Selling your life insurance to receive life settlement can be an excellent option for handling living expenses as you age, but these arrangements aren’t for everyone. Read our list of the most important pros and cons of life settlements to help decide if you should sell your life insurance policy.
What Are Life Settlements and How Do They Work?
While a life insurance policy is a great way to provide for your family after you die, there are many situations where it does not make sense to keep paying expensive premiums to maintain your policy. If your children are grown and no longer need the security of a death benefit, or if you encounter unexpected expenses and can’t afford to continue paying your premiums, selling your life insurance policy to receive a life settlement can be a viable option.
A life settlement is a legal sale of your life insurance policy in exchange for a lump sum equal to a portion of the death benefit. Life settlement arrangements typically pay 20% to 60% of your original payout, but can sometimes provide a greater return.
A life settlement is not an option for everyone. Most life settlement companies only purchase your life insurance policy if you are over the age of 65 and have health conditions or a terminal illness. Most businesses also require your policy to have a minimum $100,000 death benefit.
4 Benefits of Life Settlements
- A life settlement provides cash now. If you have a life insurance policy that pays $250,000 in death benefits, you may receive anywhere from $50,000 to $150,000 from a life settlement to help with current expenses. This amount could be enough cash to sustain you through your remaining years. Some individuals who sell their policies to receive a life settlement need the money for unanticipated expenses — for example, many people obtain life settlements to help pay for experimental or alternative cancer treatments not covered by insurance.
- A life settlement is a better option than defaulting on life insurance payments. If your life insurance premiums have become too expensive for you to pay consistently, a life settlement is almost always a better option than defaulting on your payments and losing the entire death benefit of your policy.
- Life settlement proceeds can grow your investment portfolio. If you don’t need the full value of your life settlement for current expenses, you can invest the remainder into your retirement portfolio and continue to grow your net worth.
- A life settlement helps fund long-term care. You can put the proceeds of a life settlement into a specialized account to pay for long-term care needs. These needs include nursing homes, residential facilities and in-home care. The accounts allow you to designate a beneficiary who inherits any remaining funds after your death.
4 Disadvantages of Life Settlements
- A life settlement may get taxed. In most situations, a portion of a life settlement is considered taxable income or capital gains by the IRS, so you’ll owe taxes on it. Typically, any amount received above total premiums paid into your life insurance gets taxed unless your settlement qualifies as a viatical settlement. These settlements are for the terminally ill who have less than 24 months to live. If you don’t sell your life insurance policy, the beneficiaries pay no tax on the death benefit.
- Accepting a life settlement may make you ineligible for government support. A life settlement can place you into a higher income bracket and make you ineligible for some types of government aid. A settlement does not affect eligibility for Medicare or SSDI (disability), but it could remove your eligibility for:
- SNAP food benefits
- Section 8 or HUD housing benefits
If you use one or more of these programs, check the income limits before accepting a life settlement to ensure your income won’t exceed the limits to qualify for benefits. You can be ineligible for benefits even if you donate or give away a portion of your settlement.
- If you owe money to creditors, proceeds of a life settlement go to pay them first. Creditors can collect on your debt if you receive a life settlement payment. Creditors cannot collect unpaid debts from a death payment to your beneficiaries.
- Qualifying for a large settlement can be tricky. Most settlements are for 20% to 30% of the value of the policy death benefit. Larger settlements are generally only available if you are 70 or older, have been diagnosed with less than two years to live or have a paid-up policy with a substantial death benefit.
The Bottom Line
A life settlement is an excellent option for those who may otherwise accept the cash surrender value on their life insurance policy or simply let it lapse. It’s essential to keep the drawbacks in mind before making your choice. If you decide a life settlement is right for you, check out our list of life settlement companies and choose a reputable business to get the best settlement for your policy.