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What you should know about life settlements

Know the risks involved with selling your policy to a third-party investor

If you no longer need life insurance, a life settlement can offer a larger payout than a policy surrender. But be wary of pushy sales tactics, broker fees and tax implications.

Beware of predatory buying practices

Life settlement providers and brokers have been accused of using sales tactics to pressure senior policyholders into selling their policies. Life settlements are a complicated process and may have unintended financial consequences. Before you sell, check that your provider is licensed and explore its reputation with the Better Business Bureau.

What are life settlements?

A life settlement is the sale of your life insurance policy to a third-party investor for an upfront one-time payment. This payment is typically more than the policy’s cash surrender value but less than the death benefit.

After paying a lump sum for the policy, the third-party buyer becomes the policy beneficiary and agrees to pay the policy’s premiums for as long as you live. When you die, they receive the policy’s death benefit.

When should I sell my life insurance policy?

There are circumstances that may warrant a life settlement. Here are the most common reasons for selling a life insurance policy:

  • You can’t afford the premiums. If you can’t cover the expense of life insurance premiums, you can opt for a life settlement instead of letting your coverage lapse.
  • You don’t need the coverage. If your life circumstances change and you no longer need coverage, a life settlement may offer a bigger payout than the cash surrender value of the policy.
  • You need the money. While there are many alternatives for accessing personal capital, a life settlement may help you pay for medical bills or other upfront expenses.

How life settlements work

Here’s what to expect from the life settlement process:

  1. Explore policy regulations. Both state laws and provider guidelines govern the sale of life insurance policies. You may need to wait between two to five years before you can sell your policy, so speak to your provider or an independent advisor before you begin the process.
  2. Have your policy appraised. Find out how much your policy is worth. Life settlement brokers may offer to appraise your policy for free but will likely expect you to use their brokerage services.
  3. Find a provider. If you’re looking to bypass brokerage fees, you can find a buyer on your own. Or, opt for a life settlement provider to guide you through the process and connect you with potential buyers.
  4. Verify credentials. If you choose to work with a life settlement provider or independent broker, call your state insurance department to make sure they’re licensed.
  5. Shop for the best offer. Don’t rush the process or accept the first offer you receive. Wait for a competitive offer before you sell.

How much will I make in a life settlement?

According to a study published by the US Government Accountability Office in 2010, policyholders who underwent the life settlement process typically received 13% to 21% of their policy’s value. A London Business School study in 2014 suggested that Americans can expect to be offered more than four times their policy’s cash surrender value in a life settlement.

Typically, the older you are, the more you can sell your policy for — that’s because your life expectancy is lower. Unlike your insurance company, a buyer is invested in you dying sooner. But, ultimately how much you receive in exchange for your life insurance policy hinges on a number of factors, including the value of the policy, the cost of premiums and your life expectancy.

Drawbacks of selling your life insurance policy

Before you sell, consider the following:

  • Brokerage fees. The Government Accountability Office quoted brokerage commission fees at 9% in 2009.
  • Taxes. Your life settlement may be considered taxable income and be subject to capital gains taxes.
  • Expensive future premiums. If you decide you’d like a life insurance policy in the future, your age and health status may result in steeper premiums.
  • Benefit eligibility. The income from your life insurance settlement could disqualify you from Medicaid or other government programs.

Life settlement tax laws for 2020

In 2017, the Tax Cuts and Job Act (TCJA) was revised to make it easier and more appealing for seniors to sell their life insurance policies rather than surrendering them.

Previously, policyholders who wanted to sell their policies were required to reduce their tax basis. This meant they had to deduct expenses relating to the “cost of insurance” over the life of the policy.

Under the new law, policyholders don’t need to do that. Instead, the same tax rules apply to both life settlements and surrenders, so sellers pay less capital gains tax overall.

What life settlement alternatives are there?

If you need money but want to keep your life insurance policy, consider these life settlement alternatives before you make a decision:

  • Borrow against your policy. If you’re in need of cash and have whole life insurance, you could tap into the cash value of your policy, but this will reduce the death benefit.
  • Accelerated death benefit. In the event of a qualifying terminal, chronic or critical illness, some policies offer an accelerated death benefit rider to access cash ahead of schedule.
  • Convert the policy. If the ongoing cost of coverage is an issue, consider converting your policy or changing your coverage to reduce premiums.
  • Surrender your policy. You can surrender your policy directly to your provider for the accumulated cash value of the policy.

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Bottom line

There are many factors to consider before you sell your life insurance policy, including broker credentials, tax implications and potential fees.

Research your life insurance options before you sell to ensure you make a well-informed decision for your future.

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