Maybe you’ve heard the TV or radio ads offering to buy your life insurance policy and wondered what that was all about. The industry term for such a transaction is a life settlement. Simply put, a life settlement is the sale of your existing life insurance policy to a third party. They’re similar to viatical settlements, which emerged during the AIDS epidemic of the 1980s, but unlike viaticals, life settlements target people who are 65 or older and generally not chronically or terminal ill. A life settlement is a perfectly legal transaction, based on the U.S. Supreme Court’s finding way back in 1911 that established life insurance policies as private property that could be transferred by the policy owner without limitation. But are they a smart strategy or risky business? Like so many things dealing with investments, it depends.
How Life Settlements Work
You enter into an agreement with a life settlement provider who pays who a sum greater than your policy’s cash surrender value but less than its death benefit. You get a cash settlement, and the buyer gets your policy, assumes the premiums and, when you die, gets the death benefit. Life settlement providers must be licensed in the state where you, the policy owner, resides.
Good Reasons to Opt for a Life Settlement
According to LISA, the Life Insurance Settlement Association, more than $100 billion face value of life insurance held by people over 65 lapses each year. Rather than lose out after paying premiums for years, LISA says a life settlement might make sense under the following circumstances:
- You can’t afford the premiums anymore
- The need to replace your lost income for your beneficiary if you die doesn’t apply anymore
- Your term policy is nearing the end of its coverage period
- You need cash for medical expenses
- You want cash for lifestyle reasons
LISA strongly advises that you talk with your financial, legal or insurance advisor about tax, legal and other consequences before you sell your policy.
Reasons to Think Twice before You Sell Your Life Insurance Policy
Jim Miller, creator of Savvy Senior, a syndicated information column for Boomers and Seniors, cautions anyone thinking about entering into a life settlement to take these facts into consideration:
- You should understand that the cash you receive will depend on a number of factors including your age, health, life expectancy, the type of policy you’re holding, premium costs and policy’s value. Most sellers, he says, usually get just 20 to 30 percent of the death benefit.
- Life settlements are taxable income if the cash surrender value of the policy exceeds the premiums paid on it. Death benefits paid to your beneficiaries, on the other hand, are generally tax-free.
- The cash received from a life settlement can affect your eligibility for Medicaid, food stamps and other public assistance programs.
- There may be fees associated with the life settlement, so be sure to shop around and get quotes from several credible providers or brokers. He suggested LISA as a good resource.
Good Source of Cash but Not for Everyone
FINRA, the Financial Industry Regulatory Authority, concludes that “life settlements can be a valuable source of liquidity for people who would otherwise surrender their policies or allow them to lapse–or for people whose life insurance needs have changed. But they are not for everybody.” FINRA warns that you should proceed with caution, especially if you may have ongoing life insurance needs after you’ve settled. Your age, health and other factors could make it difficult or cost prohibitive to get a new policy. Because the policy you sold is still in effect, it may impact your ability to get additional coverage. They suggest you consider other options. These include a 1035 Exchange, which lets you switch one life insurance policy for another or accelerated death benefits, available if you have long-term, catastrophic or terminal illness. You might also consider cash value withdrawal or a loan against the policy’s cash value.
Life settlements are a moot point if you don’t have a policy to sell. You can learn more about available life insurance products and shop for quotes online here.