Exit Strategies for Life Insurance Policies
There are many reasons why you may no longer want or need your life insurance policy.
Perhaps your beneficiaries will no longer need the life insurance proceeds after you are gone. Maybe premiums for the coverage have become unaffordable. Perhaps you need to use all of the policy’s cash value to bolster retirement income or fund a healthcare need.
Maybe the original need for insurance protection—to pay off a mortgage, fund an educational expense, or provide income replacement for your spouse—has changed. You might have an expiring term policy that is that you are not planning to renew. The list of reasons goes on.
So, what do you do if you don’t need your life insurance policy anymore? Luckily, there are ways to get out of these policies.
Let’s sit down with David Jacobs, J.D., Principal at Acumen Insurance Solutions to talk about understanding life insurance settlements: What is a life insurance settlement? How does it work? What are some exit strategies for life insurance policies?
Let’s find out.
What is a Life Insurance Settlement?
A life insurance settlement refers to the sale of an existing insurance policy on someone’s life to a third party.
There are two types of settlements. Either where:
- A lump sum is given to the policy owner. The policy is surrendered to the new buyer and the new buyer takes over those premium payments and collects the death benefit; or,
- You can sell a portion of your life insurance policy to reduce or eliminate premiums and retain a portion at the same time. This is known as a hybrid settlement.
How Did Life Insurance Settlements Begin?
So, how did life insurance settlements come to be? Well, we’re glad you asked because there’s quite an interesting story behind it.
In 1911, Dr. Grisby and his patient, John Buchard, enacted one of the first documented private sales of life insurance.
“Grigsby offered Buchard $100 and a medical procedure for his life insurance policy. In exchange Grisby would be fully responsible for the premiums, while receiving Buchard’s death benefit when he passed.”
What happened next? The case was taken to the Supreme Court! “After an appeal, Supreme Court justices ruled in Grisby’s favor, setting the precedent that life insurance policies are property and can be bought and sold freely and legally.”
This case set the stage and is the foundation for allowing third parties to purchase existing life insurance policies today.
Exit Strategies for Life Insurance Policies
So, what do you do if you just don’t want your insurance policy anymore? There are a few options:
- Allow your policy to lapse
- Surrender your policy
- Give the policy to charity
- Have beneficiaries continue the policy
- Use a life insurance settlement
Let’s talk about each of these options in a bit more detail.
Allow Your Policy to Lapse
You can stop paying premiums and just let your policy lapse. Your policy will just eventually die on the vine; however, you don’t get any benefit from this option unless you pass away while the policy is still in force.
500,000 seniors a year lapse their life insurance policies, leaving behind $100 billion in benefits and walking away with little or nothing. Policies that lapse can be a significant source of revenue for the life insurance carriers, since they have collected premiums for years on them yet never paid out a death claim.
Surrender Your Policy
On the other hand, you can return a permanent life insurance policy to the life insurance carrier for its cash surrender value. This value may be less than what you’ve paid in premiums over the years. Cash value gains are subject to income tax when the policy is surrendered.
Give the Policy to Charity
Next, you could donate your life insurance policy to charity. There are, however, some additional factors to consider in this option. You must:
- Have some charitable intent
- Be comfortable with theoretically taking the money “away” from your heirs and instead diverting it to a charitable organization
- Find a charity that will accept donations of life insurance policy
- Calculate the charitable deduction you’ll receive by giving the policy away
Have Beneficiaries Continue the Policy
If you cannot afford the premiums any longer, you could offer your beneficiaries the option to take over the policy and pay the required premiums. This might be particularly attractive if you have had a decline in health since you originally purchased the policy. This option may require making some administrative changes to the policy with the carrier.
Use a Life Insurance Settlement Option
The final exit strategy is to use a life insurance settlement option. Life insurance settlements are available for both term and permanent life policies when the insured is age 65 and over.
(Note: If you have a term policy, it has to be convertible to a permanent policy for this to work.)
A third-party investor who wants to take over the policy will analyze your contract and your current health to estimate how much the premium is and how long they expect to pay it. The older and less healthy you are, especially compared to when you purchased the policy, the higher the settlement value can be.
This estimate will determine how much they’re willing to write a lump sum check to you for, today, in order to take over the policy. The settlement amount is often much higher than the cash surrender value option, mentioned above.
When the policy changes hands, the third-party purchaser becomes the owner and beneficiary of the policy and assumes payment of its premiums. The buyer also then receives the death benefit when the insured passes away.
The insured and current policy owner need to be comfortable with this arrangement. However, the purchaser is not an individual investor; rather, it is typically a large pension fund or institution that can afford to buy policies at scale to take advantage of the law of large numbers.
In addition, the purchaser may use its estimates to make a hybrid offer, where you agree to take a smaller lump sum amount today in exchange for retaining a portion of the death benefit for your beneficiaries when you are gone.
Why People Choose Life Insurance Settlements
Again, the benefits of a life settlement for the seller of the policy are obvious. The seller has the opportunity to benefit from their policy while they are still alive and receive a far higher amount than using the policy surrender option. The proceeds from the sale can be used for anything, including funding long-term care, medical treatments, travel, or family activities.
When an individual sells their policy, they’re essentially trading long-term benefits for short-term gain. The investor, on the other hand, is paying in the present day to receive a larger payout down the road.
Most states highly regulate life settlement transactions and require that agents hold a specialized license. The settlement paperwork can be significant and requires notarized signatures from current policy owners, beneficiaries, and insureds. The insured’s current medical records are typically required by the purchaser in order to calculate its settlement offer. The buyer also has the right to periodically obtain updates on the insured’s future health through a designated representative and physicians’ records.
Also, remember that settlement proceeds can be subject to tax. In general:
- Proceeds received up to the tax basis (total premiums paid) are free of income tax.
- Proceeds received that are greater than the tax basis up to the amount of the cash surrender value are taxed at ordinary income rates.
- Proceeds received that are in excess of the amount from Tier 2, above, get taxed as capital gains.
Please consult your legal and tax advisor before moving ahead with a life settlement.
Life Insurance Settlement Calculator
Do you want to find out the value of your life insurance policy? Use our life insurance settlement calculator below.
Still have questions? What are the tax consequences of completing a life settlement transaction? What will happen to my policy after I sell?
Get in touch with our team at Acumen Insurance Solutions today. We will help you learn the true value of your policy today.