Selling Term Life Insurance: Cashing Out Policy

If you have a term life insurance policy that you no longer want or need, you may be able to sell it for cash. This is known as a life settlement, and it involves selling your policy to a third-party company or life settlement provider. The process typically involves determining if your policy is convertible, contacting a life settlement company, and signing paperwork to finalise the transaction. The amount you receive for your policy will depend on factors such as your age, health status, and the policy's value. It's important to carefully consider the implications of selling your policy, as it may have tax consequences and affect your eligibility for certain benefits.

What is a term life insurance policy?

A term life insurance policy is a type of life insurance that provides a death benefit to the policyholder's beneficiaries if the insured passes away within a specified timeframe. This is usually between 10 and 30 years, and the policyholder pays a premium for this period. The policy has no cash value and will expire worthless if the insured person survives the term, resulting in no death benefit payout. Term life insurance is often referred to as "temporary insurance" because it meets a temporary need. For example, it can be used to ensure that a mortgage can be paid off or that children's educations will be funded if the primary earner in a household passes away before retirement.

Term life insurance policies are usually level premium policies, meaning the premium remains the same for the entire term. This is the simplest and most common type of policy. There are also yearly renewable term policies, which cover the policyholder for a year at a time and can be renewed without a medical exam, but at a higher cost each year. Another type is the return of premium policy, which refunds all or a portion of the premiums if the policyholder survives the term. However, these policies can be significantly more expensive than level term policies.

Term life insurance is distinct from permanent life insurance, which remains in force until the insured's death or the policy's maturity date. Permanent life insurance policies include a death benefit and a cash value account that can be withdrawn or borrowed against while the policyholder is still alive. Whole life and universal life insurance are types of permanent life insurance.

Term life insurance is generally more affordable than permanent life insurance, as it only offers a death benefit for a restricted time and has no cash value component. It is also more cost-effective than permanent whole life insurance. However, term life insurance premiums increase with age, and the policyholder gets nothing in return if they survive the term.

How to determine if your policy is convertible

When signing up for term life insurance, you may have been given the option to add a conversion rider. This rider allows you to convert a term life policy into a whole life policy. Typically, you must exercise your conversion privilege before the policy expires and before you turn 65 or 70.

If you added a conversion rider, it will be specified in your policy with complete details on how and when you can convert from term to permanent insurance. If you’re unsure after reading your policy, a life settlement provider can review it with you and help determine if it is convertible.

These riders may come at an extra cost, but in exchange for the increased cost, you gain the ability to reclaim some of the value through a settlement or by carrying the policy through the remainder of your life.

If you don’t have a conversion rider as part of your term life policy, you’ll likely be unable to sell it through a life settlement. The exception to this rule is if you have a term policy and have a very serious or terminal health condition. In that case, you may still be able to sell your term life insurance policy, and you should contact a life settlement provider to discuss your options.

Most convertible insurance policies allow policyholders to convert the policy for a predetermined number of years (e.g. 10 or 20 years). You decide if and when to convert during this window. When you convert a term policy to whole or universal life, the new permanent policy can have the same death benefit as the term policy. However, premiums for the new policy will be higher after conversion because permanent insurance is more expensive than term.

The conversion option may be part of the basic insurance contract, or it might be available by purchasing a special rider and attaching it to your policy. Some insurers offer the conversion option for the first few years of the policy at no charge and then provide the opportunity to add a conversion rider later for an extra cost.

Understanding convertible insurance policies

The biggest benefit of convertible insurance policies is that policyholders don’t have to undergo medical underwriting again to switch to a permanent plan. You are not required to take any new or additional screening at the time the policy is converted, regardless of your medical condition.

When you convert, the insurer cannot increase the cost based on your health status. You receive the same health rating as when you first signed up for coverage, even if you develop health problems later. However, the cost of the permanent coverage will be based on your age when you convert. It will be more expensive than if you had bought the permanent life insurance policy at the beginning rather than buying term and converting later.

How your health and age affect settlement offers

A variety of factors impact life settlement payouts, but few have a more significant impact than your health and age. Generally, younger and healthier people receive smaller payouts from a life settlement, if they qualify at all. Most people who qualify for a life settlement are at least 65 years old (and are often 75 or older) and have experienced a change in their health since they initially took out a policy.

Life settlement companies are mainly interested in buying high-value policies from older policyholders. You'll probably need to be over the age of 65 and have a policy worth at least $100,000 to sell your policy. The older you are, the more attractive your policy is to investors. This is because investors don't want to risk paying premiums on a policy for someone who could live for decades. That's why they prefer to buy policies from people with shorter life expectancies. The shorter the life expectancy, the greater the value is to the investor.

