Life insurance has traditionally been purchased for any one of a handful of reasons; to protect loved ones should we die prematurely, meet business obligations, or to fulfill estate planning goals. When these purposes are no longer relevant or premiums become unfeasible, a life insurance policy owner may begin to wonder what their options are. How do you make sure that all the premiums you have paid do not go to waste? For some, a life settlement may be the answer. A life settlement allows for a policy owner to sell their life insurance policy for an amount less than the policy’s death benefit but greater than the policy’s cash value. The new owner of the policy would then assume all responsibility for future premium payments and in return they will receive the policy’s death benefit when the policy’s insured passes away. A life settlement is not for everyone however, it may be a viable avenue to receive a payout for a policy that may no longer be needed or is too expensive to maintain.
Which policies qualify?
Term life, Universal life and Whole life policies are all eligible for sale. A Term policy may be reaching the end of its guaranteed term, but the owner does not want to see the premiums go to waste. If the policy can be converted into a permanent policy and the insured is old enough, then the policy can at least be sold for value instead of lapsing. For many Universal life policy owners, the annual premium increases as they age can become unaffordable. A life settlement allows for owners to relieve the financial burden of increasing premiums while adding to their assets for retirement, to cover long-term care costs or anything else.
The purchasers of life insurance policies buy the policies as an investment. It is a worthwhile investment for them if they can recoup more through the death benefit than they will have to pay in premiums to keep the policy active. It would be considered a risk to the purchaser if the insured lived longer than expected. For this reason, life settlement brokers primarily purchase policies if the insured is at least 65 years old although, the average age for a life settlement is 75. Health issues are also a large determining factor. Insureds that have serious health issues or may be terminally ill are more likely to have their policy purchased. Investors commonly require a minimum death benefit of $100,000 while the average death benefit of a life settlement purchase is $1,250,000.
What can I expect to receive from the settlement?
The purchase price of a policy is determined by factors such as the insured’s health, the costs to keep the policy active, and the appetite of the market. Most life settlement purchases are made by large investment firms and banks who then place the policies in blind trusts. The average cash settlement for a life settlement is around 20% of the policy’s death benefit. Meaning that a $2,000,000 policy may be purchased for $400,000.
But let us not forget that the IRS will want its share. The Tax Cuts and Jobs Act of 2017 outlined that the cost basis of a policy is equal to the total amount of premiums paid into the policy. To use our prior example, let us assume that the policy had $150,000 of cash value and $100,000 of premiums had been paid. The difference between the cost basis (premiums paid) and the cash value is taxed at ordinary income rates, in this case, $50,000. The remaining $250,000 between the cash value and sale price would be taxed at long-term capital gains rates.
The application for the sale of a life insurance policy requires that the insured agree to release medical information to the settlement company. It may feel uncomfortable to release this kind of information to someone other than your doctor, but it is an important factor in helping the potential buyer of the policy to determine the insured’s life expectancy, and resultingly, their return on investment. The release of medical information to the life settlement company would follow HIPAA guidelines. In addition to a life settlement company knowing your medical information, it may feel unsettling to know that a stranger would benefit from your death.
Life settlement brokers can earn up to 30% commission on the sale of a policy, but this percentage may be less depending on the broker that you decide to work with. It is important to ask your broker what they charge before you begin working with them. A well-connected broker will be able shop your policy to multiple buyers in hopes of getting you a higher payout.
A life settlement is not an option for everyone or every policy, but in the right circumstances it offers an escape hatch from an expensive or no longer needed policy. The settlement payout can be used to meet gifting goals, pay for a long-term care need, or supplement cash flow in retirement. As always, it’s a good idea to consult with a wealth advisor before proceeding.
Important disclosure information
Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.
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