverage that survived a business sale. And an ILIT funded for an estate tax exposure the family no longer has.
In each case the policy is being kept by inertia rather than by plan. Reduce the face amount, convert to reduced paid-up, surrender, or test the market are the four real options, and the last one is the one routinely skipped. See how the process works.
| Proceeds tier | Character | Note for the file |
|---|---|---|
| Up to total premiums paid (basis) | Tax-free return of premium | Rev. Rul. 2020-05: basis is no longer reduced by cost-of-insurance charges |
| Between basis and cash surrender value | Ordinary income | Same character as gain on a surrender |
| Above cash surrender value | Generally long-term capital gain | The tier a surrender can never produce |
| Terminally or chronically ill seller | Generally income-tax-free under IRC 101(g) | Certification requirements must be met |
| Any reportable policy sale | Information reporting under IRC 6050Y | Expect forms; align the client’s return |
Trust-Owned Coverage and the Trustee’s Monitoring Duty
A trustee governed by the Uniform Prudent Investor Act framework — adopted in Washington’s trust and estates provisions in Title 11 RCW; verify the current section references before citing them — has an affirmative duty to monitor trust assets, not merely to pay premiums out of an annual Crummey gift. A policy is a trust asset like any other.
The exposure in practice is surrender without pricing. A trustee who takes the carrier’s cash value on an in-force policy that had meaningful secondary-market value, without documenting any evaluation, has made a decision the beneficiaries can question later. Drafting attorneys can reduce that risk directly: build a policy-review provision into the instrument, and put the trustee’s monitoring duty in the trustee acceptance letter.
Washington’s Statutory Framework
Life settlements in Washington are governed by RCW Chapter 48.102, the Life Settlements Act, administered by the Washington State Office of the Insurance Commissioner. Washington is among the states that address notifying policyholders that a settlement is an alternative to lapse or surrender — verify the current 2026 scope of that provision before relying on it in a specific matter.
Standard file diligence: confirm the provider’s licensure with the OIC, require independent escrow with funds released only when the carrier confirms the ownership change, and confirm the applicable rescission window and disclosure package before closing. Detail: Washington life settlement licensing and regulation.
Screening a Policy in Under a Minute
Policies that generally price in the secondary market: an insured roughly 70 or older, or any age with a material health change since issue; a death benefit of $100,000 or more; permanent coverage or term still inside its conversion window; and in force at least two years. Commonly cited market ranges run roughly 10% to 35% of face value, and the GAO’s 2010 study (GAO-10-775) found proceeds substantially exceeding cash surrender value on the policies examined.
Policies that generally do not: small face amounts, expired-conversion term, healthy insureds in their early sixties, and coverage the family still needs for liquidity at death. When the screen fails, the honest answer may be a reduced paid-up election or surrender — and knowing that early is worth as much as a large offer. Screen: what policies qualify.
How a Referral Works
With the client’s permission you send a single document: the policy cover page. It shows carrier, product type, face amount, and issue date — enough for a free preliminary read, typically returned within one to two business days. No engagement, no fee, no obligation on either side.
If the policy is worth pursuing, three more documents produce an indicative range: a current in-force illustration, the latest carrier statement, and a signed HIPAA authorization. A standard file then runs roughly 60 to 120 days from complete documentation through funding.
The client controls the decision at every stage, can stop before closing, and can have any offer reviewed by you, by the client’s CPA, and by an independent advisor before acceptance. (305) 209-7183.
This page is educational only and is not legal, tax, or investment advice for you or your clients. Pine Lake Life Solutions does not provide legal or tax counsel, and nothing here is an offer to purchase a policy; independent professional review should precede any transaction.
Frequently Asked Questions
How is a life settlement taxed to the seller?
In broad terms, proceeds up to basis are a tax-free return of premium, proceeds between basis and cash surrender value are ordinary income, and proceeds above cash surrender value are generally long-term capital gain. The specific computation belongs to the client’s CPA or tax counsel.
What did Rev. Rul. 2020-05 change?
It conformed IRS guidance to the 2017 Tax Cuts and Jobs Act change so that a seller’s basis is no longer reduced by cost-of-insurance charges. Basis is generally total premiums paid, which is a material improvement over the earlier Rev. Rul. 2009-13 treatment on older, heavily funded policies.
What is IRC Section 6050Y reporting?
A reportable policy sale triggers information reporting by the acquirer and, in some cases, the issuer, and the client receives corresponding forms. Note it in the closing memo so the client’s return matches what is reported.
Does the transfer-for-value rule apply to a sale?
It can taint the income-tax-free character of the death benefit in the transferee’s hands unless an exception applies, which matters most when a trust or entity acquires a policy from a related party. Confirm the current exceptions and their post-2017 interaction before drafting around them.
Does a trustee have to price a policy before surrendering it?
The prudent investor framework adopted in Washington’s trust provisions imposes a duty to monitor and evaluate trust assets, and a policy is a trust asset. Surrendering without documenting any evaluation is the exposure beneficiaries can later question. Building a review provision into the instrument reduces that risk.
Which Washington agency regulates providers?
The Washington State Office of the Insurance Commissioner, under RCW Chapter 48.102, the Life Settlements Act. Confirming licensure with the OIC and requiring independent escrow are standard diligence steps.
Does Washington’s estate tax change the analysis?
It keeps estate liquidity planning relevant here in ways it is not in most states, so some clients genuinely still need the coverage. Verify current Washington thresholds with the Department of Revenue, then decide whether the policy serves a live purpose or a retired one.
What does a case that prices well look like?
An insured roughly 70 or older, or any age with a material health change since issue, $100,000 or more of death benefit, permanent coverage or convertible term still inside its window, and at least two years in force. Small face amounts and healthy younger insureds generally do not price.
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Related Reading
- Life Settlement Taxes Washington
- How It Works Policy Options
- What Policies Qualify For Life Settlement
- Life Settlement Licensing Washington
- Life Settlement Vs Surrender
- Education Center
Pine Lake Life Solutions does not purchase life insurance policies and does not provide legal, tax, or investment advice. Information provided is for educational purposes only. Eligibility for any option, including life settlements, is not guaranteed and depends on individual circumstances, policy terms, underwriting, and market conditions. Consult independent legal, tax, or financial professionals before making decisions regarding a life insurance policy.