March 31, 2022
Life Settlement FAQ: Your Questions Answered
What is a life settlement?
In a nutshell, a life insurance settlement
transaction is when a life settlement company offers to buy a life insurance policy from a policy owner for a given sum. If the policyowner agrees to the price, then the life settlement company will become the new owner and beneficiary of the policy.
The seller receives immediate cash, and the settlement company will then assume the responsibility of making the premium payments to the insurance carrier until the death of the insured. At that time, the settlement company will collect the policy death benefit from the insurer and thus recoup its purchase price and premiums paid and also make a profit.
Are life settlements legal and regulated?
In most states, yes. 43 states now have their own rules and regulations that govern life settlements, and these states cover over 90% of the U.S. population. In states with regulations, the state department of insurance or financial services is the overseeing agency.
Some states require policyowners to hold their policies for at least two years, while others require that they hold them for five years. In some cases, this requirement can be waived if the policyowner becomes terminally or chronically ill, physically or mentally disabled, retires or gets divorced.
The regulations provided by most states include when the seller must get their money after the sale, when money must be placed in escrow and other details that protect the seller from unscrupulous buyers.
Why would I sell my life insurance policy?
You can sell your life insurance coverage for any number of reasons. If you simply don’t need the coverage any more or can no longer afford the premiums, then selling your policy can be an option.
You may also need to get your hands on a large lump sum of cash within a relatively short period of time. All of these can be good reasons to sell your life insurance policy. You may also need the money for medical expenses that aren’t covered by your health insurance. If you are terminally or chronically ill, you may also be able to sell your policy in a viatical transaction so that you can use the money you get to pay medical bills (more on this later).
How much is my life insurance policy worth?
The value of your policy is determined by several different variables, including the age, health status and projected longevity of the insured, the size of the face amount and the amount of premiums that must be paid. One study from a few years ago revealed that the average seller of a life insurance policy received 2 to 3 times the policy cash surrender value of the policy. The average payout averaged around 20% of the the amount of the policy death benefit. This is over 4 times what the sellers would have received if they had simply cashed in their policies instead.
Am I eligible to sell my life insurance?
If you are at least 65 years of age and own a life insurance policy with a face value of at least $50,000, then you meet the general eligibility requirements to sell your life insurance policy. You also must have owned the policy for at least two years (or five years in some states). There are also certain medical conditions that may preclude your ability to sell your policy, so be sure to disclose your entire medical picture to the settlement company up front.
What types of life insurance can be sold?
Virtually any type of life insurance policy can be sold. The types of policies that are eligible include whole life insurance, universal life insurance, variable universal life insurance, indexed universal life insurance, group life insurance, and even term insurance in some cases. But term life policies often must be convertible in order to be eligible. Keep in mind, there are other types of term policies that still qualify. Survivorship policies of any type can also be sold, provided both parties agree to the sale.
Who buys life insurance policies?
There are life settlement companies that buy life insurance policies from seniors, and they make a profit by buying policies from sellers and then recouping their cash outlay when the insureds on the policies pass away. Life settlement investors are institutional investors such as pension funds, private equity investors, and hedge funds that buy life insurance policies.
What does the life settlement process look like?
First, the seller contacts a life settlement company and notifies them that their policy is for sale. Then the life settlement company will begin doing its due diligence on the seller to see whether it is likely that they can make a profit on the purchase of the policy. In most cases, the settlement company will require the seller to furnish their medical records for analysis.
If the life settlement underwriters decide that the company can move forward, it makes an offer to the seller for a specific sum of money that will be paid. If the seller agrees, then the settlement contract makes the company the new owner and beneficiary of the policy.
The life settlement company then assumes the responsibility of making the premium payments until the death of the insured. At that point, the settlement company collects the death benefit and recoups its premium outlay and purchase price plus a profit.
How long does the life settlement process take?
In most cases, the life settlement process will take at least two to three months to complete. From the time that the seller first contacts the settlement company to the day that the seller receives payment for the policy. The Life Insurance Settlement Association (LISA), the leading trade association in the the life settlement industry, has additional information about the life settlement process and expectations around the timeline.
What is the difference between a life settlement and a viatical settlement?
A life settlement is a sale of life insurance by a policyholder who is at least 65 years old and has a life expectancy of more than five years. A viatical settlement is done for someone with a terminal illness who owns a large life insurance policy. A viatical settlement seller must have a life expectancy of five years or less in most cases. The proceeds from a viatical settlement are generally used to pay for last wishes and medical bills, while the proceeds from a life settlement can be used for any purpose that the seller chooses.
Is a life settlement taxable?
For years, the tax laws governing the sale of a life insurance policy were very onerous. But in recent years, the IRS has laid out a boilerplate set of rules that all sellers can use to determine how much they owe on their sales.
The taxation of a life settlement will depend upon how much cash value was in the policy, the sale price and the amount of premiums that were paid into the policy since its inception. In most cases, the sales proceeds are divided up into three categories and taxed differently in each category. This is broken down as follows:
- The portion of the sale price that equals the amount of life insurance premiums already paid into the policy is classified as a tax-free return of capital for the purpose of tax basis.
- The portion of the sale price that exceeds the amount of premium paid up to the amount of cash value in the policy is taxed as ordinary income (which means that you’ll pay tax on this amount at your top marginal tax rate).
- Any amount that exceeds the cash value in the policy is taxed as a long-term capital gain.
