There is a lot of confusion about what life settlements are and whether they’re a good idea for individuals. Getting the facts about life settlements, including the pros and cons of them, will help you make a more informed decision about whether or not this is a good choice for you. Or, more specifically, whether it’s a good choice for you at this stage of your life.
What is a Life Settlement?
A life settlement occurs when an individual sells their life insurance policy to a third party for a sum of money that is greater than the cash surrender value of the policy but less than the actual death benefit (or face value) of the policy. In this event, the purchasing organization will be responsible for all future payments of premiums and receive the death benefit when it is paid out.
Facts about Life Settlements
Life settlements are a great choice for many, but not a good match for everyone. There is an ideal candidate for a favorable life settlement. This would be a person who is generally 65 years of age or older and who has a life insurance policy that exceeds $100,000 in value. Some organizations recommend a policy that is greater than $200,000 in value.
While it doesn’t pay the full face value of the policy, it does pay more than allowing the policy to lapse would pay out. For those who are facing the choice surrendering a policy or allowing it to lapse. It is certainly worth investigating the potential of a life settlement as an alternative. Then you might at least get a little more money from the settlement than a surrender.
A life settlement is completely legal, but anyone considering a life settlement may want to consult with his or her financial advisor and/or attorney before making the decision to sell.
Why Would Someone Consider a Life Settlement?
The simple answer is because that person wants or needs money now. Many retirement plans were ravaged during the recent economic downturn. While the market is slowly recovering, it has made a deep enough dent in retirement savings that people relying on those funds may need a little extra money to maintain a certain lifestyle or to pay off medical and other bills that have accumulated recently. Some people, simply didn’t have adequate retirement savings to begin with.
Retirement alone is not the only reason people consider life settlements. Some people simply no longer feel it is necessary to continue paying monthly life insurance premiums. Whether it’s as a result of losing a spouse or having adult children who are self-sufficient and no longer feeling you need to help them, many people feel that they are better served using the money to enjoy their golden years rather than leaving it behind.
People who are terminally ill, often consider them as a means of supporting themselves when they are unable to work or to help pay off costly medical expenses.
Some people find their fixed retirement incomes aren’t adequate to make ends meet. Sometimes they need a little help to pay bills. At other times, it’s simply a quality of life or standard of living decision. Regardless of the reason, people decide to choose a life settlement, many people are glad for the option.
Myths and Misconceptions about Life Settlements
There are a few myths going around about life settlements. One of the first myths is that they are identical to viatical settlements. While there are many similarities, a viatical settlement requires the person selling the policy to be terminally ill. Some organizations even require that the person has a life expectancy of two years or less. Life settlements do not have this particular requirement.
Another myth is that life settlements are bad for insurance companies and drive prices up for everyone. According to Lifestyles after 50, a Florida lifestyle magazine, the American Council of Life Insurers reports that there were $649 billion in lapsed or surrendered life insurance policies in 2015. That’s a lot of money insurance companies have been paid in premiums that will never be cashed in.
Life Settlement Pros
Before worrying about potential drawbacks and considerations of life settlements, it’s a good idea to understand the benefits and what you have to gain. If this isn’t in your wheelhouse, then there’s really no reason to move forward. These are a few reasons why people consider life settlements.
- Fast access to money. Emergencies happen – even after retirement. Sometimes people need to liquefy assets fast in order to gain access to cash. In these instances, life settlements can net a quick and large influx of cash.
- Create additional retirement monthly income. It can be arranged to have monthly payments sent rather than one lump sum payment. This will aid those who are struggling to make ends meet with limited existing retirement income. While in most cases it won’t be enough to live on by itself, it can help supplement an existing retirement income for more comfortable retirement living.
- Enjoy a little extra living after a life of hard work. This one is perhaps the most rewarding reason to consider a life settlement. You may not have need of life insurance anymore, but there’s no reason you can’t use a little cash now to enjoy the finer things in life, see the world, and add a little comfort to your golden years.
- Fund medical or hospice care. Sometimes, it’s a matter of life growing short. Life settlements can help fund things like hospice care, medical expenses, and regular expenses while seeking treatment. Some people even consider life settlements to help fund long-term care facilities and or treatments.
- Give gifts to family while you’re still here to enjoy them. Rather than leaving your family with a life insurance payout at the end of your life. A life settlement provides you with the opportunity to build fond memories with them. Take the entire family to Disney World. Buy an RV and tour the nation for the summer with grandchildren in tow. Take your children to see the country of their ancestors.
- Relieves the burdens of monthly premiums. After a certain age, term life insurance premiums become unmanageable for people living on fixed incomes. That is one reason so many policies lapse each year rather than reaching full payout. Life settlements allow you the opportunity to recover some of the money you’ve paid in over the years instead of simply letting the policy go.
- IRS benefits of life settlements. Uncle Sam has also weighed in on life settlements and taxes. According to the IRS, the proceeds from life settlements should be taxed as income. Proceeds being the amount that remains when the total amount of premiums paid in over the years are subtracted from the settlement amount. What this means is that you’re only taxed on the amount above and beyond what you’ve paid in premiums and even that is taxed at regular income tax rates rather than as capital gains.
- No longer need life insurance benefits. Some people simply have no one who needs the insurance benefits once they’re gone. There’s no reason to continue paying the policy, but allowing it to lapse is a waste of all the money that’s been paid in over the years.
All of these reasons are great reasons for obtaining a life settlement. But that doesn’t make this the right choice for everyone. Keep reading to learn a few caveats that may make this an unattractive choice for your situation.
Once you’re fully aware of the potential benefits offered by life settlements, it’s time to consider some of the potential drawbacks as well. While there are many people who will benefit greatly from life settlements, there are others who will not benefit from them. Understanding these points will help you determine where you fall according to your situation.
- Income generated from the sale may negate benefits. For those living on fixed incomes who receive government benefits such as Medicaid, a life settlement may jeopardize those benefits.
- Creditors may claim benefits. For those who owe substantial medical bills and have significant debt, the proceeds from the life settlement are subject to being seized to repay those debts. What this means is that people with large amounts of debt should carefully consider if this is the right choice to make at this time or if they would be better served to pay down some of the debt first – unless, of course, the goal is to relieve debt.
- Eliminates money that would be left to heirs. If you continue to pay the monthly premiums, your heirs will benefit from your death with a huge infusion of cash from the life insurance policy. However, the organization that purchased your life policy will receive that payment in the event of a life settlement. If you have no heirs to consider or your family is self-sufficient, this is hardly a worry at all.
- There will be taxes. This is a bit of a pro and con situation. The amount you receive above the premiums you’ve paid for insurance over the years is taxable as income. The fact that the entire amount isn’t taxable is a huge benefit as is the fact that it is taxed as income instead of capital gains. However, if you continue with your life insurance policy and leave the money to your heirs, the benefits are not typically taxed. As of 2018, the new life settlement tax law benefits now benefits life settlement consumers.
- You may outlive the added cash. Many people accept life settlements with the expectations that the funds gained will see them through to the end of their lives. That is not always the case. People are defying life expectations every day. New cures for diseases are covered. And some people just have a better gene pool to draw from. It is a risk worth considering.
Now that you understand the pros and cons of life settlements, it’s a good idea to decide how they relate to you so that you can make an informed decisions about which is the best choice – or when might be the best time to revisit the idea – if not now.