Should You Sell Your Life Insurance?

Life insurance is a way to provide for your loved ones when you pass away or to build up a cash reserve that you can use if necessary. But what happens if your beneficiaries no longer need the payout and you could use some extra cash? Is it a good idea to sell your life insurance policy?

Selling your life insurance policy may be a good idea in some cases, such as if you need the money or if the reasons for paying the premiums no longer exist. However, it's not something to rush into without serious consideration. Here are some pros and cons to help you decide.

Pros of selling your life insurance policy

- The money: If you feel your life insurance policy has outlived its usefulness, selling it can help you recoup some of the money you've invested over the years.

- No more premiums: In addition to receiving money from the sale, you'll also save cash by no longer having to pay monthly premiums.

- Less stress, more options: The additional revenue from the sale can improve your quality of life, especially during retirement.

Cons of selling your life insurance policy

- No future payout: If you have beneficiaries who were relying on the life insurance payout, you may come to regret selling your policy.

- More taxes to pay: If you make more money than you paid in premiums, you'll have to pay taxes on your profits.

- Debt collectors: Creditors could come calling, and they might be able to claim the money you receive from the sale.

- Benefits could be threatened: Selling your policy could affect your eligibility for government benefits such as SNAP or Medicaid.

- Privacy risks: Your policy could change hands multiple times, and your medical information will likely be shared with each investor.

Weigh the pros and cons

Selling your life insurance policy can be a good idea in some cases, but it's not a decision to be taken lightly. There are several benefits and drawbacks to consider before making a decision. Here are some of the pros and cons of selling your life insurance policy:

Pros of selling your life insurance policy:

• Immediate cash flow: Selling your policy can provide you with a lump-sum payment, which can be useful for various financial needs, such as medical bills, debt repayment, or funding your retirement.
• Relief from premium payments: If you're struggling to keep up with monthly premium payments, selling your policy can free you from this financial burden.
• More value than surrendering: Surrendering your policy will typically give you less money than selling it.

Cons of selling your life insurance policy:

• Loss of death benefit: Once you sell your policy, your beneficiaries will no longer receive a death benefit. If leaving a financial legacy or covering end-of-life expenses for your loved ones is important to you, selling may not be the best choice.
• Possible tax implications: Proceeds from selling your policy may be subject to income tax or capital gains tax, reducing the overall value you receive.
• Impact on Medicaid eligibility: Selling your policy could affect your eligibility for needs-based programs like Medicaid. The lump-sum payout might push you above the income or asset limits, leading to potential disqualification from benefits.
• Health check-ins: The buyer of your policy may have the right to inquire about your health and life expectancy periodically, depending on the state's laws.
• Potential for multiple sales: Your policy may be resold by the settlement provider, meaning your medical information could be disclosed to multiple third parties.

Before making a decision, it's essential to carefully consider your financial situation and the potential impact on your beneficiaries. Consult with a financial advisor or tax expert to weigh the pros and cons and make an informed choice.

Consider alternatives

If you're looking for quick access to cash while retaining your life insurance coverage, there are several alternatives to selling your policy. Here are some options to consider:

• Accelerated death benefit: If you're facing a terminal or chronic illness, your policy might include an accelerated death benefit rider. This allows you to access a portion of your death benefit while you're still alive, which can be used to cover medical expenses and other urgent needs without having to sell your policy entirely.
• Take out a loan against your policy: With permanent life insurance, you can borrow against the cash value that has accumulated in your policy. You'll need to pay interest, but the loan doesn't have a set repayment structure as long as you keep the policy active. Keep in mind that any unpaid loan balance and interest will reduce the death benefit.
• Withdraw funds from the cash value: With permanent life insurance policies, you can typically withdraw funds directly from the cash value that has built up over time. Withdrawals don't need to be repaid, but they will reduce the death benefit dollar-for-dollar. This is a quick way to access cash while still keeping your policy in force.
• Replace your policy: If your current policy no longer fits your needs or is too costly, you may be able to find a cheaper alternative. However, remember to maintain your existing coverage until the new policy is fully in place to avoid any gaps in protection.
• Surrender your policy: If you have a permanent life insurance policy with cash value, you can choose to surrender it and receive the surrender value, which is the cash value minus any fees or outstanding balances. While this option ends your coverage, it's a straightforward way to access funds if selling isn't your preferred choice.
• Opt for a Medicaid life settlement: If you require long-term care or are already on Medicaid, consider a Medicaid life settlement. This involves selling your policy to a life settlement provider, with the proceeds used to pay for care while retaining Medicaid eligibility in certain states.
• Reduce the death benefit: Lowering the death benefit can lead to reduced premiums, alleviating the financial burden of monthly payments while allowing you to maintain some level of coverage.

