Life insurance policy valuation is a critical process that helps ensure an accurate fair market value (FMV) is established when a policy is transferred, sold, or distributed. Whether for gift, estate, income tax, or business planning purposes, understanding how valuation works helps clarify potential tax implications and guides appropriate next steps.

Fair market value is generally defined by the IRS as the price agreed upon between a willing buyer and a willing seller, but applying this to life insurance policy valuation can be complex. The valuation method often depends on the type and age of the policy. For instance, newly issued policies may be valued based on premiums paid, while older or paid-up policies might be valued using replacement cost or the Interpolated Terminal Reserve (ITR) method.

However, modern policies like universal life, indexed universal life, and variable universal life challenge traditional IRS valuation rules. The ITR method, once standard, may not accurately reflect value due to evolving product designs and reserve methodologies. In such cases, alternative approaches—such as referencing the secondary market or obtaining a professional appraisal—may better align with the FMV standard.

Factors like policy loans, recent 1035 exchanges, and the insured’s health may also significantly affect valuation. For example, if the insured is severely ill, the FMV may be closer to the policy’s death benefit than to its ITR.

When navigating these nuances, working with knowledgeable professionals is key. A sound valuation process can help ensure proper reporting and mitigate risk, particularly when Form 712 values are unexpectedly high or out of sync with a policy’s real economic worth.

As life insurance policy valuation continues to evolve, a thoughtful, case-by-case approach grounded in both IRS guidance and market practices helps ensure accurate and defensible outcomes.