In these difficult financial times you may have learned that your parents lost a great deal of their retirement savings and are looking for ways to cut back on expenses. This is a suggestion only for those of you with parents who no longer need or can afford their policy. Perhaps you and your siblings are well off enough that you won’t need that inheritance. Letting their life insurance policy lapse or surrendering it for the cash value may seem like a good idea, but did you know your parents’ life insurance policy is an asset they can actually sell?
Until recently, the only options for liquidating an underperforming or unneeded policy was to let it lapse, sell it back to the original insurer for its current net cash surrender value, or to exercise a non-forfeiture option. In a life settlement, the sale price is less than the policy’s face value, but is higher than the policy’s net cash surrender value. The price can range as low as 3% to as high as 30% of the face value of the policy (death benefit), but usually averages to about 15% of your policy’s face value. The value in the life settlement transaction is determined by a number of factors including: your age and medical condition, the type of insurance, the amount of premium payments, and the status of loans on the policy.
There are many reasons you may no longer need or desire a life insurance policy:
• loss of a loved one
• need to pay for long term care or medical costs
• premiums have become unaffordable
• beneficiaries no longer need the death benefit
• financial hardship
• your estate got smaller
• a key executive retired
• sale of a business
• loan repayment
• policy underperforming your expectations
• your level term life’s conversion period is expiring
• estate tax law revisions mean your heirs no longer face a hefty tax bill at your death
Who can qualify?
A potential candidate for a life settlement is typically aged 65 or older; has a life insurance policy with a face amount of at least $250,000, and has a life expectancy greater than 2 years.
What type of insurance policy can be sold?
Most types of life insurance policies can qualify as long as they’ve been in existence for more than 2 years. However the most common are Universal Life, Whole Life, Variable Life, Survivorship Life, and convertible Term Life.
What happens to my policy?
A life settlement transfers ownership of your policy to a third party investor that only has a financial rather than an insurable interest in your life. In other words, the death benefit will eventually be paid to the new owner. Once you sell your policy you give up all rights and obligation to the investor in exchange for the sale price. The buyers are usually institutional investors such as pension funds, charitable endowments, universities, and hedge funds.
What can the money be used for?
You can spend the money on whatever you like. Some people use it to fund other investments, make charitable donations, fund a relative’s education, or even purchase replacement life insurance.
From LISA, Life Insurance Settlement Association
Case 1: Policy seller: 70 Male
Policy type: 20 year term policy
Policy value: $1,000,000
Net Settlement paid to seller: $156,000 (15.60% of death benefit)
Case 2: Policy seller: 69 Male
Policy type: Universal Life policy
Policy value: $500,000
Cash surrender value (CSV): $10,335 ( 4.01% of death benefit)
Net Settlement paid to seller: $210,000 (42% of death benefit)
Settlement vs. CSV ratio yield: 1047.6%
Case 3: Policy seller: 80 Female
Policy value: $2,000,000.00
Cash surrender value (CSV): $9,897.65 (0.49% death benefit)
Net Settlement paid to seller: $330,000.00 (16.50% of death benefit)
Settlement vs. CSV ratio yield: 3334.12%
What are the fees?
Be aware that the commissions on life settlements can be as high as 33%. These commissions are negotiated between the advisor and the purchasing company, but are not always disclosed to the client. Make sure your advisor clearly states their cut. Most commissions hover around 8% of the net death benefit or 30% of the offer price, whichever is less.
Other than commission there is no other fee. You can put your policy out for bids and decide whether or not you will accept a bid or turn it down. The whole process takes about 4 months.
Do I have to take a bid if I don’t like it?
Never! There is absolutely never any obligation or fees if you don’t want to accept the bids for your policy. It is free to put your life insurance policy out for bid just to see what it’s worth in the life settlement market.
What are the tax implications?
A life settlement is generally a taxable event.
• The portion of the policy owner’s investment (premiums paid) will be received tax-free.
• The difference between the premiums paid and the net cash surrender value will be taxed as ordinary income.
• The portion exceeding the net cash surrender value will be a gain, in most circumstances a capital gain.
Since every situation is different it is important that you consult with your tax advisor when contemplating selling your life insurance. Life settlement brokers are not tax consultants.
Life settlements can be a wonderful source of funds. But they are not for everyone. You must consider whether your parents still have a need for continued coverage. If their premiums are too expensive they may be able to lower the amount of coverage and keep the current policy by exercising a non-forfeiture option. If after the life settlement, your parents plan to replace their existing policy with another policy there may not be any other availability or comparable coverage for less cost. You must assess their circumstances, including financial need, investment objectives, tax consequences, and other relevant implications of selling a policy.
If you have a specific question about your situation or would like more information give me a call or email at firstname.lastname@example.org.
Wendy Goldband, MSW, is a Registered Representative and Insurance Producer with an expertise in long term care planning. She is the former Senior Marketing Manager for Crump Insurance Services, the largest life insurance brokerage in the nation, and the webmaster for http://lifeinsurancenoexam.biz. Author of Breaking Autism’s Barriers and Dangerous Encounters:Avoiding Perilous Situations with Autism, she also helps families with special needs plan their financial futures.