How Much Do You Get for Selling a Life Insurance Policy?

Selling a life insurance policy offers a way to access a portion of its value while the insured is still living. This financial transaction can provide a lump sum of cash, useful for unexpected expenses, retirement funding, or other financial needs. Understanding the types of sales, payout factors, deductions, and tax implications is important for anyone considering such a decision. This article details the financial considerations involved in selling a life insurance policy.

Types of Policy Sales

Two primary methods exist for selling a life insurance policy: a life settlement and a viatical settlement. A life settlement involves selling an existing life insurance policy to a third party for a cash sum greater than the policy’s cash surrender value but less than its net death benefit. The third party buyer assumes responsibility for future premium payments and receives the death benefit when the insured passes away. This option is typically available to policyholders 65 or older, or those with a serious health condition.

A viatical settlement is a specific type of life settlement where the policyholder is terminally or chronically ill. For a viatical settlement, the insured has a life expectancy of two years or less; some states define chronic illness based on inability to perform daily living activities. The distinction between a life settlement and a viatical settlement lies in the health status of the policyholder, which can affect the tax treatment of the proceeds.

Key Factors Determining Your Payout

The amount a policyholder receives for selling a life insurance policy is influenced by several factors buyers consider when evaluating the investment. A primary driver of the payout is the policyholder’s health and life expectancy. A shorter life expectancy, due to age or declining health, leads to a higher payout because the buyer anticipates receiving the death benefit sooner and will have fewer premium payments to make. Actuarial tables are used to estimate life expectancy based on age and health conditions.

The type of life insurance policy also impacts its sale value. Permanent policies, such as whole life or universal life, are more attractive for life settlements because they accumulate cash value and do not expire. While term life insurance policies do not have cash value, a convertible term policy may still be valuable. Universal life policies are often sold due to their flexibility in managing cash value and premiums.

The policy’s face value, also known as the death benefit, directly correlates with the potential payout. A policy with a higher death benefit is more appealing to buyers and can command a larger settlement. For instance, a $1 million policy will likely yield a higher payout than a $100,000 policy, assuming all other factors are comparable.

The cash surrender value of a policy plays a role in determining the payout, though the life settlement amount will always be significantly more than this value. A higher cash value can make a policy more attractive to a buyer because it can be used to cover future premiums, reducing the buyer’s ongoing costs.

Future premium costs also influence the offer price. Policies with lower ongoing premium obligations are more desirable to buyers, as they represent a smaller long-term expense for the investor. High future premium payments can reduce a policy’s attractiveness, potentially leading to a lower offer.

Policy riders and other specific features can affect a policy’s value to a buyer. Riders that enhance the death benefit or provide additional coverage, such as long-term care riders or guaranteed insurability, make the policy more appealing to investors. The competitive nature of the life settlement market can influence the offers received, and as more investors participate, policy values tend to increase.

Deductions and Fees from the Sale

The initial offer received for a life insurance policy represents a gross amount, from which various deductions and fees will be subtracted before the seller receives the net proceeds. Broker commissions are a significant cost when a life settlement broker facilitates the sale. Brokers charge a percentage of the gross sale price for their services, which can range from approximately 8% to 30%, and in some instances, even up to 50% of the settlement amount.

Administrative fees cover processing or other operational costs incurred by the life settlement provider or other entities involved in the transaction. Legal and escrow fees are incurred for services such as reviewing the sale contract or utilizing an escrow account to ensure a secure transfer of funds.

Any outstanding policy loans or liens against the life insurance policy will be deducted from the payout amount. The outstanding balance will be subtracted from the gross settlement.

Receiving the Funds and Tax Considerations

Once an agreement is reached to sell a life insurance policy, a structured process ensures the transfer of ownership and the disbursement of funds. The procedure involves transferring policy ownership and changing the beneficiary designation to the buyer. The buyer becomes the new owner of the policy, assumes responsibility for future premium payments, and receives the death benefit. Funds are disbursed as a lump sum payment, often via wire transfer or check, and an escrow account is used to secure the funds during the transfer of policy rights. The entire process can take approximately six to eight weeks.

The tax implications of selling a life insurance policy are complex and depend on several factors, including the policy’s cost basis. The cost basis of a life insurance policy refers to the total amount of premiums paid into the policy by the policyholder.

The proceeds from a life settlement are taxed in a tiered manner. The portion of the payout received up to the policy’s cost basis is considered a return of principal and is tax-free. Any amount received above the cost basis but below the policy’s cash surrender value is taxed as ordinary income. Any amount received in excess of the cash surrender value is taxed as a capital gain. Sellers receive tax forms, such as Form 1099-B, to report the transaction.

For viatical settlements, the tax treatment is more favorable. Proceeds from a qualified viatical settlement are tax-exempt under federal law. This exemption applies if the policyholder is certified by a physician as terminally ill (with a life expectancy of 24 months or less) or chronically ill (unable to perform certain activities of daily living). For chronically ill individuals, the tax-free status may depend on the use of the proceeds for qualified long-term care services. State tax rules may vary.