Should I Sell My Life Insurance Policy?

Selling a life insurance policy involves transferring ownership to a third party in exchange for a cash payment. This offers an alternative to letting a policy lapse or surrendering it for its cash value. The decision is often complex, requiring careful consideration of various financial and personal factors. This article clarifies the options, assessment process, procedural steps, and financial and tax implications involved in such a sale.

Understanding Policy Sale Options

Two primary types of life insurance policy sales exist: life settlements and viatical settlements. Their distinction largely depends on the insured’s health status.

A life settlement involves selling an existing policy to a third party for a cash payment, typically more than its cash surrender value but less than its full death benefit. This option is generally for policyholders aged 65 or older without a terminal or chronic illness. The buyer assumes future premium payments and receives the death benefit when the insured passes away.

In contrast, a viatical settlement is for individuals who are terminally or chronically ill, often with a life expectancy of two years or less. The policyholder sells their policy at a discount for immediate cash. The buyer becomes the policy’s beneficiary, pays remaining premiums, and collects the full death benefit upon the original owner’s death. Viatical settlements typically offer a higher percentage of the death benefit than life settlements due to the insured’s shorter life expectancy.

Assessing Policy Value and Eligibility

Determining if a life insurance policy is suitable for sale involves evaluating factors influencing its value to buyers. Buyers consider the insured’s age and health status, as these directly impact estimated life expectancy. Policies with a death benefit of at least $100,000 are typically required.

The policy type also significantly impacts eligibility and value. Permanent life insurance policies (e.g., whole life, universal life, variable universal life) are generally more attractive due to cash value and guaranteed benefits. Term life policies may qualify if convertible to permanent or if the insured is terminally ill. Premiums are also considered, typically needing to be less than 5% of the policy’s face amount.

To initiate an assessment, policyholders should gather essential documents. These include recent policy statements detailing the death benefit, cash value, and premium schedule. Medical records are also necessary, providing health information to estimate life expectancy.

Basic personal information and any outstanding policy loans are also required. The policy should have been active for two to five years, depending on state regulations.

The Sale Process

After understanding settlement types and gathering initial information, the next step is engaging with licensed life settlement providers or brokers. A life settlement broker represents the policyholder, shopping the policy to multiple providers for the best offer. A life settlement provider purchases the policy, either directly or through a broker. While providers do not charge a fee, their offers might be lower as they represent the buyer’s interests.

The application package requires submitting personal and policy information, medical records, and authorization for the buyer to access further details. This documentation aids the buyer’s underwriting process, which reviews the insured’s medical history to determine life expectancy. This assessment influences the policy’s value to potential buyers.

After underwriting, the policyholder may receive offers from various providers. Evaluate these offers carefully, potentially with a broker’s assistance for negotiation. If an offer is accepted, a closing package is prepared, including contracts and change of ownership documents. Final steps involve transferring policy ownership and beneficiary rights to the buyer, followed by the lump-sum payment release to the policyholder, often via an escrow agent. The entire process can take several weeks or months.

Financial and Tax Considerations

Selling a life insurance policy has distinct financial and tax implications. Proceeds from a life settlement are typically structured with three tax components: a return of basis, ordinary income, and capital gains. The return of basis (total premiums paid) is received tax-free.

Any amount above the basis but below the policy’s cash surrender value is typically taxed as ordinary income. Amounts exceeding the cash surrender value are generally taxed as capital gains. The Internal Revenue Service (IRS) provides guidance on these tax treatments, notably in Revenue Ruling 2009-13 and Revenue Ruling 2020-05.

Beyond tax obligations, receiving a lump sum from a policy sale may affect eligibility for certain government benefits, such as Medicaid, as the cash proceeds could count as an asset or income. Policyholders should consult with a financial advisor or tax professional to understand their specific situation.

Alternatives to selling a life insurance policy exist and may be more suitable depending on individual circumstances. One common option for permanent policies is surrendering the policy for its cash surrender value, which is the accumulated cash value less any surrender charges or outstanding loans. While this provides immediate cash, the payout is often less than what a life settlement would offer.

Another alternative is taking a policy loan against the cash value, which allows access to funds without surrendering the policy, though interest accrues and an unpaid loan reduces the death benefit. Policyholders might also consider converting to a reduced paid-up policy, where future premiums are eliminated, and the death benefit is reduced to a smaller, fully paid amount.

For those facing terminal illness, accelerated death benefits, if available as a rider on the policy, allow access to a portion of the death benefit while still alive, often tax-free. This option typically reduces the final death benefit paid to beneficiaries.