Case Study – Divorce

In a high-net-worth divorce case, a couple held a joint life insurance policy worth $3 million. The policy was originally intended to protect the family’s income in case of death, but after the divorce, the policy no longer served its intended purpose. Rather than continue to pay expensive premiums, the couple worked with their attorney to sell the policy via a life settlement. They received $500,000 in proceeds, which was split between them as part of the division of marital assets. This offered a cleaner, more equitable asset division than keeping the policy intact.

Cost of Premiums and the Aging Population:

Rising Premium Costs

Many seniors find that premium costs for their life insurance policies increase substantially as they age. Permanent life insurance policies, like universal life, often experience premium increases due to cost-of-insurance charges rising over time. According to industry estimates, many policyholders are unable to afford these premiums in their later years, leading to an increase in policy lapses.

Long-Term Care Costs

 The U.S. Department of Health and Human Services estimates that 70% of Americans aged 65 and older will require long-term care at some point in their lives. Long-term care can be a significant financial burden, with the average cost of a semi-private room in a nursing home being $94,900 per year in 2023. Life settlements can help seniors access funds for long-term care, providing them with liquidity without depleting their savings.

Tax Considerations

Tax Treatment of Life Settlement Proceeds

Life settlement proceeds are typically subject to income tax, but tax liabilities can be reduced or managed with strategic planning. For example, the cost basis of the policy (premiums paid) is subtracted from the payout before taxes are applied. The proceeds are usually taxed at three levels:

1. Premiums paid: Proceeds up to the amount of premiums paid are tax-free.
2. Cash surrender value: Proceeds above the premiums but below the cash surrender value are taxed as ordinary income.
3. Above the cash surrender value: Anything beyond that is taxed as capital gains.

Estate Tax Planning: For wealthy clients whose estates exceed the federal estate tax exemption (currently $12.92 million per individual in 2023), life settlements can help reduce the taxable estate by converting policies into liquid cash, which can be allocated or gifted under specific tax-exempt limits.

Family Law Considerations

Life Insurance in Divorce Settlements

Life insurance policies often form part of divorce agreements, especially when securing child or spousal support payments. Family law attorneys can use life settlements to convert policies into cash that can meet these obligations. According to the American Academy of Matrimonial Lawyers (AAML), life insurance is frequently a critical element in high-net-worth divorces, and using a life settlement can make asset division more equitable.

Impact on Alimony

In situations where the spouse paying alimony is struggling with high life insurance premiums, a life settlement offers a solution that can preserve cash flow while ensuring financial security for the receiving spouse. The proceeds from a settlement can be placed in a trust to ensure future payments, alleviating the burden on the policyholder.

Growing Popularity and Legislative Support

Consumer Protection Laws 

Many states have passed legislation to protect consumers in life settlement transactions. As of 2023, 43 states have regulations governing life settlements, ensuring that clients receive fair market value and that brokers and providers follow transparent practices.

Increasing Awareness

A survey conducted by the Life Insurance Settlement Association (LISA) found that 55% of seniors aged 65 and older were unaware of the life settlement option. However, as awareness has grown, life settlement transactions have increased. More financial advisors, estate planners, and attorneys are now recognizing the potential benefits of these transactions for their clients.

Conclusion

Life settlements present a valuable financial strategy for estate planners and family law attorneys. With growing market trends, significant potential payouts, and clear applications in estate and divorce planning, they offer an effective way to unlock liquidity and financial flexibility for clients. With supporting data showing higher-than-expected returns, the increasing number of aging policyholders, and rising premium costs, life settlements are becoming an increasingly relevant tool for professionals helping clients navigate complex financial landscapes.