Though many people are familiar with life insurance policies and have a general understanding of how they work, the process of selling a life insurance policy to a third party may be less commonly understood. When an insured party sells a life insurance policy to a third party investor, the transaction is called a life settlement.
How Life Settlements Work
Though the idea is counterintuitive to many people, life insurance policies are considered property and therefore can be bought and sold. A life settlement begins when an insured party chooses to sell this property for cash. The difference between the sales proceeds (the total amount you received) and the cost basis (the total amount you paid into the insurance policy) is a taxable gain. Depending on the amount received, the gain can be taxed as ordinary income, capital gains, or both. In addition, the amount the insured receives for the insurance policy can be up to four times greater than the surrender value of the policy but less than the death benefit. The third party that purchases the insurance policy agrees to take the insured's place by maintaining the premium payments. When the insured party passes away, the death payment goes to the third party purchaser.
Please note that life settlement transactions are distinct from, though related to, viatical settlements. Both transactions involve selling a policy to a third party investor; however, the distinction is that the law in the insurer's state may require the viatical settlement contract to be filed with and approved by the state insurance commission. Life settlements usually involve relatively healthy individuals. In contrast, viatical settlements normally involve individuals whose life expectancy is under two years because of terminal illness or a related condition.
If you are interested in selling your policy, you should use a knowledgeable broker to facilitate the transaction. Choose a licensed broker who is ready to carry out the fiduciary duties required under the law.
Why You Might Consider a Life Settlement
Selling a life insurance policy may, at first glance, seem inadvisable. However, that may not be the case. Statistically, life insurance policies rarely pay out for several reasons, including the fact that many term insurance policies ultimately lapse because the purchaser failed to pay rising premiums. For this reason and more, a life settlement can help an individual realize at least a portion of the investment in life insurance.
Depictions of life settlements in the media usually portray aged individuals expressing happiness and relief as a result of the transaction. These depictions stem from the most common use of the practice. Life settlements can be extremely valuable in a variety of situations. For example, if a loved one experiences a health crisis and funds are needed to obtain treatment, the cash from a life settlement may help.
People may also consider obtaining a life settlement when they cannot maintain the insurance premium payments. Rather than allowing the policy to lapse, an insured person may find that this option alleviates the financial pressure to continue paying. Finally, people may choose to obtain a life settlement if their current estate has decreased in value or changing laws have impacted the taxation or protection of life insurance benefits.
Life insurance settlements were on the rise at one time mostly due to individuals in their mid to late seventies who had health issues, such as heart disease and diabetes. However, more recently, the situation has changed. Currently, healthy seniors might qualify if they meet the following conditions:
- They are more than sixty-five years old,
- They have experienced an adverse change in health but are not terminal,
- They own a policy with a death benefit of $100,000 or more and a relatively low cash value, and
- They no longer need or can afford the policy.
Policy owners who meet the above qualifications may be able to sell their policy. Life settlement applicants may not have to participate in any additional screening, hastening the approval time. Healthy applicants may receive an offer for their policy within twenty-four hours.
If you are an aged individual and are considering your life settlement options, you should definitely consult with an experienced attorney, as well as your tax accountant, to determine the best course of action.