What Is a Life Insurance Settlement?
If you no longer need or cannot afford your life insurance policy, you can sell it to a third-party buyer. This entity will inherit your premium payments in exchange for your death benefit after you die. Returns on these settlements usually fall between a policy’s cash surrender value and tentative death benefit payout, providing an alternative to surrendering your policy to the insurance company due to delinquent payments.
Life settlements help people who need immediate cash for personal or medical reasons or whose beneficiaries have become entirely self-sufficient. However, after finalizing a settlement, your family permanently loses access to the financial safety net a death benefit would provide. Furthermore, life insurance settlements are subject to federal taxes and can affect your Medicaid eligibility, if applicable.
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How Do Life Insurance Settlements Work?
In most cases, a licensed broker will put the policy in a market auction and try to garner the highest bid possible in exchange for a commission. These charges vary from broker to broker and can range from a small percentage of a policy’s face value up to half its final sale price. Some agencies also charge supplemental fees to procure your medical records and schedule medical underwriting.
Alternatively, you can bypass a brokerage and sell directly to a buyer to avoid paying a commission. However, this will take additional time and effort, as you must compare offers from multiple providers in your state to secure the best possible deal.
Most investors prefer permanent life insurance policies that guarantee a death benefit payout. Of these, universal plans have the highest appeal due to their lower and often flexible premium rates. Unless you have a short life expectancy due to illness or old age, settlement companies rarely purchase term life insurance policies unless they include a clause authorizing a permanent conversion.
Rules and Regulations Of Life Insurance Settlements
A growing number of states have begun heavily regulating life settlement companies and brokers, with many state insurance commissioners now imposing stringent licensing requirements. Likewise, because variable life insurance policies involve stocks and bonds, their sale must abide by federal securities laws and Congress-backed Financial Industry Regulatory Authority (FINRA) rules.
Notably, sellers must authorize the release of their medical records, allowing buyers to determine their policy’s value and share that information with lenders and third-party investors. Sellers must also agree to pay taxes on a sale’s profits. However, if you accept an offer but quickly reconsider, some state insurance commissioners enforce laws allowing sellers to return the buyout money within a reasonable timeframe to reinstate their policies.
Who Should Consider Selling Their Policy?
Sometimes, a person significantly behind on bills or rent payments has no choice but to take the best offer on their life insurance policy. Or, they may have hefty medical expenses associated with a terminal illness or long-term care needs. Other people may have grown children with high-paying jobs who no longer lean on them for security.
Failing to secure a life insurance settlement serves nobody but your insurer, who gets to keep all the money from your previous premiums and relinquish nothing more than a policy’s cash surrender value after it lapses. Therefore, anybody who plans on ceasing premium payments may as well put their policy up for auction to tentatively prevent a total loss on their investment.
Pros
Selling your life insurance policy can present many advantages:
- It saves stress and money by eliminating your monthly premiums.
- Settlements have higher returns than cash surrender payouts.
- Not all life insurance policies include a cash surrender payout.
- It gives you additional revenue to spend during your retirement years.
- Some companies allow for partial sales, allowing customers to reduce their premiums, hang on to a reduced death benefit for the families, and secure a small payout for immediate needs.
- Licensed brokers and settlement companies can do most of the work for you.
- There are no commissions or fees if you sell the policy directly.
- Some states allow sellers to renegotiate or reverse a deal within a reasonable period.
Cons
However, life insurance settlements have numerous downsides, including:
- By selling your policy, you forfeit financial protection for your family after you die.
- You must pay taxes on any profits exceeding your previous premium payments.
- If you have a term life insurance policy, you will likely only attract a buyer if you have a short life expectancy or terminal illness.
- In addition to fees charged to procure your medical records, brokers and settlement companies can siphon a significant percentage of your policy’s final sale price.
- You may not attract buyers if your policy registers as having little value.
- A payout could negatively impact your Medicaid eligibility.
Alternatives to Life Insurance Settlements
If you cannot secure an agreeable settlement, explore the following alternatives:
- Surrender your policy for its cash value minus any surrender fees.
- If a doctor has diagnosed you with a terminal illness, you might have the option to partially accelerate your death benefit for immediate access.
- Borrow against your permanent policy’s accumulated cash value.
- Use your permanent policy’s cash value and dividends to pay your premiums.
- Request conversion to a hybrid policy with long-term care benefits. Notably, this will only work if the request occurs before diagnosis of a terminal illness or mental condition that would fail to pass medical underwriting.
Putting It All Together
Life insurance can cushion your family against significant financial losses, including reduced income, burial expenses, and debt transfers triggered by your unexpected death. However, you must consistently pay monthly premiums to keep your death benefit intact. This occasionally proves difficult for people with growing medical needs or personal debts later in life.
To prevent your policy from lapsing, you can sell it to a third-party investor in a life insurance settlement. Compare offers between multiple third-party buyers and commission fees from settlement brokers and agencies to guarantee you secure the best possible deal. Likewise, contact your state insurance commissioner to ensure all dealings occur within the confines of the law.