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

Selling a life insurance policy offers an alternative for individuals who no longer need or can afford their existing coverage. This transaction involves a policyholder selling their policy to a third party for a cash sum. The amount received is greater than the policy’s cash surrender value but less than its full death benefit. This provides a way to access a portion of the policy’s value during one’s lifetime.

Understanding Policy Sale Transactions

Selling a life insurance policy involves transferring ownership to an entity other than the original insurer, usually an institutional investor. The buyer assumes responsibility for all future premium payments and receives the death benefit when the insured individual passes away. This provides policyholders with immediate liquidity, useful for covering expenses or supplementing retirement income. The primary parties involved are the policy owner, the insured, and the buyer or investor who acquires the policy.

Two main types of policy sales exist, differentiated by the insured’s health status. A “life settlement” applies to policyholders aged 65 or older who may have a reduced life expectancy but are not terminally ill. In contrast, a “viatical settlement” is for policyholders who are terminally or chronically ill, often with a life expectancy of 24 months or less. Viatical settlements often result in a higher percentage of the policy’s face value compared to life settlements due to the shorter life expectancy.

Key Factors Affecting Payout Value

The amount an individual receives when selling a life insurance policy is influenced by several factors buyers evaluate. One primary consideration is the insured’s age and health status. Older individuals or those with significant health impairments, leading to a shorter life expectancy, attract higher offers because the buyer anticipates paying premiums for a shorter duration before receiving the death benefit. Buyers utilize actuarial tables and medical records to estimate the insured’s life expectancy, which drives the policy’s market value.

The type of policy and its death benefit amount also play a role in determining the payout. Universal life, whole life, and convertible term policies are eligible for sale. A larger death benefit translates to a higher potential payout, as this represents the ultimate return for the investor. While term life insurance is less valuable due to its lack of cash value, convertible term policies may qualify if converted to a permanent policy.

The premium payment amount and schedule significantly affect the policy’s value to a buyer. Policies with lower future premium obligations are more attractive, as this reduces the buyer’s ongoing costs and increases their potential return on investment. Buyers calculate the minimum premiums required to keep the policy in force, making those with lower or more efficient premium structures more desirable. A higher cash value can be beneficial because it may be used to cover future premiums, reducing the buyer’s outlay.

Policy riders and features, such as guaranteed insurability or long-term care riders, can influence the value, making the policy more appealing to investors. The current interest rate environment affects the present value calculation buyers use to determine their offer. Higher prevailing interest rates can lead to lower offers because the future death benefit is discounted at a higher rate.

The Sale Process and Financial Implications

Selling a life insurance policy involves a structured process that begins with an initial inquiry and culminates in the transfer of funds. A policy owner first contacts a life settlement broker or provider to explore options. The seller submits policy information and authorizes the release of medical records, which are essential for assessing the insured’s life expectancy and overall health. This medical review helps potential buyers determine the policy’s value.

Buyers perform actuarial calculations based on the detailed information gathered, including the insured’s age, health, policy type, death benefit, and future premium obligations. These calculations determine the present value of the future death benefit, factoring in the buyer’s projected premium payments and desired rate of return. Once valuations are complete, potential buyers present offers for the policy. The policy owner reviews these offers and selects one, or declines them if they do not meet expectations.

After an offer is accepted, the transaction proceeds to closing, which involves legal and administrative steps to transfer ownership and beneficiary rights to the buyer. Funds are placed in an escrow account during this phase to ensure a secure transfer. Upon successful transfer of ownership, the funds are released to the seller.

The gross offer received for a life insurance policy is not the final amount the seller will keep, as various costs and fees are deducted from the proceeds. Broker fees or commissions, which can range from 20% to 30% of the gross settlement amount, are common deductions. These are usually paid by the buyer or from the sale proceeds rather than directly by the seller upfront. Escrow fees, associated with the secure handling of funds, are also common. Legal fees may be incurred if the seller engages legal counsel to review transaction documents. If the buyer requires new medical assessments, associated costs might be deducted. Any outstanding policy loans against the cash value must be repaid from the sale proceeds, further reducing the net payout.

Tax Treatment of Sale Proceeds

The cash proceeds from selling a life insurance policy are subject to specific tax rules, which can significantly impact the net amount a seller receives. Understanding the “cost basis” of the policy is essential for tax purposes. The cost basis includes the total premiums paid into the policy, reduced by any amounts previously received tax-free, such as dividends or withdrawals. When a policy is sold, the portion of the proceeds representing the policyholder’s cost basis is received tax-free.

Any amount received that exceeds the policy’s cash surrender value but is still below the cost basis is taxed as ordinary income. This portion represents the economic gain on the policy. If the sale proceeds exceed both the cost basis and the policy’s death benefit, any amount above the death benefit would be subject to capital gains tax. This tiered taxation means different parts of the payout may be treated differently for tax purposes.

An exception to these tax rules applies to viatical settlements. If the insured is terminally or chronically ill and meets specific Internal Revenue Service (IRS) criteria, the proceeds from a viatical settlement may be entirely tax-exempt. For an individual to be considered terminally ill, a medical professional must certify they have an illness or physical condition expected to result in death within 24 months. For chronic illness, the individual must be unable to perform at least two activities of daily living, or require substantial supervision due to cognitive impairment. This tax exemption provides financial relief for those facing severe health challenges. Consulting with a qualified tax advisor or financial planner is recommended to understand the tax implications.