Understand the tax implications

Selling your life insurance policy can give you access to extra cash, but it's important to be aware of the potential tax implications. Understanding the tax consequences can help you make an informed decision and ensure compliance with tax laws. Here are some key points to consider:

Taxable Gains

When you sell your life insurance policy, you may be subject to taxable gains, which are generally calculated as the difference between the sale price and the premiums you've paid into the policy. This gain is typically subject to income tax and can result in a significant tax liability. It's important to consult with a tax professional to understand the specific tax implications of selling your policy.

Tax-Exempt Scenarios

Certain scenarios may offer tax exemptions when selling your life insurance policy. For example, if you are terminally or chronically ill, the proceeds from the sale may be partially or fully tax-exempt. Additionally, if the policy qualifies as a "viatical settlement" due to your life expectancy, you may be eligible for a tax exemption. These exemptions can provide significant relief from potential tax burdens.

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 results in 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 accumulated cash values, making them subject to taxation upon sale. Additionally, the tax treatment differs for policies owned by individuals compared to 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 may be categorized as ordinary income or capital gain, depending on factors such as policy type, ownership, and duration of ownership. It is important to accurately report the sale to avoid potential penalties. Standard forms such as Form 1099-R and Form 1040 Schedule D are commonly used for reporting life insurance transactions.

Mitigation Strategies

There are several strategies that can help mitigate the tax implications of selling your 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, reducing the taxable gain. Consulting with financial advisors and tax experts can help you identify the most advantageous strategies for your specific situation.

Know the steps to sell

If you've decided to sell your life insurance policy, there are several steps you should take to ensure a smooth and informed process. Here are the key steps to follow:

• Explore your options: You have a few options when it comes to selling your life insurance policy. You can surrender the policy to the insurance company, sell it in the secondary market through a life settlement, or convert it into a long-term care benefit if your policy offers accelerated death benefits.
• Determine your eligibility: Not all policies may qualify for sale. Factors such as your age, policy type, cash surrender value, health status, and the policy's investment potential will impact your eligibility. Most buyers look for policies from individuals aged 65 or older or those with certain health conditions.
• Prepare the necessary documentation: Gather all relevant policy documents, including the original policy contract, amendments, riders, and correspondence with the insurance company. Obtain comprehensive medical records outlining your health history, recent medical exams, diagnoses, treatments, and medications. Compile a record of premium payments made, including receipts or bank statements.
• Consult with a life settlement broker: Engage the services of a reputable life settlement broker who can evaluate your policy's characteristics, assess its market value, and guide you through the selling process.
• Get multiple appraisals: Seek appraisals from different life settlement providers or brokers to ensure an accurate valuation of your policy. This allows you to compare offers and determine the best possible sale price.
• Understand the tax implications: Selling your life insurance policy may have tax consequences. Consult with a tax professional to understand the specific tax implications based on your jurisdiction and personal circumstances.
• Negotiate and finalise the sale: Evaluate the reputation and experience of potential buyers or providers. Obtain multiple offers and compare the terms and conditions, including the purchase price, fees, commissions, and the provider's reputation for timely payments. Be prepared to negotiate and discuss any additional provisions or requirements.
• Complete the required paperwork: Sign a purchase agreement or contract provided by the buyer. Carefully review the document to ensure all terms and conditions are accurately reflected.
• Transfer ownership and beneficiary information: Work with the buyer to facilitate the transfer of ownership and update beneficiary designations.
• Receive the cash payment: The payment may be provided as a lump sum or in installments, depending on the negotiated terms. Verify the receipt of the payment and confirm that it aligns with the agreed-upon amount.

Find the right buyer

There are two main ways to find a buyer for your life insurance policy: going through a life settlement broker or directly to a life settlement provider.

A life settlement broker will do the work of finding multiple buyers and negotiating on your behalf, but they will take a cut of the final sale price—often a significant chunk, such as 20% or 30%. If you go down this route, be sure to shop around for a reputable broker with fair commission rates and full transparency about their fees. Check their license status and look for any complaints through your state insurance department.

If you don't want to pay broker fees, you can contact life settlement providers directly. Be sure to get multiple offers to ensure you're getting a fair deal.

Whether you go through a broker or directly to a provider, the process of selling your life insurance policy will typically involve the following steps:

• Provide the details of your life insurance policy, along with medical records.
• The buyer will calculate your life expectancy based on your medical records.
• If you receive an offer, you can sell your policy.
• The buyer becomes the new policy owner and starts paying your premiums.
• You will occasionally need to confirm you're still alive (for example, by signing and returning a postcard).
• When you die, the owner receives your death benefit.

Frequently asked questions