It is important to check with your financial advisor on your specific tax consequences of entering into a life settlement contract. Also, additional information can be found about life settlement taxation from the IRS website.
Bill paid $40,000 of premiums into his indexed universal life policy. He has $55,000 of cash value in the policy and sells his policy for $65,000. The first $40,000 of the sale is considered a tax-free return of principal. The next $15,000 is taxed as ordinary income. The final $10,000 is taxed as a long-term capital gain.
Although these rules generally apply to all settlement transactions, there are also state-specific rules and regulations that can apply in certain situations. Be sure to consult with a qualified tax advisor on this matter before you file your tax return.
Will I still pay premiums if I sell my policy?
No, the life settlement company will take over the responsibility of paying the future premiums on the policy. They will continue to pay those premiums until your death.
Can I use my life settlement money however I want?
Yes. There are absolutely no restrictions on how you can use the sale proceeds from a life settlement transaction. Life settlement transactions differ from viatical settlement proceeds in this manner, as viatical settlement money is usually used to pay for healthcare expenses or other final requests by the seller.
Do I need to use a life settlement broker?
No, this is not absolutely necessary, but if you know nothing about life settlements, then you may be wise to enlist the help of one. A broker can help the sales process to move smoothly from one step to another. However, these brokers don’t work for free, so if you feel like you know what you’re doing well enough to do this on your own, you may not want or need to pay the hefty fee for a broker’s services. Working directly with a life settlement provider allows you to avoid paying a fee to a life settlement broker. Just make sure the life settlement provider you work with gets offers from multiple life settlement companies.
Are there alternatives to life settlements?
Yes, there are several other ways that you can get cash out of your life insurance policy, but none are as profitable as a settlement transaction. You can either withdraw money directly from the cash value, take out a policy loan against the cash value or cash the policy in entirely.
Accelerated benefit riders can also allow you to access some or all of your death benefit before you die if you need money because you have become disabled or need some form of long-term care. However, you will almost always get more from a life settlement than you can using any other alternative. Accelerated benefit riders may be the only exception here, as you may be able to access more than the cash value in the policy in some cases, depending upon your need.
Do I need to get a medical exam to be eligible for a life settlement?
INo! No medical exam is required to sell your life insurance provider. Life settlement companies will request an authorization to get access to your medical information – medical records, list of healthcare providers, etc. – but will not require any blood work or physical examination. This disclaimer will allow the life settlement company to review your medical history and complete an underwriting of your health conditions, a necessary part of the valuation process. In some cases, a life settlement providers may also want to complete a medical interview over the phone to review your medical history and conditions.
Am I obligated to sell my life insurance policy when I receive an offer?
You are under absolutely no obligation to accept any payout offer that is made. There is no legal requirement of any kind obligating you to accept an offer. You can entertain offers from several different settlement companies to see who will give you the best deal. And in fact, you should. Don’t just jump at the first offer that you get; you may get a much better offer from a competitor. If you can get two of them into a bidding war, you may come out ahead by thousands of dollars in the end.
What if I change my mind after I sell my policy?
In all states with life settlement regulations, you have anywhere from 15 to 30 days after the sale is done to rescind the offer if you like. But once this grace period has passed, then you are locked into the sale. The same time frames also apply to life insurance companies in most cases.
What is a death benefit?
The death benefit is also known as the face value or face amount of a life insurance policy. The death benefit pays out when the insured on the policy dies. The death benefit is the largest amount of money that you can get out of a life insurance policy under any circumstances, unless you have a cash value policy and you buy an extra rider that adds the cash value to the death benefit as well. (Of course, then this entire amount would still be considered to be the death benefit). The death benefit is always exempt from income taxes but may be subject to estate taxes in some cases.
What is cash surrender value?
The cash surrender value of a life insurance policy is the amount that you receive after you cash in the policy. The cash surrender value equals the total amount of cash value in the policy minus any applicable surrender fees and also minus any loan balances that are outstanding.
If your cash surrender value exceeds the total amount of premiums that you paid, then you will be taxed on the difference at your top marginal tax bracket. If you cash in your policy during the first few years, then your cash surrender value will usually be rather low because a greater portion of your premiums were used to pay for the death and living benefits in the policy. If you cash in your policy after it has been in force for ten years or longer, then there’s a good chance that your cash surrender value will exceed the amount of premiums that you have paid.
How much is my life insurance policy worth?
Life insurance policies vary based on policy type, size, the health of the insured, and other factors. For example, viatical settlements usually pay out significantly higher than life settlements because they are made to people who are terminally ill. If you are terminally ill, the life settlement company can recoup their investment sooner, and so they are willing to pay more. If you want an instant estimate on how much you could earn from selling your life insurance policy, try our free life settlement calculator.
Author: Steven Shapiro
Steven Shapiro is the founder of the Company and also the President and CEO of Q Capital Strategies, LLC and Life Settlement Solutions LLC. Steven has been active in the life settlement industry for the last 18 years. In addition to his life settlement experience, Steven has expertise in strategic consulting, investment banking advisory services, and private equity investing. Steven holds a B.A. degree in economics from the University of Pennsylvania and an M.B.A. in finance and entrepreneurial management from The Wharton School of the University of Pennsylvania. Steven is also the immediate past Chair of LISA (having previously served as Chair), the Life Insurance Settlement Association, the oldest and largest trade organization in the life settlement industry.