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If you are at least 65 years old and own a whole life policy or other type of permanent insurance policy that you no longer want or need, then you may want to consider a life insurance buyout. This type of arrangement is becoming popular with senior citizens who need cash upfront to pay for various kinds of expenses such as medical bills or the costs associated with long-term care. But how do life settlements work?
History of life insurance buyouts
In the United States, the practice of buying life insurance policies began back in the 1980s during the AIDS epidemic. At that time, life settlement brokers known as viators were created that would offer patients with this terminal illness who were also policyholders a substantial sum of money for their cash value life insurance policies. The patients could then use the proceeds from the sale to pay for medical treatments.
However, these transactions were almost completely unregulated and were often unwieldy, with very subjective criteria being used to judge the present value of a life insurance policy. This segment of the financial marketplace was rife with corruption and uncertainty, and many of the brokers and salespersons who engineered these transactions were earning outlandish commissions. Eventually the public began to call for more regulation in this area in order to keep patients from being cheated.
Since then, the life settlement industry has become considerably more regulated and streamlined, and many life settlement companies now offer complete turnkey programs that can easily facilitate the sale of a life insurance policy. There is still an element of subjectivity in some instances, but it is far smaller than it was in the early days.
Selling your life insurance policy
The process of selling your life insurance policy is fairly straightforward. The whole process happens in the following order:
- First, as the policy owner you will have to contact a life settlement company and let them know that you have a life insurance policy that you would like to sell. You may even want to get a list of companies that purchase life insurance policies in the secondary market so that you have several options to choose from. Most life settlement companies are only interested in working with clients who are at least 65 years old and own a fairly large cash value life insurance policy (the general minimum amount of the policy’s death benefit is $100,000).
- The settlement company will then analyze the value of the policy you want to sell to determine its present value. The settlement company will also consider the health condition and other personal information of the insured (you). If you have a number of medical issues, then this raises the value of your policy, and the settlement company may be willing to offer you more money than they would if you were in the bloom of health. This is because an unhealthy insured person is more likely to die sooner than a healthy one, and the life settlement company will obviously be able to collect the death benefit more quickly this way. In a nutshell, higher death benefits, lower premiums and an insured who is not likely to make it to their life expectancy will get the largest payouts.
- If your life insurance policy has accelerated death benefit riders that you believe you will have a good chance of needing, then be sure to compare the offer that the life settlement company is making to the amount of benefits that you could draw from. It may not make sense to sell your policy if you are going to receive less than the value of these additional benefits.
- After the insurance department of the life settlement company has taken these two factors into account, it will make you an offer for your policy.
- If you are satisfied with the amount of money that they are willing to pay, then you will sign over the ownership of the policy to the life settlement company.
- The company will then assume the responsibility of making the annual premium payments for the policy and will also name itself as the beneficiary on the policy.
- Then, when you die, the life settlement company will collect the death benefit to recoup its cash outlay from paying the life insurance premiums and also make a profit.
Most life settlement transactions take between six and ten weeks to complete. The amount of time that it takes can also be much longer or shorter depending upon your financial situation and the state of your health. For example, the settlement company may request more information after looking over your preliminary medical records. Your life settlement provider should be able to give you an idea of how long the process will take after you have signed all of the necessary paperwork and submitted it to them.
Any policy sale that nets the customer more than the cash surrender value in the policy but less than the death benefit is called a viatical settlement. It is not the only type of life settlement transaction, but it is the most common. All of the earliest life settlements done back in the 1980s were viatical in nature, and most life settlements today are as well. The average policy sale today nets the customer a little over 20% of the policy’s face value.
Pros and Cons of Life Settlements
Life settlements can benefit three separate parties in the following manner:
- The customer who sells the policy can get a tidy sum of cash upfront that he or she (or they) can use however they wish.
- The customer is also no longer required to pay the premiums on the policy, thus freeing up additional money in their budgets.
- The investors who fund the life settlement companies get a diversified portfolio of lucrative life insurance investments.
- The life settlement company earns a commission on the sale and also collects the death benefit upon the death of the customer (insured).
However, selling your life insurance policy also means disinheriting your original beneficiaries, so be sure that they are not going to need the death benefit in order to stay solvent before you sell. It is also a good idea to go over any offer you receive with a tax expert or your financial advisor to make sure that you are getting a good deal.
Tax ramifications should also be taken into account. The tax implications for life settlements were simplified with the Tax Cuts and Jobs Act of 2017, but Uncle Sam will still take a cut of your profit in three different ways. They are:
- The return of all premiums that you have paid into the policy will be treated as a tax-free return of principal.
- The amount you receive that equals the amount that your current cash value in the policy exceeds the total premiums paid will be taxed as ordinary income. This means that it will be taxed at your top marginal tax bracket.
- Any amount in excess of the amount of cash value is treated as a capital gain (a long-term capital gain in most cases).
Example of a life insurance buyout
Suppose you have a universal life insurance policy with New York Life that has a death benefit of $200,000. You have paid $150,000 in premiums into the policy over the past 20 years and the cash value now stands at $170,000.
You sell your policy for $185,000 to a life settlement company. The first $150,000 is a tax-free return of principal. The next $20,000 ($170,000 – $150,000) is taxed as ordinary income. The remaining $15,000 is treated as a long-term capital gain.
What's your life insurance policy worth?
It would be wise for you to consult with your tax or financial advisor before selling your policy to ensure that you know what kind of taxes you will owe on your sale. Don’t let yourself get hit with a nasty surprise when you file your taxes next year.
Can I sell my term life insurance policy?
Unfortunately, the answer in most cases is no. The only type of term life policy that you can sell to a life settlement company is a convertible term policy. This type of policy can be converted from a term policy into a smaller amount of paid-up permanent life insurance. Once the policy has been converted, it can be sold, provided that the death benefit is still at least $100,000. But you cannot sell any other type of term life insurance because there is no cash value component.
However, virtually any permanent type of insurance policy can be sold, as long as it meets the criteria described above. Whole life, universal life, and variable life policies can all be sold if their death benefits are sufficiently large.
What role does the life insurance company play in a sale?
For all practical purposes, the life insurance company doesn’t really do much of anything pertaining to the actual life insurance settlement process. It just collects the premiums, credits the cash value and pays the death benefit. It doesn’t matter to the life insurance company who the beneficiary is or who is paying the premiums as long as they are paid. They will simply change the names of the owner and beneficiary over to the life settlement company and everything else remains the same.
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Selling your life insurance policy can be a key decision that impacts both your short and long-term financial future, as well as the financial futures of your current beneficiaries. In most cases, potential sellers should thoroughly discuss the matter with their beneficiaries and other loved ones so that there are no surprises later on. But a life insurance buyout can net you a substantial lump sum of cash upfront that you can use to pay medical or long-term care expenses or for any other purpose that you want or need. This amount will usually be at least two to three times larger than the policy’s cash value. I’m
Be sure to consult closely with your tax and financial planners as well as your insurance agent before selling your policy. That way you can have at least some idea of how much you should get for your policy and what the tax bill might look like. It is also probably a good idea to contact the life insurance settlement association for more information on your potential buyers. Doing your homework before you sell may just net you a much better deal in the long run.
Want to find out how much you sell your life insurance for? Try our instant life settlement calculator.