If you no longer need life insurance coverage, you may be able to sell your policy through a life settlement. You receive a lump sum payment and then no longer owe life insurance premiums. While that might sound like an attractive offer, you should still compare against your other options. Here’s how a life settlement works and when it might be a possible strategy.
Key Takeaways
- In a life settlement, you sell your life insurance policy to another person or company.
- You receive a lump sum payout, which will likely be larger than what you'd get for cancelling the policy.
- The buyer takes over future premium payments on your policy.
- When you pass away, the buyer receives the death benefit from your policy, not your heirs.
- Not everyone is eligible for a life settlement. You usually need to be over 65 and have a permanent life insurance policy.
Life Settlement Features
A life settlement is when the owner of a life insurance policy sells it to another individual or company. The buyer pays you a lump sum and then takes over as owner of your policy. The buyer covers future premium payments and would receive the future death benefit when you pass away.
The amount you receive for a life settlement depends on your age, health, and policy type. The payment will be smaller than your death benefit, so the buyer can make a profit when you pass away.
You typically need to be at least 65 or older to use a life settlement, depending on the buyer’s standards. You do not have to be terminally ill to sell your life insurance policy. A similar life insurance deal, called a viatical settlement, requires you to have a terminal illness but a life settlement does not.
Policy Eligibility
It is more common to sell permanent life insurance policies that do not expire. That way, the buyer knows they can get a death benefit payment one day as long as they keep up with the premiums. If your permanent life insurance has cash value, you would likely get more through life settlement than you would from canceling the policy to cash out yourself.
If you have a temporary term life insurance policy, you may be able to sell it if it has a convertibility option. A conversion swaps the term coverage for permanent coverage that won’t expire. If you don’t have this feature, you likely cannot sell your term policy.
Life Settlement Bidding
Most policy owners solicit the assistance of a life settlement broker when attempting to sell their policies. Life settlement brokers contact life settlement companies to let them know that your policy is available for purchase.
The broker then waits for the life settlement companies to bid on the policy (not unlike an auction). Upon receiving all of the bids, the broker lets you know which company offered the most money for your policy. Most policy owners typically sell to the company willing to pay the most money.
Companies who purchase life insurance policies do so legally and are heavily regulated by the government.
Life Insurance Policy Purchasing
Life settlement companies buy your policy so they can become the beneficiary. They receive the death benefit from your policy when you pass away, not your heirs. You might feel a little uncomfortable with the thought of a person or company profiting off your death. While the arrangement might feel strange, the industry is heavily regulated to protect consumers.
When you apply for a life settlement, you will need to submit information about your life insurance policy as well as your health. The purchaser may also request the chance to speak with your healthcare provider. They do so to estimate your life expectancy and to set a price for buying your policy.
If you are happy with the offer, you will sign a contract transferring ownership of your policy to the buyer. You then receive the life settlement payout.
Life Settlement Drawbacks
Life settlements do have some downsides. The biggest drawback is that you give up your life insurance coverage. Your heirs will no longer receive a death benefit when you pass away. If you change your mind later and decide you want coverage again, you'll need to apply for a new policy, which means passing health underwriting again. There’s no guarantee you will be able to buy life insurance again.
When you receive a life settlement, you owe income tax for any amount you receive above what you paid in premiums. The broker overseeing the deal could also charge considerable commissions and fees, so you could end up getting less than you expected.
Finally, some people simply are not comfortable with the idea of an investor profiting off their death, so they wouldn’t consider a life settlement.
Alternatives to a Life Settlement
Before moving forward with a life settlement, you do have some other possible options to generate cash from your policy and/or to maintain coverage without an ongoing premium:
- Surrender for cash value: In a surrender, you cancel a permanent policy with cash value. The insurer sends you a check for your balance and your coverage ends. A life settlement would likely pay you more money, but a surrender could make sense if you cannot qualify for a life settlement, such as if you’re still too young.
- Convert to a paid-up policy: You could use your cash value to create a paid-off policy that no longer charges premiums. You could switch to another permanent policy with less coverage or a term policy with the same death benefit, but it will expire eventually. With this approach, you remove a bill from your budget while keeping an inheritance for your loved ones.
- 1035 to an annuity: In a 1035 exchange, you swap your life insurance policy for an annuity, a contract that turns your cash value into future income. An annuity would not charge you ongoing premiums. It could also give you a higher return and guaranteed future income payments. However, an annuity would not provide the same death benefit for your heirs.
- Use living benefits for a serious illness: If you need money because you have a chronic or terminal illness, see if your policy offers an accelerated death benefit. The policy might pay out some or all of your death benefit while you’re alive, so you have money for your medical bills.
How Does a Life Insurance Buyout Work?
When you sell your insurance, you will receive some cash but not the full death benefit, and the buyer will resume your payments on the policy. You owe tax on any amount you receive over what you paid in premiums.
How Much Do You Get if You Surrender Your Life Insurance Policy?
If you have a life insurance policy with a cash value, you can surrender the policy and collect the money in it, minus the fees your provider charges you for the surrender. Your policy statement should show the surrender value of your life insurance policy. You can also contact your insurer to find out the specific amount.
Why Would a Company Buy Your Life Insurance Policy?
Companies buy life insurance policies as an investment. They estimate how long you will live and then give you a payment that's less than your policy death benefit. The company looks to make a profit by collecting the death benefit after you pass away.
Is It Worth It to Cash Out a Life Insurance Policy?
If you have a policy with a high cash value and you don't need the coverage, it may be worth it to cash out. If you simply need access to cash, there may be better ways to come up with the money such as taking a policy loan. That way you still keep insurance protection for your heirs.
The Bottom Line
You should not feel pressured or rushed into a life settlement. Before moving forward with a deal, consult with a financial planner and your insurance agent. Together you can weigh the value of the buyout versus your alternatives so you can find the right solution for your insurance and retirement needs.
