Can I Sell My Life Insurance Policy for Cash?

It is possible to convert an existing life insurance policy into a cash sum, providing liquidity to policyholders. This option becomes relevant when financial needs or life circumstances change, making the original purpose of the policy less pertinent. It offers a solution for those who no longer require coverage or find premium payments burdensome.

Understanding Life Settlements and Viatical Settlements

A life settlement involves selling an existing life insurance policy to a third-party buyer for a cash payment. This payment is more than the policy’s cash surrender value but less than its net death benefit. These transactions are for policyholders at least 65 years old who hold a permanent life insurance policy, such as whole life or universal life, with a face value exceeding $100,000. The buyer assumes responsibility for future premium payments and receives the death benefit when the insured passes away.

Permanent policies accumulate cash value over time, which term policies do not. This cash value provides a basis for policy valuation in a settlement. While some convertible term policies may be eligible if they can transition to permanent coverage, traditional term life insurance does not qualify unless the policyholder is terminally ill.

A viatical settlement is a specific type of life settlement for policyholders with a life expectancy of two years or less due to a chronic or terminal illness. This distinction based on health status means viatical settlements involve higher payouts due to the shorter time until the death benefit is paid. Eligibility is determined by a medical professional’s certification of a terminal or chronic illness, rather than age.

For both types of settlements, the policy must be beyond its contestability period, typically two years from issuance. Buyers seek policies with a face value of at least $100,000, though some prefer $200,000 or more. The insured’s health impacts the offer; a shorter life expectancy in a life settlement increases the policy’s value to the buyer.

The Process of Selling Your Policy

Selling a life insurance policy begins with an inquiry to a licensed life settlement provider or broker. The policyholder needs to gather documentation, including original policy documents, medical records, and financial statements related to the policy. This information helps the provider assess the policy’s value and eligibility. Medical records are important as they determine life expectancy, a factor in the offer amount.

Upon receiving documentation, potential buyers, often institutional investors, conduct an underwriting process. This involves reviewing the policyholder’s health status, including past and current medical conditions, and estimated life expectancy. The policy type, cash value, death benefit, and ongoing premium costs are also evaluated to determine the policy’s economic viability for the buyer. This assessment helps buyers formulate a competitive offer.

After underwriting, the policyholder receives an offer, or multiple offers if working with a broker. The offer amount is influenced by the policy’s face value, remaining premium payments, policyholder’s health and life expectancy, and current market conditions. Policyholders can negotiate terms and compare offers for the most favorable terms.

Once an offer is accepted, the closing process begins, involving legal and administrative steps. The policyholder formally transfers ownership of the policy to the buyer. This transfer includes changing the beneficiary designation from original beneficiaries to the new policy owner. Funds are then released to the original policyholder, usually within a few business days after all necessary documents are signed and verified.

Financial and Tax Considerations

When selling a life insurance policy, the cash offer received is greater than the policy’s cash surrender value but less than the full death benefit. The final payout is subject to fees and commissions, which reduce the net amount received. These fees include commissions to brokers and administrative costs, and they vary.

The tax treatment of life settlement proceeds is important. The Internal Revenue Service (IRS) views these proceeds in a “three-bucket” approach. First, the portion representing the policyholder’s “cost basis” (total premiums paid, minus any prior tax-free distributions or withdrawals) is tax-free. Second, any amount received above the cost basis, up to the policy’s cash surrender value, is taxed as ordinary income. Third, any remaining amount above the cash surrender value is taxed as a capital gain.

For example, if a policyholder receives a $100,000 settlement, paid $75,000 in premiums (cost basis), and the cash surrender value was $85,000, the first $75,000 is tax-free. The next $10,000 ($85,000 cash surrender value minus $75,000 cost basis) is taxed as ordinary income. The final $15,000 ($100,000 settlement minus $85,000 cash surrender value) is taxed as a capital gain. This tiered approach means the entire payout is not always subject to the same tax rate, with long-term capital gains often taxed at lower rates than ordinary income.

Viatical settlements receive more favorable tax treatment. If the policyholder is certified as terminally ill with a life expectancy of 24 months or less, proceeds from a viatical settlement are tax-free under federal law. This is because the IRS views these payments as an advance on the death benefit, which is tax-exempt for beneficiaries. For chronically ill individuals, tax-free status may apply if proceeds are used for qualified long-term care expenses. Consult a qualified tax advisor to understand specific tax implications, as tax laws are complex and individual circumstances vary.

Exploring Alternatives to Selling Your Policy

Before selling a life insurance policy, consider other options that might better suit changing financial circumstances. One alternative is surrendering the policy for its cash surrender value. This involves terminating the policy and receiving the accumulated cash value, though this amount is less than what a life settlement might offer and any gain over the cost basis is taxed as ordinary income.

Another option for policies with accumulated cash value is taking a policy loan. Policy loans allow borrowing against the cash value, and these loans are not taxable as long as the policy remains in force. However, outstanding loans reduce the death benefit paid to beneficiaries and accrue interest, which can diminish the policy’s value if not repaid.

Policyholders might also consider converting their policy to a reduced paid-up policy. This option uses existing cash value to purchase a smaller, fully paid-up policy, meaning no further premium payments are required. While the death benefit is reduced, coverage remains in force for the policyholder’s lifetime, providing continued protection without ongoing costs.

For individuals facing a terminal or chronic illness, accessing accelerated death benefits, if available, can be an alternative. This provision allows the policyholder to receive a portion of the death benefit while still alive, to cover medical expenses or long-term care costs. Availability and terms vary by policy, and the payout reduces the eventual death benefit paid to beneficiaries.