Consumers Urged to Research, Consult Experts Before Selling Life Insurance Policies
Life insurance plays a crucial role in safeguarding a family’s financial future. However, life is full of changes, and circumstances might arise where maintaining a policy becomes unnecessary or financially challenging. Reasons for considering selling a policy could include terminal illness, the passing of a covered loved one, or the need for a financial boost.
In recent times, numerous companies are actively promoting the purchase of both universal and term life policies from consumers. But is it a wise move?
“My first question would be, what’s the reason for wanting to sell such a policy?” said Miranda Marquit, a life insurance agent and financial expert based in Idaho Falls. “I’d want to understand the considerations that are driving someone to enter into a settlement.”
Marquit emphasizes the necessity of thorough research before liquidating or offloading a policy, also known as a life settlement. The goal is to determine if other, more favorable solutions are available before proceeding. “You need to weigh the pros and cons, whether it is a life settlement, or one of the other options such as a surrender or a loan.”
Other options for policyholders to consider include:
- Taking a loan against the policy, which could limit the financial impact on beneficiaries.
- Entering a partial surrender.
- Opting for reduced coverage.
- Utilizing accelerated death benefits, if the policy allows.
“Before selling, double-check your policy to see if an accelerated benefit is associated with it,” Marquit advises. “If you meet certain conditions, you might be able to get a portion of your death benefit paid to you without going through the process of reaching a settlement.”
Dean Cameron, who leads the Idaho Department of Insurance (DOI), agrees. However, he notes that circumstances are always individual when it comes to life settlements. “If the goal is to obtain money, policyholders should find out if they have any cash value built up in the policy,” Cameron said.
Several factors come into play to determine whether a policy sale is possible, starting with the requirement that the policyholder, who must be age 65 or older, is eligible to sell. Selling permanent coverage, like whole life or universal life protection, is more complex due to the policy’s cash value component.
“If they can no longer afford the premium, or need cash, they could ask the insurance company to reduce the death benefit or remove any additional riders or supplemental policies that may add to the policy’s cost,” he said. “Examples could include accidental death benefits, critical illness coverage, or disability income protection.”
Marquit also stresses that policyholders should know the distinctions between whole life and term life policies, which lack cash value. “If you have a permanent life insurance policy, you likely have other solutions because of the cash value associated with it,” she says. “There is a lot more flexibility with a universal life policy as opposed to a traditional term life policy.”
Converting a policy or entering into a life settlement essentially exchanges the policy’s beneficiary for a lump-sum payment, typically at a reduced rate. The specific settlement depends on the policy type and the policyholder’s situation.
“Whatever the figure is, it is rarely going to be anywhere approaching what the face value of the actual policy is regarding the death benefit,” Marquit said. While some companies advertise settlements up to 25% or higher, Cameron states this isn’t usually the case. “The settlement contracts seen by the Department of Insurance for 2024 averaged slightly above 10%.”
Moreover, other financial considerations come into play when selling a life insurance policy. “Creditors could claim the proceeds from the sale,” Cameron mentions. “And consumers could lose public assistance benefits such as Medicaid or food stamps if they receive a cash settlement.”
Taxes are a significant factor when offloading a life insurance policy. Settlement payments may be considered taxable income or capital gains. The tax percentage is calculated by determining the difference between premiums paid and the final settlement payout.
“Settlements may be subject to taxes depending on the situation,” Cameron says. “We recommend that consumers seek advice from a tax specialist before selling their policy.”
Tax implications exist even with a partial surrender. “Make sure you understand this with any type of surrender,” Marquit advises. “You may have additional tax liabilities, which is always a factor to consider.”
However, a viatical settlement, which allows those with a terminal illness to sell their life insurance policy to a third party, is often a tax-free transaction according to Cameron. Typically managed with a broker’s help, viatical settlements offer immediate payouts. Though less than the death benefit, the payout is usually greater than in a traditional life settlement. Due to the policyholder’s illness, the payout is often immediate. Similar to a reverse mortgage, the company or the third-party purchaser claims the death benefit after the policyholder passes away.
While many policy purchase advertisements target life settlements, Cameron clarifies that the DOI doesn’t “distinguish” between life and viatical settlements, and they do not collect data on which is more common.
Ultimately, deciding to forego a life insurance policy for a cash settlement depends on many factors, including:
- Age.
- Health status.
- Life expectancy.
- The amount of premiums paid.
- The actual death benefit.
As an insurance regulator, the DOI offers no specific guidelines for those considering selling a policy, but highly recommends research and asking questions, and to work with a qualified broker.
“Consumers should get all the facts about their policy options, including financial and tax consequences,” Cameron said. “We always recommend finding a qualified settlement broker who understands the process. And if they choose not to use a broker, we encourage them to shop around on their own.”
In the end, selling a life insurance policy is all about choice, the individual, and their life. “Consumers purchase policies for certain reasons, typically to protect someone in the event of their death,” he says. “If that reason still exists, they should ask themselves if selling the policy outweighs why they initially purchased it.”
Marquit agrees and believes taking a step back and asking why this route is necessary is a huge part of the consideration for selling a policy. “Once you go with a settlement, the beneficiary, spouse, kids, or grandchildren that you had designated as the policy beneficiary will no longer receive a payout,” shared Marquit. “Sure, you get immediate financial relief for whatever it is you are trying to solve. But again, down the road for planning purposes, you are taking away whomever is your designated beneficiary.”
When asked why there are more advertisements targeting consumers to sell their policies, Marquit believes it may simply come down to the current state of the economy. “Right now, there is still a lot of economic uncertainty,” she said. “And we know that during the past three to four decades, wages have not kept pace with inflation and the high cost of living. So, I think people are feeling the tension and often times are looking at any kind of assets they could sell to help benefit them financially.”
A veteran of the financial industry, Marquit said some people may also decide they no longer need some sort of financial protection in the future and that it makes sense for them to unload a policy. But she said her preference would be to seek other solutions. “My personal opinion in doing so is rarely the first step you should take, but the last step you should take.”
