How Does Selling Your Life Insurance Policy Work?

Selling a life insurance policy, known as a life settlement, involves transferring ownership of an existing policy to a third party. This transaction provides the policyholder with a cash sum that is typically greater than the policy’s cash surrender value but less than its full death benefit. Individuals often consider this option if their financial circumstances change, they no longer require the coverage, or premiums become unmanageable. This financial transaction requires careful consideration.

Understanding Policy Eligibility

Certain characteristics determine whether a life insurance policy qualifies for a life settlement. Permanent policies, such as universal life, whole life, and variable universal life, are generally eligible. Term life policies are typically not, unless they are convertible to a permanent form. The insured individual’s age is a significant factor, with most buyers focusing on those aged 65 or older. However, younger individuals with severe health impairments may also qualify.

The insured’s health status plays a role in eligibility, as deteriorating health or a shorter life expectancy can increase a policy’s appeal and potential value. Policies generally need a minimum face value, often $100,000 or more. The policy must have been active for a certain period, commonly ranging from two to five years. The premium structure and any accumulated cash value within the policy are also assessed.

The Life Settlement Process

Initiating a life settlement begins with contacting a life settlement broker or provider. The policyholder typically submits an application along with necessary documentation. This documentation often includes policy statements, details about the existing beneficiaries, and release forms authorizing access to the insured’s medical records.

After the application and documents are submitted, the buyer’s medical team conducts a thorough review of the insured’s health records. This medical underwriting process estimates the insured’s life expectancy, which is a primary determinant of the policy’s value to the buyer. Based on this assessment and other policy information, potential buyers generate offers for the policy.

The policyholder then reviews these offers, often with assistance from their broker, to determine the most suitable option. Upon acceptance of an offer, the transaction moves into the closing phase. This involves legal and administrative steps to transfer policy ownership and beneficiary designation to the buyer. Once all legal requirements are met and ownership is transferred, the policyholder receives the agreed-upon lump-sum payment.

Determining Policy Value

The value of a life insurance policy in a life settlement is a price determined by market factors and investor interest. The insured’s life expectancy is the primary factor influencing the final cash offer; a shorter life expectancy generally results in a higher offer because the buyer anticipates receiving the death benefit sooner. The amount and frequency of future premium payments required to maintain the policy directly affect the buyer’s costs, thus impacting the offer.

The type of policy also influences its value, with universal life policies often yielding higher offers due to their flexibility. Policy size, or the death benefit amount, is another significant consideration, as larger policies typically attract more interest and potentially higher offers. Broader market conditions, including the supply and demand within the life settlement market, can also influence the offers policyholders receive.

Financial and Tax Considerations

Receiving proceeds from a life settlement involves specific financial and tax implications for the policyholder. The payment is typically a lump sum, which can provide immediate liquidity. Tax treatment of these proceeds is generally structured into three components. The portion representing the return of premiums paid (cost basis) is typically received tax-free.

Any amount above the cost basis, up to the policy’s cash surrender value, is generally taxed as ordinary income. Proceeds exceeding the cash surrender value are typically taxed as capital gains, which may be subject to a different tax rate. Beyond taxation, receiving a lump sum can affect eligibility for financial assistance programs, such as Medicaid, as the payment may be counted towards asset limits.