What Are the Alternatives to a Life Settlement?

Life insurance policies represent a financial asset that can offer solutions beyond simply providing a death benefit. When policyholders consider a life settlement, which involves selling their policy to a third party for cash, it is important to recognize that various other avenues exist for accessing value or managing the policy differently. These alternatives can provide financial flexibility or address changing needs without a full sale to an investor.

Direct Policy Value Access

Accessing the cash value directly from a permanent life insurance policy offers immediate liquidity as a direct transaction with the insurer. This option allows policyholders to utilize funds that have accumulated within their policy over time.

Policy Surrender

Policy surrender involves discontinuing the life insurance policy in exchange for its cash surrender value. This value is determined by the premiums paid, any investment gains, and deductions for charges or fees. Upon surrender, the policy terminates, meaning no death benefit will be paid to beneficiaries.

Policy Loan

Alternatively, a policy loan allows borrowing money directly from the insurer, using the policy’s cash value as collateral. Interest accrues on the loan, and while repayment is optional, outstanding loans reduce the death benefit payable to beneficiaries. Unpaid interest can cause the policy to lapse if the loan amount grows to exceed the available cash value.

Health and Care Related Benefits

For policyholders facing health challenges, specific alternatives exist that allow access to policy funds to address medical or long-term care needs. These options provide financial relief tailored to such circumstances, differing from selling the policy for general liquidity.

Accelerated Death Benefits (ADBs)

Accelerated Death Benefits (ADBs), often called living benefits, are policy riders or provisions that enable access to a portion of the death benefit while the insured is still alive. These benefits are typically triggered by specific qualifying conditions, such as a terminal illness with a limited life expectancy, a chronic illness requiring assistance with daily living activities, or certain critical illnesses. Benefits can be paid as a lump sum or in installments, and receiving them reduces the death benefit that would otherwise be paid to beneficiaries.

Viatical Settlement

A viatical settlement involves the sale of a life insurance policy by a policyholder who is terminally or chronically ill to a third-party company. This transaction provides a percentage of the policy’s face value as a lump sum. The key distinction from a standard life settlement is the policyholder’s health status, as viatical settlements are specifically for those with a shortened life expectancy, often two years or less.

Policy Restructuring and Transfers

Beyond directly liquidating a policy, several alternatives involve changing its structure, use, or ownership. These options provide ways to manage the policy for specific long-term goals or charitable intent, rather than converting it into immediate general cash.

Reduced Paid-Up Option

The reduced paid-up option uses the policy’s existing cash value to purchase a smaller, fully paid-up life insurance policy. With this option, no further premium payments are required. The new, reduced death benefit is calculated based on the available cash value. The original policy remains in force, but for a lower face amount.

Extended Term Option

The extended term option uses the policy’s cash value to purchase a term life insurance policy for the same face amount as the original policy. This new term policy remains in force for a specific period, without requiring additional premium payments. The length of this extended term is determined by the amount of cash value available. Coverage under this option is temporary, and there is no cash value accumulation during the extended term.

1035 Exchange

A 1035 exchange allows for a tax-free transfer of funds from one life insurance policy to another life insurance policy, an annuity, or a long-term care policy. The primary benefit is the deferral of taxes on any gains accumulated within the policy. Policyholders often consider a 1035 exchange to move to a policy with better features, lower fees, or different benefits, such as stronger living benefits. This process focuses on the direct transfer of funds between financial products without the policyholder receiving direct cash.

Policy Donation

Policy donation involves contributing a life insurance policy to a qualified charitable organization. This act can provide a charitable income tax deduction, if applicable, and removes the policy from the donor’s taxable estate. This allows the charity to either receive the death benefit upon the insured’s passing or surrender the policy for its cash value.