Life settlements: the questions sellers and their heirs ask

A life settlement is the sale of a life insurance policy you own to a third party, for more than the policy's cash surrender value and less than its death benefit. The buyer pays you now, keeps the policy going, and collects the death benefit later. Owners who consider a sale, and the relatives who would be affected, ask a predictable set of questions, and the honest answers include real costs: your beneficiaries receive nothing from that policy afterward, part of the gain can be taxed, and the market for policies is narrower than advertising suggests.

This post answers the questions in the order a seller meets them. The overview is in life settlements: selling your life insurance policy; here we go through the practical details. Figures are hypothetical.

Who can sell and what a buyer wants

Who qualifies for a life settlement?

There is no single rule, because buyers set their own standards and states set the legal framework. In general, buyers look for a policy with a meaningful death benefit, an insured who is older or has health problems that shorten life expectancy, and a policy type that can stay in force, such as universal life or whole life. Some convertible term policies can be sold if the conversion right can be exercised. Minimum face amounts and ages differ among buyers, so ask each one rather than assume.

If the insured is young and healthy, offers are often no better than the surrender value, because a buyer would have to pay premiums for many years before collecting. This is why many people who ask about selling learn that the better choice is to keep the policy or surrender it.

What is a buyer actually paying for?

A buyer is paying for a stream of costs followed by a payout of uncertain timing. The buyer will pay all the future premiums and then receive the death benefit when the insured dies. Everything depends on when. The price comes from three inputs: the death benefit, the premiums needed to keep the policy in force, and a life expectancy estimate based on medical records. Buyers then discount for the time value of money and for their own margin and costs. how a life settlement offer is priced and why offers differ goes through this in more detail.

A hypothetical illustrates why life expectancy matters. Say a policy has a $250,000 death benefit and costs $9,000 a year to keep in force, and a buyer pays $90,000 to acquire it. If the insured dies in 8 years, the buyer has paid $90,000 + (8 x $9,000) = $162,000 and receives $250,000. If the insured dies in 15 years, the buyer has paid $90,000 + (15 x $9,000) = $225,000. The buyer breaks even, before considering any return on the money, at ($250,000 - $90,000) / $9,000, about 17.8 years. A shorter life expectancy makes the policy worth more to a buyer, which is why health records are central to the process, and why the sale is a bet on the insured's life that seller and buyer see differently.

How do I know whether an offer is fair?

Compare it to your alternatives, not only to the buyer's number. Three benchmarks help:

1. The cash surrender value. If an offer is not clearly above what the insurer would pay on surrender, selling makes little sense. Ask the insurer for the current value in writing, using an how to request and read an in-force illustration.
2. The value of keeping the policy. If your family needs the death benefit, or if you can afford the premiums, keeping may be worth more than any offer.
3. Other offers. A broker may solicit bids from several providers. A single offer is a weak signal.

The keep, surrender or sell your policy? compares the three paths using your own figures. For surrender mechanics see surrendering a life insurance policy: what you get and what it costs.

Who is on your side and who is paid

What does a broker do, and is the broker working for me?

A life settlement broker finds buyers and negotiates for the seller. Under the NAIC Viatical Settlements Model Act (#697), a settlement broker is deemed to represent the seller and owes the seller a fiduciary duty, regardless of who pays the broker's fee. That is a stronger duty than many sellers expect. A provider, by contrast, buys the policy and is on the other side of the table.

Not every state follows the model, and the details differ. Ask in writing who you are paying, who the broker represents, and what the state says. Your state insurance department can confirm whether a broker or provider is licensed, and you can ask for the license number from anyone you deal with. The insurance commissioner page explains how to find the right office.

How are fees disclosed?

The model act requires disclosure of the compensation brokers and others receive in the transaction. Ask for a written breakdown: the gross offer, the broker's fee, any provider fees, any escrow or closing costs, and the net amount you will receive. Compare offers by the net amount, not the headline. A $100,000 offer with $15,000 in fees is worth less than a $90,000 offer with none.

An upfront fee for an "evaluation" or a promise of a guaranteed price before any medical review are warning signs. See the red flags at the end of this post.

Taxes, benefits and creditors

How is the sale taxed?

The tax treatment depends on your basis and on the policy's cash surrender value. In general terms, under IRS guidance in Revenue Ruling 2009-13 as updated by Revenue Ruling 2020-5, cost basis is the premiums you paid, with no reduction for the cost of insurance charges after a 2017 law change. Your gain is the sale price minus basis. The part of the gain up to the policy's cash surrender value over basis is generally taxed as ordinary income, and the remainder of the gain can be a long-term capital gain.

A worked example with made-up figures. Say a whole life policy has total premiums paid of $40,000, a cash surrender value of $55,000, and an offer of $90,000.

• Gain: $90,000 - $40,000 = $50,000.
• Ordinary-income portion: $55,000 - $40,000 = $15,000.
• Capital-gain portion: $50,000 - $15,000 = $35,000.

If the owner had surrendered the policy for $55,000 instead, the taxable gain would have been $55,000 - $40,000 = $15,000, all ordinary income. So the sale produced $35,000 more in cash before tax and a larger tax bill, because the extra gain is taxable at capital gain rates. Prior withdrawals, dividends or loans change the numbers, and a policy sold for less than basis is treated differently. A tax professional should model your case. See how the tax on a life settlement sale works in principle for a fuller treatment.

