What Are Alternatives to a Life Settlement?

Life insurance policies often represent a significant financial commitment, and circumstances can change, leading policyholders to reconsider their coverage. Individuals may find they no longer require the original death benefit, or ongoing premium payments have become burdensome. When faced with such situations, exploring various options for managing a life insurance policy is prudent. While a life settlement is one potential avenue, this discussion clarifies other available strategies for policyholders.

Understanding Life Settlements

A life settlement involves the sale of an existing life insurance policy to a third party. The policyholder receives a cash sum for their policy, typically greater than the policy’s cash surrender value but less than the full death benefit. The buyer assumes ownership, takes over future premium payments, and receives the death benefit when the insured passes away.

This option is generally considered by policyholders typically 65 or older, whose health condition may influence the policy’s value. It provides an immediate lump sum payment, offering liquidity from an asset that might otherwise only provide a future benefit. The decision to pursue a life settlement often arises when the policy is no longer needed, desired, or affordable for the original owner.

Surrendering Your Policy

One direct alternative to a life settlement is surrendering your life insurance policy to the issuing insurance company. This action terminates the insurance contract, and the policyholder receives the accumulated cash surrender value. This option is available for permanent life insurance policies, such as whole life or universal life, which build cash value. Term life insurance policies do not accumulate cash value and cannot be surrendered for a payout.

The cash surrender value is calculated based on premiums paid, any interest or dividends earned, minus fees and potential surrender charges. Policyholders contact their insurer to initiate a surrender and receive the cash value.

Any amount received that exceeds the total premiums paid into the policy, known as the cost basis, is generally considered a taxable gain. This gain is typically taxed as ordinary income, which could increase the policyholder’s tax liability. Consulting with a tax professional before surrendering is advisable.

Accessing Policy Value While Alive

Policyholders can access the financial value of their life insurance without fully surrendering the policy, providing alternative avenues for liquidity. One method involves taking a policy loan, where the policyholder borrows against the accumulated cash value of a permanent life insurance policy. The policy remains in force, and the cash value serves as collateral for the loan.

Policy loans accrue interest, and any outstanding loan balance will reduce the death benefit if not repaid before the insured’s passing. While policy loans do not have a fixed repayment schedule, managing them is important to avoid eroding the policy’s death benefit.

Another option is utilizing accelerated death benefits (ADB), features or riders often included in life insurance policies. These benefits allow policyholders facing a terminal or chronic illness to access a portion of their death benefit while still living. Eligibility conditions, such as a prognosis of limited life expectancy, are outlined in the policy’s terms. The amount received through ADB reduces the remaining death benefit.

A viatical settlement is another distinct option for individuals who are terminally or chronically ill. Unlike a general life settlement, viatical settlements are specifically for policyholders with a short life expectancy, typically two years or less. In a viatical settlement, the policyholder sells their life insurance policy to a third party for a lump sum payment. The buyer assumes responsibility for future premiums and receives the full death benefit.

Adjusting Policy Coverage

Policyholders can modify their life insurance coverage to reduce or eliminate premium payments while maintaining some death benefit. These adjustments serve as alternatives to completely selling or surrendering a policy.

One such option is the reduced paid-up option, available for permanent life insurance policies with accumulated cash value. Under this option, the policyholder uses the existing cash value to purchase a new, fully paid-up policy for a lower death benefit amount. No further premium payments are required, and coverage remains in force for the rest of the insured’s life. This is a practical solution when ongoing premiums become unmanageable but lifelong coverage is desired.

Another adjustment is the extended term option, also known as extended term insurance. This allows the policyholder to use the policy’s cash value to purchase a new term life insurance policy. The new term policy typically retains the same death benefit amount as the original but is in force only for a limited, specified period. No further premium payments are required, with duration depending on the cash value and the insured’s age. This option suits those wishing to maintain the original death benefit for a period without continuing premiums.

Charitable Donation of Policy

Donating a life insurance policy to a qualified charitable organization is another distinct alternative. This involves irrevocably assigning ownership of an existing policy to the charity. Once the charity becomes the owner, it typically becomes the beneficiary. The charity can hold the policy until the insured’s death to receive the death benefit, or surrender it for its cash value immediately.

This type of donation can offer tax advantages. If ownership is transferred to a qualified charity, the policyholder may be eligible for an income tax deduction. The deduction amount is generally based on the policy’s fair market value or the donor’s cost basis, whichever is less. If the donor continues to pay premiums directly to the charity, these may also qualify as tax-deductible charitable contributions.

Donating a life insurance policy can also help reduce the donor’s taxable estate, as the policy is removed from their personal assets. This method provides a way to make a substantial charitable contribution. It is advisable to consult with a financial advisor and the chosen charity to ensure the donation aligns with regulations and personal financial goals.