Can You Sell a Term Life Insurance Policy?

Selling a term life insurance policy for cash is possible through a financial transaction known as a life settlement. This option allows policyholders to gain value from a policy they no longer need or want, instead of letting it lapse without return. The process involves specific steps and considerations, offering an alternative to surrendering a policy back to the insurer. Understanding how these transactions work is important for those considering monetizing their coverage.

Understanding Life Settlements

A life settlement involves the sale of an existing life insurance policy to a third-party investor for a lump-sum cash payment. This payment is typically greater than the policy’s cash surrender value, if any, but less than the full death benefit. The transaction transfers ownership of the policy from the original policyholder to the investor. The new owner becomes responsible for all future premium payments and receives the death benefit when the insured passes away.

This financial arrangement operates within a secondary market for life insurance policies. Unlike surrendering a policy, which cancels coverage for its cash value, or letting it lapse, which yields no financial return, a life settlement allows the policyholder to recover a portion of the policy’s value while still living. The investor purchases the policy as a financial asset, aiming for a return on investment when the death benefit is paid. This mechanism provides liquidity for policyholders whose insurance needs have changed or whose premiums have become unaffordable.

Eligibility for Life Settlements

Specific criteria determine whether a term life insurance policy and its owner are eligible for a life settlement. Policyholders are commonly 65 years or older, as age is a significant factor for buyers evaluating the policy’s payout timeframe. Younger individuals may also qualify if they have a significant health impairment that shortens their life expectancy, making the policy more attractive to investors.

The insured’s health condition is a primary consideration for life settlement companies. Buyers assess life expectancy to predict when the death benefit will be paid, influencing the policy’s valuation. While the focus is on term life, only convertible term policies, which can be changed into permanent coverage, are considered eligible. This convertibility is important for buyers as it allows them to maintain the policy indefinitely.

Policies need a minimum face value of $100,000 or more to be economically viable for life settlement providers. Policies with higher face values, such as $200,000 or more, are preferred by providers. The policy also needs to have been in force for at least two years to overcome any contestability periods.

The Life Settlement Process

Initiating a life settlement begins with contacting a life settlement broker or provider to explore options. These entities guide policyholders through the steps of selling their policy. The provider requests comprehensive information, including policy details like the insurer, face value, and premium schedule, along with authorization to access medical records. A signed HIPAA authorization is required to obtain health information for evaluation.

Once documentation is gathered, the policy undergoes a valuation, which includes an assessment of the insured’s life expectancy by independent medical experts. This life expectancy report, combined with policy terms and premium costs, helps determine the market value. Based on this assessment, offers are presented to the policyholder from various institutional investors.

Upon accepting an offer, legal documents are prepared to finalize the transaction. This includes a purchase agreement, along with forms to assign policy ownership and change the beneficiary to the new owner. Funds are placed into an escrow account and released to the policyholder within a few days of the policy’s ownership transfer confirmed by the insurer. After the settlement, the new owner assumes responsibility for premium payments and receives the death benefit when the insured passes away.

Tax Implications of Selling a Life Insurance Policy

The proceeds received from a life settlement can be subject to income tax, making it important for policyholders to understand the tax consequences. The calculation of taxable income considers the policy’s “cost basis,” which is the total amount of premiums paid into the policy by the seller. The amount of settlement proceeds received up to this cost basis is considered a tax-free return of capital.

Any amount received that exceeds the cost basis but is less than or equal to the policy’s cash surrender value may be taxed as ordinary income. For term policies, which lack a cash surrender value, this tier is minimal or non-existent. Any remaining proceeds from the settlement that exceed both the cost basis and any cash surrender value may be subject to capital gains tax.

Life settlement providers are required to issue IRS Form 1099-LS to report the transaction to the Internal Revenue Service, detailing gross proceeds paid. This form assists both the policyholder and the IRS in correctly reporting the income. Given the complexity of these tax rules and their impact on personal finances, individuals considering a life settlement are advised to consult with a qualified tax professional for guidance.