Why Would Someone Sell Their Life Insurance Policy?

Life insurance policies, designed to provide financial protection, can also become a financial asset for the policyholder. As personal circumstances and financial needs evolve, understanding policy options becomes important. One option, particularly for permanent life insurance, is converting the policy into immediate cash. This allows policyholders to leverage existing coverage for current financial goals or unexpected expenses.

What is a Life Settlement?

A life settlement involves selling an existing life insurance policy to a third party, typically a financial institution, for a cash sum. This payment is generally greater than the policy’s cash surrender value but less than its full death benefit. The buyer assumes future premium payments and receives the death benefit upon the insured’s passing. This offers an alternative to lapsing or surrendering a policy, which often yields minimal value.

Whole life, universal life, and convertible term policies are commonly eligible for a life settlement. Permanent policies are favored due to cash value accumulation. While less common, a convertible term policy might qualify if converted to permanent.

Eligibility often includes policyholders aged 65 or older, or younger individuals with significant health impairments. Policies typically need a face value of at least $100,000, with some providers preferring $200,000 or more. The policy needs to have been in force for at least two years, sometimes up to five, depending on state regulations.

A life settlement differs from a viatical settlement. Viatical settlements apply to individuals with a terminal or chronic illness, often with a life expectancy of two years or less. Life settlements are for policyholders who are typically older but not necessarily terminally ill. Viatical settlements may also offer different tax treatment, often being tax-free.

Key Motivations for Selling a Policy

Individuals often sell policies when financial situations or life circumstances change. A common motivation is no longer needing the original coverage, such as when children become financially independent or debts like a mortgage are paid, reducing the need for a large death benefit.

Rising premium costs are another frequent reason. As policyholders age, particularly with permanent policies, premiums can escalate, becoming difficult to afford on a fixed income. Selling the policy eliminates this obligation while providing immediate capital.

Many policyholders seek funds for urgent medical expenses, long-term care, or other substantial financial needs later in life. A life settlement provides a lump sum to cover these expenditures, allowing access to capital tied up in the policy. This is relevant for costs not fully covered by health insurance or Medicare.

Some individuals reallocate assets towards pressing financial goals or investments, such as supplementing retirement income, funding travel, or pursuing other aspirations. A life settlement transforms an illiquid asset into usable cash, offering financial flexibility and control.

Steps in the Life Settlement Process

The process begins with the policyholder seeking an evaluation, often by contacting a licensed life settlement provider or broker. A broker acts as the policyholder’s representative, shopping the policy to multiple providers for competitive offers, while a provider may buy directly.

After initial contact, the policyholder submits necessary documentation, including policy details, premium schedules, and medical records. These records are crucial for buyers to assess the insured’s health and estimate life expectancy, directly impacting the policy’s valuation and offers.

Once information is gathered, providers evaluate the policy and insured’s health to determine an offer. This assessment considers factors like the policy’s face amount, premium costs, and projected life expectancy. Multiple offers may be solicited, especially with a broker, to ensure favorable terms.

If an offer is accepted, the closing process begins. This involves signing transfer-of-ownership documents, legally assigning the policy and its future benefits to the buyer. Upon completion, the cash payment is disbursed to the policyholder, typically within 72 hours of transfer finalization.

Financial and Tax Implications

Selling a life insurance policy through a life settlement has distinct financial and tax implications. Proceeds are generally taxed based on the policy’s cost basis and cash surrender value. The portion up to total premiums paid (cost basis) is typically tax-free.

Amounts received above the cost basis, up to the cash surrender value, are generally taxed as ordinary income. Proceeds exceeding the cash surrender value are taxed as capital gains. This layered tax treatment means a segment will be subject to ordinary income tax rates, while a significant portion might be tax-free or taxed at capital gains rates.

A life settlement can also impact eligibility for government benefits, particularly Medicaid. Since Medicaid is needs-based with asset limits, a lump sum payment could disqualify an individual from current or future benefits. However, some states have Medicaid life settlement provisions that convert the policy into a long-term care benefit account, potentially preserving eligibility if structured for care expenses.

Alternatives to a life settlement exist for policyholders who no longer need or can afford their coverage. Options include surrendering the policy for its cash surrender value (often lower payout, potential tax on gains), borrowing against cash value (loans accrue interest, reduce death benefit), reducing the death benefit to lower premiums, or utilizing accelerated death benefit riders for chronic or terminal illnesses.