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Time to Sell Your Life Insurance?

Originally published
Originally published: 8/10/2020

You know that life insurance policy you’ve been paying for all these years? It could get you a nice sum of money now — while you’re still around to use it.

That’s because you may be able to sell your policy for cash through a process known as a life settlement.

Here’s how it typically works:

  • Most types of life insurance policies can qualify for a life settlement — including universal life, whole life, variable life and term life.
  • You sell your policy to a life settlement investment fund for a one-time payment.
  • That payment is more than your policy’s cash surrender value (the money in the cash account) but less than the death benefit the insurance company would pay out if you died.
  • The investment fund takes ownership of the policy, pays the ongoing premium payments, and pockets the entire death benefit when you pass away.

While not extremely well-known, life settlements are becoming more common — especially among some affluent households that have insurance policies meant to pay their estate taxes down the road. The reason: The Tax Cuts and Jobs Act of 2017 increased the estate tax exemption to approximately $11 million for individuals and approximately $22 million for couples.

That higher amount means more families may no longer need life insurance they’ve earmarked to pay the federal estate tax — so they’re selling their policies for tidy sums.

Here’s a closer look at life settlements, along with advice that can help you decide whether they may be a smart move for you.

Reasons to consider selling your existing life insurance

If you have a life insurance policy you no longer need or want, you can surrender it to the insurance company and receive its cash value or you can let the policy lapse.

However, as noted above, a life settlement is almost always the superior choice economically. Chances are, you’ll get more money if you go this route.

People sell their life insurance policies for a variety of reasons. If you find yourself in one or more of these situations, it probably makes sense to at least consider a life settlement:

  • The face value (or death benefit) is no longer needed due to the death of a spouse, divorce, changes in the tax code or other circumstances.
  • The premiums are no longer cost-effective or affordable.
  • Money is needed to finance retirement or other lifestyle benefits.
  • The money can be better used for gifts to loved ones or philanthropic concerns.
  • The money is needed for medical treatments or other large expenses.

The caveat: Life settlements are generally for seniors usually no younger than 65. That’s because a company that buys policies doesn’t want to be stuck paying premiums for decades as it waits to collect on the death benefits. Put more simply, you’ll probably get a better offer if you’re old and in relatively poor health.

The life settlement process

The amount of money you might be paid for your policy depends on several factors — including the policy’s face value and premiums along with your life expectancy. Getting a life settlement payment is a five-step process:

1. Screening. This is a preliminary analysis to eliminate situations where a life settlement is clearly not appropriate.

2. Collection of information. Your life insurance and your health are evaluated.

3. Life expectancy report. Using this information, a life expectancy report — a mathematically calculated projection of how long you will live — is produced.

4. Life insurance policy analysis. Your life insurance policy is evaluated in the context of your life expectancy report.

5. Value calculation and offer. The current monetary value of your life insurance policy is calculated, and you are made an offer by the fund. There are three types of life settlement payouts:

  • Cash for your life insurance policy. This is the most common life settlement payout. You receive a single payment for your policy and give up any future benefit from it.
  • Retained death benefit. Using this approach, you will not get any money. Instead, you no longer have to pay premiums. Upon your death, your beneficiaries will receive part of the life insurance policy’s death benefit.
  • Hybrid. This approach is a combination of the two previous payout types.

6. Decision. In the sixth and final step, you make the decision whether or not to accept the offer.

The new tax situation for life settlements

It’s important to realize that life settlement proceeds are taxable (unlike death benefits to beneficiaries). The good news: Thanks to the Tax Cuts and Jobs Act of 2017, the tax rules on a life settlement you receive are now the same rules that apply if you surrender your policy to the insurance company. This can make it more tax-effective to choose the life settlement option.

Case studies

To see how life settlements can make good sense, consider these examples.

  • After reviewing his estate plan, an 82-year-old man realized his policy was no longer necessary. Because of his advanced age and medical history, his policy sold for $1.2 million — almost double the cash surrender value of $573,601, and roughly half of the death benefit of $2.5 million. He is now using the money to prepare for continued care as he ages.
  • An 89-year-old woman needed additional funds to help with family issues (the monthly premiums were also getting difficult to afford). After rejecting the idea of letting the policy lapse, she sold it for $110,000 — more than double its $47,281 cash value.
  • A 70-year-old man with Alzheimer’s required 24-hour care. His daughter needed cash to pay for medical expenses and to get relief from rising premiums. The policy had a hefty death benefit ($7.5 million) but a cash value of just $237,535. It eventually sold for $1.5 million in cash — while the daughter retained a death benefit of $3 million, using a hybrid-sale approach.

Making the right decision

Navigating the life settlement process can be tricky. Certainly, the industry is better regulated than it used to be.

Most states now require the companies that buy policies to be licensed and disclose fees and other financial information to policyholders.

That said, regulations can vary from state to state. And there’s no shortage of fine print in some of the offers that these companies make.

Our advice: Sit down with a wealth manager who has experience in this area, to determine whether the strategy in general makes sense — and whether a particular contract to buy your policy has terms and conditions that are really in your best interest.

Action step: If you think you or a family member could potentially benefit from selling an existing life insurance policy, contact your legal or financial professional to explore the topic further. u


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