The state of your health is another key factor. Life settlement companies will pay more if you have a health condition that leads to a lower life expectancy. Typically, you must be terminally ill with a life expectancy of less than two years, or chronically ill and unable to perform at least two "activities of daily living" such as bathing, eating, dressing, or going to the bathroom unassisted. The more health issues you have and the shorter your life expectancy, the more money you'll get.

Other Factors Affecting Settlement Offers

In addition to your health and age, there are several other factors that determine the value of your term life insurance policy when selling it. These include the policy's face value, the policyholder's age and health, premium payments, remaining term, market conditions for life settlements, and the insurance company's ratings. Together, these factors influence the policy's attractiveness and potential value.

The process of selling your term life insurance policy

Selling your term life insurance policy is a big decision and should be considered carefully. Here is a step-by-step guide to help you through the process:

• Determine if your policy is convertible: When you signed up for term life insurance, you may have been asked if you wanted to add a conversion rider. This rider allows you to convert your term life policy into a whole life policy. If you have a conversion rider, read it carefully as it will specify the details of how and when you can convert your policy. If you are unsure, a life settlement provider can help you determine if your policy is convertible.
• Check your health and age: Your health and age will affect the settlement offers you receive. In general, older individuals with health conditions that lead to a lower life expectancy will receive higher payouts.
• Check if you qualify for a life settlement: Before making any changes to your policy, check with a life settlement company to see if you qualify. This step is usually free and can be done quickly.
• Explore additional options: Before finalizing the sale, understand all your options. If you are in good health and can afford the premiums, you may want to hold on to your policy or wait for a better settlement payout. You may also want to consider alternatives such as an accelerated death benefit rider or a long-term care rider.
• Have your policy appraised by a life settlement company: Contact a licensed life settlement company to receive an appraisal of your policy. They will ask you additional eligibility questions and collect policy and medical records to provide a full and accurate appraisal.
• Evaluation: Submit an application with relevant policy and health information to the life settlement company for an evaluation.
• Review the offer: If your policy qualifies, the life settlement company will provide an offer.
• Acceptance and closing: If you accept the offer, work with the life settlement company to complete the necessary paperwork and finalize the sale.
• Funds disbursement: Once the sale is completed, you will receive the agreed-upon cash payout.

It is recommended to consult with a professional experienced in life settlements to guide you through the process. Additionally, be aware of potential tax implications and fees associated with selling your policy.

Tax implications of selling your term life insurance policy

Selling your term life insurance policy can have several tax implications. It's important to understand these implications to make an informed decision about selling your policy. Here are some key points to consider:

• Taxable Gains: When you sell your life insurance policy, you may generate taxable income in the form of gains. The taxable gain is typically calculated as the difference between the policy's sale price and the premiums you've paid into the policy. This gain is subject to income tax and can result in a significant tax liability.
• Tax-Exempt Scenarios: Certain scenarios may offer tax exemptions when selling a term life insurance policy. For example, if you're terminally or chronically ill, a portion or all of the proceeds from the sale may be tax-free. Additionally, if the policy qualifies as a "viatical settlement" due to your life expectancy, a tax exemption could apply.
• Impact of Policy Type and Ownership: Term life insurance policies generally have minimal tax consequences upon sale since they lack a cash value component. However, permanent policies such as whole life, universal life, or variable life policies may have accumulated cash values, potentially making them subject to taxation upon sale. The tax implications also depend on the ownership of the policy, with policies owned by individuals treated differently from those owned by trusts or corporations.
• Capital Gains and Reporting: The sale of a life insurance policy is typically taxed as a capital gains tax. The gain can be categorized as either ordinary income or capital gain, depending on factors such as policy type, ownership, and duration of ownership. Accurate reporting of the sale is essential to avoid potential penalties. Form 1099-R and Form 1040 Schedule D are commonly used for reporting such transactions.
• Mitigation Strategies: There are strategies to mitigate the tax implications of selling your term life insurance policy. One option is a tax-deferred exchange, where you exchange your current policy for another investment property, potentially deferring the tax liability. Another strategy is to use the proceeds to purchase a new life insurance policy with a lower face value, reducing the taxable gain. Charitable donations of the policy can also provide tax advantages.
• Professional Guidance: Given the complexity of tax implications, it is highly recommended to seek professional guidance from financial advisors, tax experts, and legal professionals. Their insights can help you navigate the intricacies of selling your policy, ensure compliance with tax laws, and optimize your financial outcome.

By carefully considering the tax implications and seeking expert advice, you can make a more informed decision about selling your term life insurance policy while maximizing your financial benefits and minimizing potential tax liabilities.

Frequently asked questions