How Can You Sell Your Life Insurance Policy?

Selling a life insurance policy offers a financial option for policyholders seeking immediate cash from an asset they may no longer need or want. This process primarily involves two mechanisms: life settlements and viatical settlements. Both allow a policyholder to receive a cash sum for their policy while still alive, providing liquidity that would otherwise only be available as a death benefit. This article will guide you through the intricacies of selling a life insurance policy, detailing the different types of settlements, the preparation involved, the procedural steps, and the important tax considerations.

Understanding Life Settlements and Viatical Settlements

A life settlement involves the sale of an existing life insurance policy to a third party for a cash sum. This payout is greater than the policy’s cash surrender value but less than its net death benefit. The buyer, usually an investor or institution, assumes responsibility for all future premium payments and becomes the policy’s new beneficiary, receiving the death benefit when the insured passes away. Life settlements are for policyholders who are not terminally ill, often those aged 65 or older, or younger individuals with significant health impairments.

Common policy types eligible for life settlements include universal life, whole life, and convertible term policies, particularly those with a face value of $100,000 or more. Many states require a minimum in-force period, often two to five years, to prevent immediate resale. The policyholder’s age and health status play a significant role, as a shorter life expectancy makes the policy more attractive to buyers due to a quicker return on investment.

A viatical settlement is a specific type of life settlement designed for policyholders who are terminally or chronically ill. The primary distinction lies in the health status of the insured, as viatical settlements require a certified life expectancy, 24 months or less, by a physician. Because of the shorter life expectancy, viatical settlements often result in a higher payout percentage of the death benefit compared to standard life settlements, as the buyer anticipates fewer premium payments. This type of settlement offers a way for individuals to access funds for medical expenses or to improve their quality of life during their illness.

Preparing Your Policy for Sale

Before initiating the sale process, gathering specific information and documents is a necessary step. You will need the original policy documents, which detail the policy number, type, face amount, cash value, and premium schedule. Additionally, comprehensive medical records are required, including diagnoses, treatment history, and physician’s statements, which provide crucial information about your current health status. Personal identification documents are also needed to verify your identity and ownership of the policy.

These documents enable potential buyers to conduct thorough underwriting and valuation. Underwriters review medical history to estimate life expectancy, a primary factor in determining value. Policy details allow buyers to assess future premium obligations and the death benefit. Understanding these requirements streamlines the process.

Several factors influence a policy’s market value. The policyholder’s age and health status, particularly their life expectancy, are the most significant determinants. Policies on older individuals or those with declining health often command higher offers because the buyer expects to receive the death benefit sooner. The policy’s face amount, or death benefit, is another factor, with larger policies being more attractive to buyers.

The amount and schedule of future premiums also affect the value, as buyers assume these ongoing costs. Policies with lower future premium obligations or those that are paid up tend to be more valuable. The policy’s cash surrender value and the issuing insurer’s financial rating are also considered.

The Policy Sale Process

The journey to selling a life insurance policy begins by contacting a licensed life settlement broker or provider. A broker acts as your representative, soliciting offers from multiple life settlement providers to help you secure the highest possible payout. Conversely, a provider is the entity that directly purchases the policy, either for its own investment portfolio or on behalf of other investors. While you can work directly with a provider, engaging a broker can create a competitive bidding environment among various buyers, potentially leading to a better offer.

Once you choose to proceed, you will submit the required documents to the broker or provider. This initiates the underwriting phase, where buyers review your health information to establish an estimated life expectancy. This assessment is fundamental for calculating a potential offer.

Following the underwriting review, you will receive offers from interested buyers. These offers specify the gross amount, and it is important to understand the net payout you would receive after any fees or commissions. If you accept an offer, you will sign a settlement agreement, a legally binding contract outlining the terms of the sale. Funds are placed into an escrow account at this stage, ensuring they are held securely until the transaction is complete.

The next step involves formally transferring ownership and beneficiary designation of the policy to the buyer. This process requires notifying the original insurance company and submitting the necessary forms to effectuate the change.

After all conditions stipulated in the settlement agreement are met and the transfer of ownership is confirmed by the insurer, the funds are released from the escrow account directly to you. This concludes the sale process, providing you with the lump sum payment from your policy.

Tax Considerations

Proceeds received from a life settlement are subject to federal income tax, and potentially state income tax, as a combination of ordinary income and capital gains. The taxable amount depends on the relationship between the proceeds, the policy’s cost basis, and its cash surrender value at the time of sale. The “cost basis” for a life insurance policy is the total amount of premiums paid, reduced by any dividends or withdrawals received.

The Internal Revenue Service (IRS) taxes proceeds in a tiered manner. The portion equaling your cost basis is tax-free. Amounts above cost basis, up to the policy’s cash surrender value, are taxed as ordinary income. Any remaining proceeds above the cash surrender value are taxed as capital gains.

For viatical settlements, the tax treatment is distinctly different. If the policyholder is certified as terminally ill, with a life expectancy of 24 months or less by a physician, the proceeds may be entirely tax-exempt under federal law. This exemption is provided by the Health Insurance Portability and Accountability Act (HIPAA) of 1996. If the individual is chronically ill, the proceeds may also be tax-free, provided they are used for qualified long-term care expenses.

Viatical settlement providers issue Form 1099-LTC, while life settlement providers might issue Form 1099-B, which reports the transaction to the IRS. Consulting with a qualified tax advisor is strongly recommended to ensure proper reporting and understanding of the specific tax implications related to your settlement.