What Financial Advisors Should Know About Life Settlements

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Financial Advisor

Is your financial advisor familiar with life settlements?  Odds are, probably not.

According to a 2015 survey published by WealthManagement.com 4 out of 10 financial advisors said they weren’t familiar with the option. Of those familiar, only 11% had recommended a life settlement or assisted a client with one.

This means a significant number of financial advisors aren’t bringing potentially valuable information clients.

3 Misconceptions Financial Advisors Reportedly Have About Life Settlements 

There are a few misconceptions that stop advisors from recommending life insurance settlements.  So, let’s clear the air. 

1 – Transferring ownership of life insurance is illegal.  False.

Transferring ownership of life insurance is legal and is a highly-regulated process. Insurance companies can’t cancel a life insurance policy after two years so long as the premiums are being paid.  The beneficiary of the policy does not need to have an insurable interest in the insured. This means anyone can become the new beneficiary.  

2 – Life Settlements aren’t worth it after taxes. False.

Life settlement tax laws benefit consumers.

In fact, if Joe Biden’s new tax plan becomes law, it could lift the life settlement market to new heights.  With an increase in capital gains taxes, many advisors are urging clients to sell their businesses soon to avoid this big tax increase.  Many companies have life insurance policies for their employees.  When the business sells, typically those policies are surrendered.  However, with more people discovering the life settlement option, this is no longer the case and life insurance companies are preparing for an increased key-man and company-owned policies sold to third parties.

The Tax Cuts and Jobs Act of 2017 (TCJA) has both simplified the taxation process of life settlements and increased the payout from selling. This new law changed how profit is defined to the IRS. You pay taxes on the money from a life settlement that’s a profit. 

The profit is now defined as the difference between the premiums you paid and the cash payout you receive from selling the policy. Some of this profit is taxed as ordinary income and some as capital gains. 

This change in taxation provides a significant benefit to people choosing to sell their policy, making life settlements worth the transaction after taxes. 

3 – You need to be an expert to recommend Life settlement options. False.

Life settlement brokers do all the heavy lifting. As long as you understand enough about life settlements you can recommend them when appropriate to your clients. You can also recommend a life settlement broker to make sure they get the most out of their policy.  

When you understand how life settlements work you can stop your clients from making the costly mistake of surrendering their policy. Typically, more money comes from selling a policy than surrendering it.

Life insurance companies make their money when policies lapse. 88% of all universal life insurance policies are lapsed or surrendered.  That means the majority (nearly all!) of life insurance policies lapse without ever paying a death benefit. As a financial consultant, you need to make sure your clients realize this and don’t miss out on the opportunity to get money from their policy.  

Life Settlement Brokers Get You More Money

When compared to lapsing a policy life settlement brokers secure higher offers.  In fact, offers from brokers are on average 4x higher than the surrender value.

A life settlement broker actually invests thousands of dollars of their own company’s funds into each of their life settlement clients. The qualifications and underwriting process involves extensive communication with insurance companies and doctors’ offices. They acquire and prepare all of the documents needed to field offers in a life settlement marketplace.

Brokers are financially invested and prepared to deal with insurance companies who drag their feet with life settlements. Understandably, since lapsing policies are how insurance companies make their money. 

Once the underwriting process is finished, the broker will begin accepting bids. This process involves communication with different buyers until the highest offer is accepted by the policy owner.

The alternative is working with a direct buyer. Using a direct buyer will get the policy sold quickly. However, you will be accepting a lower offer in this scenario. Life settlement brokers can get you a substantially higher offer but it takes time to complete the bidding process. 

Who Qualifies for Life Settlements?

A life settlement calculator can give you an idea of whether a policy can qualify for a life settlement. There are three elements to keep in mind as you are considering this option for your clients:

  • The client must be at least 70 years old or have significant health impairments. 
  • The face amount of the policy should be at least $100K. 
  • The policy needs to be in force for at least 2 years, a few states require 5 years. 

All Types of Life Insurance Policies Can Qualify for a Life Settlement 

Different types of life insurance policies have slightly different processes when it comes to settlements. Whole, universal, and term are the most valuable policies. Term life policies can be converted into a permanent product and then they may qualify for a life settlement.  

Convertible term life policy – This type of policy you can convert or renew without any additional medical qualification. 

Non-convertible term policies – These are harder to sell as they are a much higher risk for the buyer unless there is a terminal illness. 

Variable life policies – These policies are less desirable if monthly premiums are too high and they have the highest fees involved.  

Lapsed life insurance policies are an expensive mistake. A financial advisor in the know prevents clients from making such a mistake. They only need to know enough to make sure their client isn’t missing out on the settlement option. Even though selling a policy may not be the best fit for everyone, keep the life settlement option in your toolbox when creating the best financial situation for yourself or your clients. 

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