Sellers who are terminally or chronically ill may qualify for different tax treatment under section 101(g); that is a viatical settlement, covered in viatical settlements for the terminally or chronically ill.

What happens to my government benefits?

A cash payment can count as a resource or income for need-based programs. The NAIC model requires sellers to be told in writing that receiving proceeds could affect Medicaid or other government benefits. If you receive Medicaid, Supplemental Security Income or similar help, or may need long-term care coverage soon, talk to an elder law attorney first. medicaid eligibility and life insurance cash value describes how life insurance is counted and how the 60-month look-back works. A sale at less than fair value could raise questions on a later application.

Can creditors reach the money?

The model act's disclosures also warn that proceeds could be subject to the claims of creditors. Life insurance death benefits paid to a named beneficiary are often protected from the insured's creditors in many states, but once you sell the policy and receive cash, the cash is an ordinary asset in your hands, and its protection may be weaker. If you owe significant debts, or are in or near bankruptcy, get legal advice before selling.

Privacy, process and second thoughts

What will buyers see about my health?

A lot. You authorize release of medical records so that independent reviewers can estimate life expectancy. Those records go to the broker, the provider, and often to investors and their agents. The model act includes confidentiality rules, and after the sale a provider may contact the insured about health status only at limited intervals, no more than once every three months if life expectancy exceeds a year, and once a month at most if it is a year or less.

Ask each company how it stores records, whom it shares them with, and how long it keeps them. If you decide not to sell, ask that your records be returned or destroyed.

How does the sale proceed, and how long does it take?

The usual sequence is:

1. Gather the policy, an in-force illustration and a statement of loans.
2. Authorize medical records and obtain life expectancy estimates.
3. Collect offers, if a broker is bidding the policy to several providers.
4. Receive the required disclosures and a contract, which may need state approval of the forms.
5. Complete insurer paperwork to change ownership and beneficiary, with the buyer's payment held in escrow until the insurer confirms.
6. Receive the funds after any rescission window.

Expect weeks to months. The pace depends on records, the insurer's processing and the state's rules. how a life settlement sale works from appraisal to closing follows a sale in order.

Can I change my mind after signing?

Often, within a limited window. Under the NAIC model, a seller may rescind before the earlier of 60 calendar days after all parties sign or 30 days after the proceeds are paid, by giving notice and repaying what was received. States set their own periods, and some are shorter. Read the contract's rescission clause and your state's rule before you sign, and do not spend the proceeds until the window closes.

What the family gives up

What do my heirs lose?

The death benefit. After a sale, the buyer is the owner and beneficiary, and your family receives nothing from that policy when you die. If your spouse or children were counting on it for the mortgage, living costs, taxes or a funeral, you need another plan before you sell. The money you receive may be larger than any share they would have gotten, or smaller, depending on the policy and how long you live.

Tell the family before you decide, and especially the named beneficiaries. Some people also need consent: an irrevocable beneficiary designation generally requires the beneficiary's agreement to a change, and a lender who holds a collateral assignment on the policy must release it. In community property states, a spouse's interest may be involved. An attorney can tell you whose signature you need.

What should I bring to the first conversation?

Bring the policy and its most recent annual statement, a current in-force illustration, a list of any loans or withdrawals, your premium history, and the names of every beneficiary and any assignee. Add a list of your doctors and medications; you will need it for the records request. Also bring a short list of what you want the money to do. A seller who knows the goal, such as paying for care, clearing a debt or replacing premiums, can judge each offer against it, and can tell quickly when a sale would not reach that goal. Ask the broker or provider to put every number in writing, and take the paperwork home. Nothing about a settlement is so urgent that it cannot wait a few days for a tax adviser, an attorney or a trusted relative to read it.

Are there better alternatives to selling?

Several, depending on why you want to sell. If the problem is premiums, ask the insurer about reducing the death benefit, using the cash value to pay premiums, or taking reduced paid-up coverage. If you need money, a policy loan or a partial withdrawal may be available, though both reduce the benefit. If you are seriously ill, an accelerated death benefit rider (see accelerated death benefit riders: how they work and how they're taxed) may pay part of the benefit early, with no sale. If you simply no longer need the coverage, surrender may be the simplest route. A fee-only planner who earns nothing from a sale can help sort these out.

What are the red flags?

• Someone who contacts you unprompted and promises a high price for a policy they have not seen.
• A request for a fee up front, or a demand to sign quickly.
• A buyer or broker who cannot give a license number your state department confirms.
• Pressure to take a loan or buy a policy so that it can be sold later. That pattern is associated with stranger-originated schemes, which states restrict; see Stranger-originated life insurance (STOLI): what it is and why it is restricted.
• A contract that does not state net proceeds, fees and the rescission period.

Key takeaways

• A buyer pays for your policy by estimating when the death benefit will arrive, so the offer depends mainly on life expectancy, the death benefit and the premiums.
• Compare any offer, net of fees, with keeping the policy and surrendering it; many policies get no offer above surrender value.
• A broker under the NAIC model represents the seller, and sellers are entitled to written disclosures about alternatives, taxes, creditors and benefits.
• The gain can be partly ordinary income and partly capital gain, and the proceeds can affect Medicaid and creditor claims, so get tax and legal advice first.
• Your heirs lose that policy's death benefit; tell them, check who must consent, and use the rescission period.