As more American seniors learn about a life settlement as a rewarding option for a life insurance policy they no longer need or can afford, they conclude that it’s an attractive alternative to lapsing or surrendering the policy back to the insurance company. However, as with any financial planning strategy, life settlements are not suited for every individual situation.
LISA is dedicated to educating American seniors about their financial planning options, so we want you to be aware of a few potential downsides to selling a life insurance policy. This information will help you make an informed decision about whether to pursue a life settlement transaction.
Loss of the death benefit
First of all, there is a basic principle about life insurance that all seniors should understand: you will always obtain the greatest benefit from your life insurance policy for your heirs by keeping the policy until you die. So if you want your beneficiary to obtain the full death benefit from your life insurance policy, then by all means you should keep it!
- Not enough value in your policy
A life settlement is only a good idea if you will receive a cash payment for the sale of your policy that makes it worth your while. As we explained on this blog recently, there are a few things that will pretty much eliminate the feasibility of a life settlement for some folks, but the most common disqualifying factors are age and the size of the policy. If you are younger than 65, it’s unlikely your policy will find value in the secondary market that will be greater than the cash surrender value from the insurance company. And if the death benefit on the policy is less than $100,000, it won’t attract a lot of interest from potential buyers – in fact, realistically, a policy probably needs to have a face value of at least $200,000 to generate the most meaningful offers.
- Tax implications
Another factor that may reduce the appeal of life settlements for some seniors is the tax implications from the sale of a life insurance policy. A 2009 IRS ruling established some complex regulations governing the amount of income recognized by a taxpayer upon the surrender or sale of a life insurance contract. According to most legal interpretations of this ruling, some of the proceeds of a life settlement are almost certainly taxable. If this tax burden reduces the proceeds from the sale too much, then a life settlement may not be feasible.
- Transfer of personal information
Life insurance policies are considered to be private property that can be bought and sold, so if you choose to sell your policy, the personal information attached to it will be held by a third party after the transaction is completed. That means the insured individual's name and contact information will be made available to the new owners of the policy, who will track the insured person’s health status from time to time. This information is of course subject to a wide range of data privacy laws in the U.S. that require it to be treated with great care and confidentiality; but nonetheless this is another factor that should be considered by anyone exploring a possible life settlement.
- Claims of creditors or public agencies
Finally, the proceeds of a life settlement could be subject to the claims of creditors. This is an important consideration for any senior contemplating a restructuring of their debt and assets since laws on the books now require bankruptcy trustees to maximize the value of life insurance policies for the benefit of creditors. Moreover, receipt of the proceeds from a life settlement contract may adversely affect the recipient’s eligibility for public assistance or other government benefits or entitlements.
Life settlements may not be for everyone, but the more information you have about all of your options for what to do with a life insurance policy you no longer need or can afford, the better decision you will be able to make for your family.