How To Sell Your Life Insurance Policy?

Life insurance is a way to provide for your loved ones when you pass away. However, if your beneficiaries no longer need the payout and you could use some extra cash, you may consider selling your life insurance policy. Selling your life insurance policy is known as a life settlement. Life settlement companies buy life insurance policies and continue to pay the premiums. Upon your death, the company receives the payout instead of your original beneficiaries. Although this option may be suitable for some, it is important to carefully consider the pros and cons before making a decision.

Life settlements

A life settlement is the sale of a life insurance policy to a third party, known as a life settlement provider. The owner of the life insurance policy sells the policy and receives an immediate payment in return. The life settlement provider becomes the new owner of the life insurance policy, pays any future premiums, and receives the death benefit when the insured person dies.

How Life Settlements Work

Life settlement transactions can be handled by a life settlement broker or directly with a provider. A life settlement broker can solicit multiple bids on a policy to get the best sale price, but they will charge for the service. Here are the basic steps of the process:

• Application: Complete an application for each life insurance settlement and grant the settlement company permission to obtain information about your policy and health.
• Documentation: The settlement company underwriters will gather information about your policy and your medical records.
• Appraisal: The underwriters will determine the market value of your life insurance policy.
• Offer: The settlement company will extend an offer, which you can accept or decline.
• Closing: If you accept the offer, the settlement provider will send a closing package for you to review and sign. Once the signed documents are returned, your insurance provider will be notified of the transaction, and you will receive the settlement funds.

Factors Affecting Payout

How much you will get for selling your life insurance policy depends on several factors, including:

• Your life expectancy: The older you are, the higher the offer will be.
• The life insurance face amount: The higher the death benefit, the higher the offer will be.
• The policy's premiums: The lower the premiums, the more the company benefits.
• Your health: A health condition that reduces your life expectancy will result in a higher offer.

Pros and Cons of Life Settlements

Pros

• No longer having to pay premiums
• Receiving a lump-sum payment

Cons

• Complexity of the process
• Poor returns: Most people get paid far less than their death benefit, and brokers charge high commissions.
• Tax implications: You may have to pay taxes on the life settlement amount.
• Impact on public assistance: A cash settlement could make you ineligible for public assistance, such as Medicaid.
• Loss of the death benefit for your family: Your family will not receive the death benefit when you die.

Viatical settlements

The buyer of a viatical settlement pays the seller a cash sum that is less than the full amount of the death benefit in the life insurance policy. The buyer then takes over the payment of any future premiums. This type of settlement is often chosen by those who wish to preserve their estate's other assets, such as a home, which they may not want to sell before their death.

In the US, companies that buy viatical settlements to sell to investors are licensed by state insurance commissioners. Before entering into a viatical settlement contract, it is important to understand all the tax implications, as well as how it may affect your eligibility for public assistance programs.

How to sell your life insurance policy

Yes, you can sell your life insurance policy. This is known as a life settlement. However, there are a few things to consider before you do so.

Firstly, you should be aware that you can only sell your policy once, so it is worth taking your time to ensure you get the best deal. You should also be aware that your family will no longer receive the death benefit when you die, and the money you gain from the sale may be subject to taxes and debt collection.

• Familiarize yourself with life settlement transactions and associated regulations. Check with your state's insurance authority for more information about the process, licensing requirements, and potential scams.
• Decide whether to use a broker. This choice involves a trade-off between cost and convenience. A licensed life settlement broker can answer your questions, look out for your interests, pull quotes, and handle negotiations—but they will charge for the service.
• Complete an application for each life insurance settlement from which you solicit offers. As part of the application process, you must grant the settlement company permission to obtain information about your policy and health. You may also be given disclosures and asked to provide additional information or documentation.
• Once you have submitted your application and granted the necessary permissions, the settlement company underwriters will begin gathering information. They will contact your life insurance provider to request details about your policy, including its death benefit and premiums. The underwriters will also request a copy of your medical records from your healthcare providers.
• After reviewing the relevant information, underwriters will determine the market value of your life insurance policy. They will consider whether your policy is a good investment based on its value and the opinion of medical experts regarding your health. They will also look for signs of fraud.
• Assuming your policy is deemed suitable for purchase, the settlement company will extend an offer. You can either accept or decline the offer. It is recommended to compare offers from multiple companies before making a final decision. If you hired a broker, you may be able to negotiate a better deal.
• If you accept the offer, the settlement provider will send a closing package for you to review and sign. Once you return the signed documents, your insurance provider will be notified of the transaction. Ownership of the policy will change, and you will receive the settlement funds.

Tax considerations

Selling a life insurance policy can have significant tax implications, so it's important to understand the potential tax consequences before making a decision. Here are some key tax considerations to keep in mind:

• Taxable Gains: When you sell your life insurance policy, you may generate taxable income in the form of gains. This gain is generally calculated as the difference between the policy's sale price and the premiums you've paid into the policy. This gain is then subject to income tax, which can result in a substantial tax liability.
• Tax-Exempt Scenarios: Certain scenarios may offer tax exemptions when selling a 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: The type of life insurance policy and its ownership can also influence the tax implications. Selling a term life insurance policy often has minimal tax consequences since it lacks a cash value component. On the other hand, permanent policies such as whole life, universal life, or variable life policies may have cash values, making them potentially subject to taxation upon sale. Policies owned by individuals are also treated differently from those owned by trusts or corporations.
• Capital Gains and Reporting: The taxation on the sale of a life insurance policy typically falls under capital gains tax rules. The gain is categorised 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 several strategies that can help mitigate the tax implications of selling a life insurance policy. One approach is a tax-deferred exchange, where you exchange your current policy for another investment property, potentially deferring the tax liability. Another option is to use the proceeds to purchase a new life insurance policy with a lower face value, thus 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 optimise the financial outcome, ensure compliance with tax laws, and identify the most advantageous strategies.
• State-Specific Tax Considerations: In addition to federal tax laws, there may be state-specific tax considerations for life settlements. These laws can vary from state to state, impacting factors such as the tax treatment of income from life settlements, potential exemptions or deductions, and reporting requirements.
• Understanding the Tax Basis: The tax basis of your policy is generally the total amount of premiums you have paid over the years. When you sell your policy, the proceeds up to this tax basis are typically not taxable. However, any amount received above the tax basis may be taxed as ordinary income or capital gains, depending on the specific circumstances.
• Estate Tax Exemption: The Tax Cuts and Jobs Act of 2017 (TCJA) increased the estate tax exemption significantly. This higher exemption may make some policies purchased for estate tax purposes unnecessary.
• Viatical Settlements: In the case of viatical settlements, where an individual with a terminal or chronic illness sells their life insurance policy, the sale price is often treated as an advance of the life insurance death benefit, which is typically not taxed.

Pros and cons of selling your life insurance policy

Pros of selling your life insurance policy

• You will no longer have to pay monthly premiums, which tend to increase as you get older.
• You will receive a higher payout than if you surrendered or lapsed your policy.
• You can use the proceeds for anything, such as retirement savings, assisted living, or a memorable vacation.
• You can free up some room in your budget.

Cons of selling your life insurance policy

• Your beneficiaries will no longer receive a death benefit when you pass away.
• You will have to pay taxes on at least some of the money you receive from the sale.
• You may have to pay broker fees.
• The money you gain from the sale may affect your eligibility for certain public assistance programs, such as Medicaid.
• It can be hard to find the right buyer for your specific policy.
• You won't get the full death benefit back and will likely lose most of it.

Frequently asked questions