Yahoo Finance Life Settlements: Should You Sell Your Life Insurance?
You've probably seen the TV ads: turn your unneeded life insurance policy into cash.
These "life settlements" serve policyholders who no longer need their life insurance for any of various reasons. Maybe the children have grown, the spouse has died, or investments have grown large enough to provide for survivors.
Or perhaps the policy is too expensive to maintain because premiums have gone up.
Typically, the policyholder can convert a portion of the benefit into cash. The original policyholder no longer has to pay premiums, and the buyer then gets the death benefit after the seller passes away.
In a typical life settlement, the seller gets 20 to 25 percent of the policy's death benefit, says Lingke Wang, co-founder of Ovid, a life settlement startup based in San Francisco that serves both policyholders and investors.
"For a $500,000 policy, this amounts to $100,000 to $125,000, which is a substantial amount of money for a retiree," he says.
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But although a cash infusion can be a lifesaver for a policyholder in a financial crisis, a life settlement is not always a good option, says Richard Myerson, president and CEO of The Myerson Agency in Los Angeles.
"In our practice, this comes up every few months," he says. "When it does, we actively try to find a way for the family to maintain the policy."
"People who no longer need their life insurance policies are the ideal candidates, such as parents whose children are financially independent and who have no debts or other financial obligations to worry about," says Amy Danise, insurance expert at personal finance site NerdWallet. "If there's no one who would truly benefit from the life insurance payout if you were to die, perhaps you no longer need the policy."
The groundwork for this industry was laid more than 100 years ago with a U.S. Supreme Court decision that life insurance was property that could be transferred just like a parcel of land. But the market didn't take off until the AIDS epidemic of the 1980s, when "viatical settlement" firms began offering to buy policies from patients likely to live two years or less.
As AIDS patients started living longer, the industry became less profitable and broadened in to the life settlement industry by offering deals to policyholders likely to live longer than two years.
Though the industry may be seen as ghoulish, a Senate committee found that life settlements average four to eight times as much as policyholders can receive by taking their policy's cash value. Though the buyer does better if the seller dies sooner rather than later, a seller can enjoy some benefit from the policy while still alive.
Most states regulate the industry and require that life settlement brokers be licensed. The industry is small, with its trade group, the Life Insurance Settlement Association, reporting that $1.7 billion in policies were purchased in 2015. The most likely seller is 65 or older and has a policy with a death benefit of at least $100,000.
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Generally, these deals involve some type of permanent insurance that lasts until the policyholder's death, rather than term life policies that end after a given period, since a buyer would not get a death benefit if the seller lived beyond the term. However, term policies with a provision to be converted to permanent policies can be eligible as well, Myerson says.
Garrett Hurley, financial advisor with Brix Wealth Management in New York, has found life settlements work best for people who own universal life policies. These are a type of permanent insurance that have a relatively small investment component designed to eventually help pay premiums.
The typical life settlement user, he says, is aging couple short on money for medical costs or long-term care.
"The strategy has practical application when a client no longer needs the insurance coverage, believes the capital to be more valuable while they are living, and who has significant liquidity concerns that cannot be addressed through other assets," he says.
Hurley says these settlements are not appropriate for policyholders with dependents, those who can afford the premiums, and those who find the death benefit would be more valuable to the family than the life settlement proceeds.
But there's a serious drawback. Cash received in a life settlement is taxable as a capital gain or income while a death benefit is tax free, Myerson says.
"The calculation of possible taxes payable on the sale of a policy is fairly complex and could have both ordinary income and capital gain consequences," Myerson says. "Care must be taken in evaluating the potential for taxes prior to completing a sale."
Sale proceeds, he says, are based on factors like the policyholder's life expectancy according to actuarial tables, the size of the policy and premiums, the buyer's borrowing costs and profit margins.
Myerson says he often finds a client a better alternative, such as a home equity loan or a reverse mortgage -- converting the home to cash and leaving the life insurance policy in force.
Not surprisingly, life settlement deals often favor the buyer over the seller, Hurley says, and many experts recommend getting a financial advisor or insurance broker familiar with the industry to evaluate the offer.
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"Consumers can be at a disadvantage here because they'll have no experience at evaluating what their policies are worth," Danise says. "It's like selling a diamond ring that you haven't had appraised. You wouldn't do that, would you? Consumers can gain better footing by using a life settlement broker who will shop around for the best offer."
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