Some people may decide that keeping a life insurance policy is no longer worth it. When they do, they can sell the policy for cash to use for other life expenses. However, people should understand that the final payout can change based on their policy circumstances, state regulations, and taxes. Understand the process and how things can fluctuate before you make this decision.
What Is a Life Settlement?
The settlement is a sale of your existing life insurance policy to a third party for a lump sum payment that’s usually greater than the policy’s cash surrender value but less than the expected death benefit. Bear in mind that once you sell this policy, your heirs will no longer receive the death benefit.
You may have a life insurance settlement you no longer need or want to keep paying for. Many people are complaining about rising insurance premiums across the board, and your financial circumstances may change, causing this premium to be too hard to maintain.
People with grown children or a paid-off home may no longer need to have a life insurance policy. Some retirees may choose to liquidate this policy to pay for current life expenses, which may include medical care or moving to an assisted living facility.
How Will My Policy Be Appraised?
Upon selling your policy to a third party, they must appraise its overall value. They will look at factors such as your policy type and death benefit. Buyers also consider your age and overall life expectancy.
Plus, there’s the cash surrender value, cost of your monthly premium, and future premium requirements. Like any other service, you can shop your policy around to different parties who can place competing bids.
Just because your policy has a large death benefit doesn’t mean you automatically will get a large settlement. Before you get your payout, expect fees and commissions to be taken out first.
What Is the Expected Timeline?
Expect the process to take about 2 to 3 months from your time of application to final payout.
1. The first step in turning a policy into capital is to determine your eligibility, which is based on your:
- Health
- Age
- Policy size
2. Start contacting your insurance and medical providers for necessary documents.
3. The underwriting process can take a few days to a week.
4. Now, you can start obtaining and comparing offers to see which one offers the best payout.
5. Once you’ve selected an offer, complete your required paperwork, which includes closing documentation.
Are There Consumer Protections?
These policies are regulated by your state insurance departments. Key consumer protections here include a mandatory state license for brokers and providers. You should be able to cancel the contract within 15 to 30 days after receiving your cash, during what is known as a rescission period.
Before signing a contract, your broker’s fees, commissions, and the provider compensation should always be fully disclosed. There are strict regulations regarding how your sensitive data will be shared and protected.
Red Flags
Sellers should know that not all potential insurance buyers are kosher. Watch out for third parties who attempt to rush you into making a quick decision and have unclear commissions. Always know what those fees will be upfront before you sign anything.
No one should guarantee returns and step back if they ask for unnecessary personal or medical information, as it could be a threat to your identity protection.
What About Taxes?
Yes, you can expect to pay taxes on your final payout. Your taxes are affected by the cost basis, the tax-free return of the premiums you’ve already paid into the policy. The amount exceeding the cash surrender value is taxed as capital gains.
A major exception here is if the policyholder is terminally or chronically ill. The holder can get a viatical settlement to sell or cash out their policy entirely tax-free.
Are There Alternatives to Consider?
Instead of cancelling your entire coverage, review your policy for options like taking out a loan against it or reducing certain benefits that can make cash more accessible. You can borrow against the accumulated cash value tax-free but keep your core death benefit active. Just remember that unpaid loans will reduce the final payout for beneficiaries.
You can also decide to stop paying future premiums at all, which will maintain a smaller permanent death benefit.
Life Insurance Doesn’t Have to Be for Life
You may have more flexibility with your life insurance policy than you realise. After years of paying into a policy, your life circumstances may change to where you no longer need one or can afford it.
A life settlement sale can help you get fast access to the cash you need. However, you should understand the tax implications and other factors that can influence your final payout.
