Why Would You Sell Your Life Insurance Policy?

Life insurance provides a financial benefit to designated beneficiaries upon the insured’s death. While typically a long-term asset, policyholders may consider selling their policy before its natural maturity. This transaction, known as a life settlement, allows them to unlock the policy’s value during their lifetime.

Common Reasons for Selling a Life Insurance Policy

Policyholders often sell their life insurance policies due to unexpected financial challenges. Job loss, significant medical expenses, or an economic downturn can make premium payments difficult. Selling the policy provides immediate funds to address these needs, preventing a lapse and loss of value. This option is relevant when maintaining the policy strains personal finances.

Another common motivation stems from a change in financial needs or priorities. The original purpose of a life insurance policy, such as income replacement for young dependents, may become less relevant as children become financially independent or other assets accumulate. If an individual’s estate has grown substantially, the need for a large death benefit might diminish. The policy may no longer align with current financial planning.

The need for funds for other purposes also frequently prompts policy sales. These funds can be utilized for various expenses, including long-term care costs, medical treatments for chronic illnesses, or to supplement retirement income. Some policyholders might also use the proceeds to invest in a new business venture or to pay down high-interest debt. Accessing the policy’s value provides financial flexibility for these diverse needs.

For some policyholders, the policy itself becomes too expensive to maintain. This is particularly true for universal life policies where the cost of insurance can increase significantly with age, making premiums unaffordable. When premiums escalate to an unsustainable level, selling the policy can be a more advantageous option than simply surrendering it. The increasing cost can erode the policy’s value, making the sale a practical financial decision.

Finally, a desire to reallocate assets can drive the decision to sell a life insurance policy. Policyholders might identify alternative investments that promise a higher rate of return or better align with their current risk tolerance and financial goals. Converting a less liquid insurance asset into cash allows for greater control and investment flexibility.

Understanding the Life Settlement Process

A life settlement involves selling an existing life insurance policy to a third-party buyer for a cash payment. This payment typically exceeds the policy’s cash surrender value but is less than the full death benefit. The buyer assumes ownership, pays future premiums, and receives the death benefit when the insured passes away.

Key parties include the policyholder, who sells, and the life settlement provider, who buys. A life settlement broker often acts as an intermediary, representing the policyholder and soliciting offers from various providers. The broker helps secure the most favorable terms.

Determining Eligibility and Value

Several factors determine eligibility and policy value. These include the policy type, death benefit amount, and any existing cash value. The insured’s age and health status are significant, influencing the buyer’s projection of when the death benefit will be paid. Future premium payments are also assessed to evaluate the ongoing cost to the new owner.

Application and Offer Process

The application and offer process begins with the policyholder submitting personal and policy information to a broker or provider. This involves providing medical records, allowing potential buyers to assess life expectancy. Multiple life settlement providers may submit offers. The policyholder, with broker guidance, reviews and negotiates these offers to select the most suitable one.

Closing Process

Once an offer is accepted, the closing process commences. The policyholder signs transfer documents, legally assigning ownership to the life settlement provider. The beneficiary designation changes from the original beneficiaries to the new owner. After all legal requirements are met and the transfer is complete, the agreed-upon funds are transferred to the policyholder.

Tax Considerations When Selling a Policy

When a life insurance policy is sold through a life settlement, the proceeds can be subject to taxation. The amount received exceeding the policy’s cost basis is considered taxable income. The Internal Revenue Service (IRS) views these transactions as a sale of property, and gains are subject to income tax.

The cost basis is the total premiums paid into the policy, reduced by any prior distributions like withdrawals or dividends. Only the portion of proceeds exceeding this cost basis is a taxable gain. Keeping meticulous records of all premiums paid is important.

The tax treatment of the gain can be complex. The gain up to the policy’s cash surrender value is typically taxed as ordinary income. Any gain above the cash surrender value may be treated as a capital gain. This distinction is important because capital gains are often taxed at different rates.

Policyholders receive a tax form from the life settlement provider, reporting the gross proceeds, cost basis, and gain. This helps accurately report the transaction on their tax return.

Consult a qualified tax professional before entering a life settlement. A tax advisor can provide personalized guidance based on individual financial circumstances and policy specifics. They can help determine the exact tax liability and explore strategies to mitigate the tax burden.

Exploring Alternatives to Selling

Selling a life insurance policy is one option, but alternatives exist.

Surrendering the Policy

Policyholders can surrender their policy to the insurance company. They receive its cash surrender value, which is the cash value less any surrender charges. This terminates the policy and provides immediate funds, though often less than a life settlement.

Allowing the Policy to Lapse

Another alternative is to let the policy lapse by stopping premium payments without formally surrendering. If the policy has no cash value or it’s depleted, coverage will cease. The policyholder receives no funds, and the death benefit is forfeited.

Taking a Policy Loan

Policyholders with cash value policies can take a policy loan. This allows them to borrow against the accumulated cash value while keeping coverage in force. The loan accrues interest, and if not repaid, it reduces the death benefit payable to beneficiaries. This provides access to funds without terminating the policy.

Reduced Paid-Up Option

Some permanent life insurance policies offer a “reduced paid-up” option. The policyholder can stop paying premiums and convert the existing policy into a new, smaller policy that is fully paid up. The death benefit of the new policy will be lower than the original, but coverage continues without ongoing costs.

Accelerated Death Benefit (ADB)

For policyholders facing severe health challenges, an accelerated death benefit (ADB) rider might be available. This provision allows individuals with terminal or chronic illnesses to access a portion of their policy’s death benefit while still alive. This can provide funds for medical care or living expenses, and the amount received typically reduces the final death benefit.