Is Selling Your Life Insurance Policy a Good Idea?

A life insurance policy, often viewed solely as a protective measure for beneficiaries, can also be considered a financial asset with a potential market value. Policyholders sometimes find themselves in situations where their existing coverage no longer aligns with their financial needs or circumstances. In such cases, selling the policy can emerge as a viable financial decision. This process allows individuals to unlock liquidity from an asset that might otherwise go unused or become a financial burden.

Understanding Life Settlements and Viatical Settlements

Selling a life insurance policy involves one of two distinct transactions: a life settlement or a viatical settlement. A life settlement occurs when a policyholder sells their 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 full death benefit. The buyer then assumes responsibility for all future premium payments and receives the death benefit upon the insured’s passing.

A viatical settlement, conversely, is specifically for policyholders who are terminally or chronically ill. In this arrangement, an individual with a shortened life expectancy, often certified as two years or less, sells their policy for a lump sum. The cash received in a viatical settlement is also a discount from the policy’s face value, but it is a higher percentage of the death benefit than in a life settlement. Both types of settlements involve third-party investors or companies who purchase these policies, becoming the new policy owner and beneficiary.

Factors Influencing a Policy’s Sale Value and Eligibility

Several factors determine whether a life insurance policy is eligible for sale and how much it might be worth in a settlement. The policyholder’s age is a significant consideration, with most life settlements requiring the insured to be at least 65 or 70 years old. Younger policyholders may qualify if they have a severe health condition that significantly shortens their life expectancy. The insured’s health status and estimated life expectancy are important, as these directly influence the buyer’s potential return on investment.

The type of policy also plays a role; permanent policies like whole life, universal life, and variable universal life are more desirable for settlements due to their cash value components and guaranteed death benefits. Term life policies may be eligible if they are convertible to permanent insurance. Policies with a face value of at least $100,000 are preferred by buyers. The policy’s premium payment schedule and any outstanding loans against its cash value can also influence its attractiveness and the final offer. Policies need to have been in force for a certain period before they can be sold.

The Process of Selling a Life Insurance Policy

Selling a life insurance policy involves a structured process that begins with the policyholder evaluating their needs and exploring options. The initial step involves contacting a licensed life settlement provider or a life settlement broker. A broker represents the policyholder and can shop the policy to multiple providers to secure competitive offers, though they charge a commission for this service. The policyholder will then need to provide detailed information about their policy and authorize the release of their medical records.

This documentation is important for potential buyers to conduct their medical underwriting and assess the insured’s life expectancy, which then informs the offers presented for the policy. The policyholder must review the terms and conditions of any offer, considering the cash payout, fees, and the purchasing entity’s reputation. If an offer is accepted, the closing process involves transferring ownership and beneficiary rights of the policy to the buyer. Funds are disbursed after all closing documents are finalized and approved by the insurance carrier. The entire process, from initial inquiry to receiving funds, takes several weeks.

Tax Implications of Selling a Life Insurance Policy

The proceeds received from selling a life insurance policy through a life settlement or viatical settlement have specific tax implications that policyholders must understand. For a life settlement, the cash received is taxed based on different components. The portion of the payout that represents a return of the premiums paid into the policy (cost basis) is received tax-free. Any amount received above the cost basis but up to the policy’s cash surrender value is taxed as ordinary income. Any proceeds exceeding the cash surrender value are subject to capital gains tax.

For viatical settlements, special tax exemptions apply for individuals who are terminally or chronically ill. Proceeds from a viatical settlement are excluded from gross income for federal tax purposes if the insured is certified by a physician as terminally ill. For chronically ill individuals, the proceeds are also tax-free, provided the funds are used for qualified long-term care expenses. These definitions are outlined in IRS guidance, such as IRS Code Section 7702B. Given the complexity of these tax rules, policyholders should consult with a qualified tax professional or financial advisor before entering into any settlement agreement.

Other Options for Life Insurance Policies

For policyholders who no longer need or can afford their life insurance policy, selling it is one of several financial strategies available. One alternative is to surrender the policy to the issuing insurance company. With permanent life insurance policies, surrendering means the policyholder receives the cash surrender value, which is the accumulated cash value minus any surrender charges and outstanding loans. This action terminates the policy, and no death benefit will be paid.

Policyholders can take a policy loan against the cash value of a permanent life insurance policy. The policy remains in force, but interest accrues on the loan, and any outstanding loan balance at the time of death will reduce the death benefit paid to beneficiaries. Policyholders can also reduce the policy’s face value. This lowers the death benefit and results in lower premium payments, making the policy more affordable while retaining some coverage.

Certain life insurance policies may include an accelerated death benefit (ADB) rider, also known as a living benefit, which allows policyholders with a terminal or chronic illness to access a portion of their death benefit while still alive. Unlike a viatical settlement, the policy remains in force, and a reduced death benefit is paid to beneficiaries upon the insured’s passing. A policyholder could stop paying premiums, allowing the policy to lapse. If the policy has no cash value, coverage would cease immediately, resulting in no payout. If it has cash value, the policy might remain in force for a limited time under non-forfeiture options, or the cash value could be exhausted by policy charges.