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Selling Unwanted Life Insurance Policies

May 24, 2018

Last week a friend told me he was going to let his term life insurance policy lapse since he felt he no longer need it. This led to a discussion of how he could sell it to an institutional investor and receive a very nice check for it. Here is what I was talking about.

Selling a life insurance policy is a transaction called “a life settlement.” This is where the owner of an unwanted life insurance policy transfers ownership and beneficiary rights to an institutional investment fund. In exchange for transferring ownership, the owner receives a cash settlement that can be much greater than the cash surrender value or more than you might believe possible if it is a term policy. A life settlement is a one-time cash transaction. Policies with as little as a $100,000 death benefit can be sold in this manner, although I’ve known of transactions for policies over $35 million being sold.

Many people that no longer want to maintain a policy terminate the policy and take the cash value, if there is any; or let the cash value run out until the policy is terminated. If they have term life policies with no cash value they are simply terminated for nonpayment of premiums. In any event, the insurer never pays a death benefit, an advantage the insurance industry has come to rely on.

Common Reasons for Pursuing a Life Settlement: There is a variety of motivating factors for seniors who sell their policies, some of which include the following:

  • No longer a need for the insurance originally bought for a spouse to rely on the funds.
  • Spouse or beneficiaries have passed away.
  • Spouse that was beneficiary is divorced from insured.
  • Children have attained their financial independence.
  • Insured has “outlived” the policy and cash value is as much as the coverage.
  • Premiums are no longer affordable.
  • Financial assistance is needed to pay for medical bills.
  • Funds are needed for long-term care.
  • A family business is sold or the owner retires and key person insurance is no longer needed.
  • The business loan that the policy was obtained to provided added comfort to the lender has been paid.
  • Cash is needed to pay off debt.
  • Funds are needed for retirement or lifestyle enhancement.
  • Getting cash that can be used for gifts to family members or to make an unusual purchase such as a vacation home.

When a decision is made not to keep a policy, a life settlement should be considered. For existing term policies, the policy must be within the guaranteed convertibility period in order to qualify for a life settlement option. In those cases the policy will be converted to a permanent policy and paid for by the institutional investor. All permanent life insurance policies may qualify and would need to be analyzed to determine eligibility. Many policies that appear not to be convertible are. Always check it out.

How life settlement proceeds are taxed: The general treatment is that the amount received to the extent of cost basis is tax free; amounts above basis up to the cash surrender value in the policy is treated as ordinary income; and anything above the cash surrender value would be taxed as capital gains.

Conclusion: A life settlement can be an extremely viable option to keep in mind to consider when you no longer need the insurance coverage. We strongly recommend consulting with your insurance, tax or financial advisor should you find yourself with an unwanted life insurance policy. There is no downside to finding out what can be done.

The above was written with the assistance of Richard Machado, CFP® who can be reached at rbmachado1@icloud.com. You can also contact me for additional information at emendlowitz@withum.com.

Ed Mendlowitz

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