How to Sell Your Life Insurance Policy

Life insurance policies, traditionally seen as a safeguard for beneficiaries, can also hold value during a policyholder’s lifetime. These policies can be converted into cash. Understanding the methods for accessing this value, especially selling a policy, offers financial flexibility. This article details how to liquidate a life insurance policy, focusing on the process, preparation, and tax implications of a life settlement.

Understanding Your Policy Liquidation Options

Policyholders seeking to access their life insurance policy’s value during their lifetime have several options. One common approach is a policy surrender, where a permanent life insurance policy is terminated before the insured’s death. Upon surrender, the policyholder receives the policy’s cash surrender value, which is the accumulated cash value minus any applicable surrender charges and outstanding loans. This action permanently ends the insurance coverage and its death benefit.

Another method for accessing policy value is through policy loans, available with permanent life insurance that accumulates cash value. Policyholders can borrow against the cash value, using the policy as collateral. These loans typically do not require a credit check and often have flexible repayment schedules, though unpaid loans and accrued interest can reduce the death benefit paid to beneficiaries.

Accelerated death benefits, also known as living benefits, offer another way to access funds under specific health-related conditions. These provisions allow policyholders to receive a portion of their death benefit in advance if diagnosed with a terminal or chronic illness. Funds received through accelerated death benefits are typically paid directly by the insurance company and reduce the final death benefit.

A distinct option is a life settlement, which involves selling an existing life insurance policy to a third-party investor. The policyholder receives a lump-sum cash payment greater than the policy’s cash surrender value but less than its full death benefit. The new owner assumes responsibility for future premium payments and receives the death benefit upon the insured’s passing. A viatical settlement is a specific type of life settlement for individuals with a terminal or chronic illness, often resulting in a larger payout due to shorter life expectancy.

Preparing for a Life Settlement

Initiating a life settlement requires preparation, including specific eligibility criteria and gathering documents. A life insurance policy is eligible for a life settlement if it is a permanent policy, such as universal life or whole life, or a convertible term policy. Most life settlement providers typically consider policies with a face value of at least $100,000 and prefer policyholders who are generally aged 65 or older. Younger policyholders with significant health impairments may also qualify, particularly for viatical settlements.

The policy’s duration in force is a consideration; many states require a policy to have been active for at least 25 months, some up to five years. The insured’s current health status plays a role in determining the policy’s market value, as a shorter life expectancy can increase its attractiveness to buyers. Unaffordable policy premiums can also be a reason for pursuing a settlement.

To facilitate the valuation process, specific documents and information must be compiled. This includes:
Comprehensive policy information, such as the policy type, its face amount, current cash value, premium payment schedule, and policy number.
Detailed medical records, including physician statements, a complete medical history, and any relevant prognoses, for assessing the insured’s health and life expectancy.
Contact information for healthcare providers, enabling the life settlement company to obtain necessary medical verifications.
Personal identification documents.
Details of any existing policy loans or liens.
This information allows potential buyers to accurately assess the policy’s value and determine a fair offer.

The Life Settlement Transaction Process

Once all information and documents are gathered, the life settlement transaction can begin. The first step involves identifying and engaging with licensed life settlement providers or brokers. A broker acts on behalf of the policyholder, shopping the policy to multiple buyers for a competitive offer, while a provider directly purchases the policy. The policyholder submits the compiled documentation, including policy details and medical records, to these entities.

Following submission, the life settlement company or broker undertakes an underwriting process. This involves reviewing the provided information and obtaining a life expectancy report from an independent underwriter. This report, based on medical history and other factors, determines the policy’s value to buyers. Offers are then solicited from a network of buyers, and the policyholder may receive multiple bids.

Upon receiving offers, the policyholder reviews them with independent financial advice to determine the most suitable option. Once an offer is accepted, the transaction moves into a closing phase, which involves preparing a closing package. This package includes the settlement contract, life expectancy report, a competency letter affirming the seller’s capacity to make informed decisions, and verification from the insurer that the policy remains active. The policyholder must also sign transfer-of-ownership and change-of-beneficiary forms, legally assigning the policy to the buyer.

A neutral third-party escrow agent plays a role in the transaction. The agreed-upon settlement funds are placed into an escrow account until all conditions of the sale are met. Once the change of ownership and beneficiary designation are recorded with the life insurance carrier, funds are released from escrow to the policyholder. The process, from initial application to fund release, can take several weeks to a few months, depending on case complexity and party efficiency.

Tax Considerations for Policy Sales

Selling a life insurance policy through a life settlement carries specific tax implications. Proceeds received from a life settlement are generally subject to a tiered taxation structure, distinguishing between non-taxable return of premiums, ordinary income, and capital gains. The initial portion of the settlement proceeds, up to the policyholder’s cost basis, is typically not taxable. The cost basis is the total amount of premiums paid into the policy by the policyholder over its lifetime.

Amounts received that exceed the cost basis but are less than the policy’s cash surrender value are usually taxed as ordinary income. This portion reflects accumulated earnings within the policy that would have been taxed had the policy been surrendered. Any remaining proceeds from the life settlement that exceed both the cost basis and the cash surrender value are typically taxed as capital gains. If a term life insurance policy is sold with no cash value, the entire gain above the cost basis may be treated as a capital gain.

Life settlement providers report the proceeds of these transactions to the Internal Revenue Service (IRS). Policyholders receive Form 1099-LS, “Report of Organizational Taxable Events,” for tax reporting. This form assists policyholders in accurately reporting the income on their annual tax returns. Because tax rules can vary based on individual circumstances and policy specifics, consulting with a qualified tax professional is advised. This ensures compliance with tax laws and helps understand the full financial impact of the life settlement.