Have a life insurance policy that you don't want anymore? Don't just cancel it, consider selling it!
Life Settlement or Viatical Settlement allow for the owner of a life insurance policy to sell their policy, generally for between 50% and 80% of the death benefit. (Thanks, Dawn for the question about Life Settlement companies)
Because they may offer far more than the cash value of whole life and universal life policies, there may be significant financial benefits to choosing a settlement over simply cancelling and cashing out a policy. They can also a helpful tool when an individual has a non-optimal life insurance policy and wishes to lower their premium costs by purchasing life insurance that is more appropriate to their needs.
Originally, viatical settlements were only for the terminally ill, but they have been expanded to pretty much anyone with an active life insurance policy.
How Life/Viatical Settlements Work
Without going into unnecessary detail, the basics of these settlements are as follows. You shop your existing life insurance policy around to multiple companies. Based on your insurance policy, your age, your current health, and other factors, the company will make you a cash offer to 'purchase' the life insurance policy from you. Once you come to an agreement, they will take over the payment of the premiums and will become the beneficiary of the policy when you die.
The upside is that you might get a lot more cash than you otherwise would have for the policy you were going to cancel. The downside: somewhere out there, there is a group of people who are rooting for your death. Because when you finally kick it, they'll get a nice payday.
Finding Settlement Offers
Before you can sell your insurance policy you need to find a company (or preferably companies) that are willing to purchase your policy. The two sources to start a search are your state's Insurance Commissioner and LISA. (LISA is the Life Insurance Settlement Association.)
Even if you are using LISA to find a company, check to make sure the settlement company is licensed in your state. (Checking Site in CA for Dawn who asked the question) Also check with your state for the license status, any complaints, or any regulatory actions against the company.
Researching Settlements
Before signing on the dotted line for a settlement, make sure to answer the following questions. If you feel uncomfortable with any of your answers, it's a good sign that you need to research more.
• Do I still need life insurance?
The answer is yes if you have people who would experience financial difficulties if you were to die. Make sure before your cancel or sell any life insurance policy, that you have an appropriate amount of replacement life insurance already in place.
• Is this the best deal I can get?
This isn't an area where monogamy is rewarded. Shop quotes from a few places to get the best deal possible and to see the trade-offs. And remember, maximizing the cash payout isn't the only consideration. One company may offer you more money, but another may not ask for as many ongoing medical updates, and a third might just make you feel more comfortable.
• What will the tax impacts be?
Life insurance benefits are generally tax-free; but with a life settlement, you are actually selling an asset. As a result, there could be a capital gains tax. The good news is all the money you've paid into the policy over the years is your 'basis,' so you can deduct that from your settlement amount. Make sure to run the deal by your tax adviser before you sign.
• Have I consulted whom I need to?
Aside from taxes, there are other potential implications that need to be considered. Make sure to consult anyone who should be involved in the decision. A few examples: Your spouse or adult children to see how they might be affected. Your investment advisor to see how it could affect your overall portolio. Your estate planner to see how it may affect your will or trust.
• Will this affect my public benefits?
If you are receiving social security, food stamps, Medicaid, or other social benefits, a cash settlement could change your benefits by affecting your net worth calculations. Talk to a qualified adviser or the agency to see if a change in your net worth could impact your benefits.
• Am I comfortable with the small invasion of privacy?
The company you sell your policy to can ask you for periodic health updates. Read the privacy notice carefully to make sure you are comfortable with this slight invasion of privacy.
• Is everything in the contract accurate?
It is up to you to make sure everything on the forms is filled out accurately and completely, including your medical history. Errors and omissions here could leave you open to a legal battle if they are construed as intentional. This may be unlikely unless (by the company's standards) it's a large sum of money. A chat with your doctor may be appropriate as you fill out the forms.
• Do I trust the funding process?
If you are uncomfortable with how you will get the money, choose a different settlement company or another route altogether. Remember, you found a bunch of other companies you could sell to when you shopped around. At the very least, make sure that the company uses a third party escrow account to deposit the funds into. And verify the funds are in the escrow account before you execute the final contract.
• Can I change my mind?
Hopefully you don't need to, but determine if you can change your mind after you receive the money and how long you have to undo the contract. If you do change your mind, you'll have to give all the money back, and the contract may have fees you have to pay. The take-away: don't spend any of the money until you are 100% confident in your decision and/or the time period to change your mind has passed.
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