What Does It Mean to Sell Your Life Insurance Policy?

Life insurance policies are transferable assets. Policyholders can sell their existing coverage to a third party, accessing the policy’s value during their lifetime. This offers financial flexibility beyond its role as a future death benefit.

What it Means to Sell a Life Insurance Policy

Selling a life insurance policy involves transferring ownership to a third party for a lump sum cash payment. This payment is typically greater than the policy’s cash surrender value, but always less than the full death benefit.

Once sold, the buyer assumes all future premium payments and becomes the new owner and beneficiary. The buyer receives the death benefit upon the original insured’s death. This transaction is called a “life settlement,” an umbrella term for selling a policy to a third party. It differs from taking a loan against cash value or surrendering the policy to the insurer.

Scenarios for Selling a Life Insurance Policy

Policyholders may sell their life insurance policy when financial or personal circumstances change. This often occurs when the original need for coverage diminishes, such as when children are financially independent or major debts are paid.

Another scenario involves escalating premium costs, which can become financially burdensome. Selling the policy can alleviate this strain. Policyholders might also need immediate liquidity for medical expenses, long-term care, or other urgent financial challenges. Changes in estate planning objectives can also prompt selling a policy rather than maintaining it.

Distinguishing Life Settlements from Viatical Settlements

Life settlements and viatical settlements both involve selling a life insurance policy, but they differ based on the policyholder’s health and life expectancy. A life settlement applies to policyholders typically aged 65 or older who are not terminally or chronically ill. The payout usually ranges from 10% to 25% of the death benefit. This option provides financial liquidity for individuals who no longer need or can afford their policy.

A viatical settlement is for policyholders diagnosed with a terminal or chronic illness, often with a life expectancy of two years or less. Due to the shorter life expectancy, viatical settlements offer a significantly higher payout, often 50% to 85% of the death benefit. This increased percentage reflects the buyer’s expectation of receiving the benefit sooner. Viatical settlements also receive favorable tax treatment, often being tax-free under specific conditions.

The Selling Process and Key Considerations

Selling a life insurance policy involves several preparatory steps. Policyholders should gather essential documents, including the original policy contract, premium payment history, and comprehensive medical records. Understanding how potential buyers value policies is important; factors such as policy type, death benefit, ongoing premium costs, and the policyholder’s age and health status all influence the offer. Research and identify licensed, reputable life settlement providers or brokers.

After preparation, the process begins with submitting a formal application package to a chosen provider or broker. This often includes undergoing medical underwriting, where the potential buyer assesses the insured’s life expectancy based on medical records and sometimes an independent medical examination. Formal offers are then received and evaluated. If an offer is accepted, the policyholder reviews and signs a life settlement contract, legally transferring policy ownership and beneficiary designation to the buyer. The lump sum payment is then typically disbursed to the policyholder, often into an escrow account, before final transfer.

It is important to thoroughly understand all terms and conditions within the life settlement contract, including any potential rescission periods. Policyholders must also know that selling the policy means the death benefit will no longer be paid to their original beneficiaries. This fundamental change can have significant implications for estate planning and family financial security.

Tax Treatment of Policy Sale Proceeds

Proceeds received from selling a life insurance policy are generally subject to specific tax rules, which can vary depending on the components of the payout. The Internal Revenue Service (IRS) typically categorizes the proceeds into three tiers for tax purposes. First, the portion of the proceeds up to the policyholder’s “cost basis” is considered a tax-free return of capital. The cost basis refers to the total amount of premiums paid into the policy over its lifetime.

Second, any proceeds received above the cost basis but not exceeding the policy’s cash surrender value are taxed as ordinary income. This portion represents the accumulated earnings within the policy that would have been taxed had the policy been surrendered. Finally, any remaining proceeds that exceed both the cost basis and cash surrender value are taxed as capital gains. For term life insurance policies, which do not accumulate cash value, the entire gain above the cost basis is treated as capital gains.

A notable exception applies to viatical settlements. If the policyholder is certified as terminally or chronically ill, the proceeds from a viatical settlement are tax-free under federal law. This exemption acknowledges the policyholder’s circumstances and the potential need for funds to cover medical or living expenses. Due to the complexity and individual variations in tax situations, it is always advisable for policyholders to consult with a qualified tax professional to understand the specific tax implications of selling their life insurance policy.