Life Insurance provides peace of mind that our loved ones will be protected from financial loss after we die. But the need for this protection changes throughout our lives. What was important when the kids were young is less important when they’ve grown up and moved out on their own. Marriage and business ventures also begin and end, and the importance of life insurance in financial plans changes with them.
Some people find that they no longer need the life insurance policies they bought 20 years ago. You have a few options for what to do when your policy is out of date: hold on to the policy and keep paying for it; stop paying for it and hold on to it until the cash value is exhausted and the policy lapses; or accept the surrender value from the insurance company and terminate the policy.
Another alternative is to sell the policy to someone else in what is known as a life settlement. In a life settlement, the policyholder sells the policy to a third party for a price greater than its cash surrender value. These policyholders are typically over age 70 (or 65 with significant health problems).
There are a variety of situations in which a life settlement might make sense:
- The policy was purchased to finance the sale of a business if the business owner passed away, and now the business has been sold.
- The business owner has retired or stepped away from the business.
- The policy was purchased to cover estate taxes, but changes in the estate’s value and tax laws have made it exempt from these taxes.
- A term life policy is nearing the end of its term, or the policyholder is about to lose the ability to convert it to a whole life policy, or its premiums are about to jump.
- The policyholder is retiring, and the family no longer needs to replace the person’s wages.
- Persistent low interest rates have caused the premiums to increase to the point where the policyholder can no longer afford them.
- The policyholder suffers from a chronic illness and needs extra money to cover medical costs.
Why would someone buy a life insurance policy for more than its surrender value? Because if they evaluate the risk properly, they stand to reap a substantial value.
Suppose they buy a universal life policy with a face value of $1 million from a 75-year-old man with heart disease. Let’s say the surrender value is $100,000, and they buy the policy for $125,000 and assume responsibility for making the $1,500 monthly premium payments.
If the man lives another three years, the buyer has paid out $179,000 (the purchase price plus $54,000 in premiums) and collected $1 million, more than a fourfold return on investment. Such a purchase makes sense for the buyer only if the policyholder is elderly and/or has life-threatening health problems.
However, it also makes sense for sellers if:
- Their survivors no longer need the death benefit.
- They need extra money to cover unavoidable expenses.
- They want to cut expenses by eliminating premium payments.
- They want the money to finance family members’ educations, make gifts to charity, buy annuities, pay down debt, or just enjoy retirement more.
If you feel a life settlement might be right for you, call your agent to figure out the potential impact on your taxes. You should carefully consider the effect on your survivors of forfeiting the policy proceeds. If a life settlement still makes sense, a professional life insurance agent can obtain bids.