A life settlement is one option that may be available when an existing life insurance policy is no longer needed, has become difficult to maintain, or no longer fits the policyowner's planning objectives. Surrendering the policy is not necessarily the only option.
In some situations, an existing life insurance policy may be sold to a third party through a transaction known as a life settlement. The buyer becomes the policyowner and beneficiary, assumes responsibility for future premiums, and receives the death benefit when the insured dies.
A life settlement may provide the policyowner with more value than surrendering or allowing a policy to lapse. But selling a life insurance policy is a permanent decision that can involve taxes, transaction costs, privacy considerations, future insurability, and the loss of a death benefit that might otherwise have been available to beneficiaries.
Before selling or surrendering coverage, it is important to understand the policy, the available alternatives, and the financial consequences of each option.
A Life Insurance Policy May Have Value Beyond Its Cash Surrender Value
If a policy is no longer needed or wanted, surrender is only one possible outcome. Depending on the policy and the insured, a life settlement or another policy-management strategy may provide an alternative worth evaluating.
What Is a Life Settlement?
A life settlement is the sale of an existing life insurance policy to another person or company for a negotiated cash payment.
After the transaction is completed, the buyer generally becomes the owner and beneficiary of the policy, assumes responsibility for future premiums, and receives the policy's death benefit when the insured dies.
The amount paid to the seller is typically less than the policy's death benefit. For policies with cash surrender value, a life settlement offer may be greater than the amount the policyowner would receive by simply surrendering the policy to the insurance company.
Not every policy will qualify for a life settlement, and receiving an offer does not necessarily mean selling the policy is the best decision.
What Does It Mean to Surrender a Life Insurance Policy?
Surrendering a life insurance policy generally means terminating the contract and receiving any cash surrender value available under the policy.
Once the policy is surrendered, the life insurance coverage ends and the death benefit is no longer available.
The amount received depends on the type of policy, its accumulated policy value, surrender charges, outstanding policy loans, and other contractual provisions.
A policy with substantial cash value may provide meaningful surrender proceeds. Other policies may have relatively little surrender value even though the death benefit remains significant.
That difference is one reason a policy should be evaluated before it is surrendered.
Life Settlement vs. Surrender: What's the Difference?
Both a life settlement and a surrender can result in the policyowner giving up an existing life insurance policy, but the transactions are fundamentally different.
| Consideration | Life Settlement | Policy Surrender |
|---|---|---|
| Who Acquires the Policy? | A third-party buyer | The policy is terminated with the insurer |
| Amount Received | Negotiated purchase price | Available cash surrender value |
| Death Benefit | Generally transferred to the new owner/beneficiary | Coverage terminates |
| Future Premiums | Generally become the buyer's responsibility | No future premiums because the policy ends |
| Tax Treatment | Depends on the transaction and policy's tax basis | Gain above the policyowner's investment in the contract may be taxable |
| Transaction Process | May involve underwriting, offers, disclosures, and closing requirements | Generally handled directly with the insurance company |
The appropriate choice cannot be determined solely by comparing the settlement offer with the surrender value. The value of the death benefit being relinquished, future premiums, taxes, family objectives, estate planning, and alternatives to giving up the policy should also be considered.
Why Might Someone Consider a Life Settlement?
Life insurance needs can change substantially over time. A policy that served an important purpose when it was purchased may no longer fit the policyowner's circumstances years or decades later.
Reasons someone might evaluate a life settlement include:
- The original need for the death benefit no longer exists
- Beneficiaries no longer depend on the coverage
- Estate planning objectives have changed
- Business or succession planning needs have changed
- Premiums have become difficult or undesirable to maintain
- The policy requires more funding than originally anticipated
- The policyowner is considering surrendering or allowing the policy to lapse
- Other assets are now available to address the financial need the policy was intended to cover
None of these circumstances automatically means a policy should be sold. They are reasons to evaluate the policy and available alternatives.
Who May Be a Candidate for a Life Settlement?
There is no single age, policy size, or life expectancy that universally determines whether a policy will qualify for a life settlement.
Life settlement buyers evaluate transactions based on a number of factors that can include:
- The insured's age and health
- Estimated life expectancy
- The amount of the death benefit
- The type of life insurance policy
- Current policy values
- Premiums required to maintain the policy
- Policy loans or other encumbrances
- The insurer and contractual provisions
Generally, the economics become more attractive to a potential buyer when the expected cost of maintaining the policy is lower relative to the death benefit and the expected period before the death benefit is paid is shorter.
Market conditions and buyer requirements can also change. A policy that does not attract an offer today may be evaluated differently at another time, and two buyers may value the same policy differently.
Eligibility Is Not the Same as Suitability
A policy may qualify for a life settlement without selling it being the best planning decision. The transaction should be evaluated in the context of the policyowner's family, financial, estate, and insurance objectives.
How Does the Life Settlement Process Work?
The exact process varies by transaction and jurisdiction, but a life settlement generally involves several stages.
Policy Review
Policy information is gathered to understand the death benefit, cash value, premiums, guarantees, loans, and projected cost of maintaining the coverage.
Health Evaluation
With appropriate authorization, medical information may be reviewed so potential buyers can evaluate the insured's health and estimated life expectancy.
Market Evaluation
Potential buyers evaluate the policy economics and determine whether they are interested in making an offer.
Offer and Closing
If an acceptable offer is received, transaction documents are completed and ownership and beneficiary rights are transferred according to the applicable process.
A policyowner is not required to accept an offer simply because the policy has been evaluated.
Depending on the state and transaction, additional disclosures, licensing requirements, privacy protections, escrow procedures, or rescission rights may apply. State-specific requirements should be confirmed before completing a transaction.
What Determines the Value of a Life Settlement?
A life settlement buyer is purchasing the economic rights associated with the policy while also assuming the obligation to maintain the coverage.
As a result, the value of an offer is influenced by both the expected death benefit and the expected cost and timing associated with receiving it.
Factors can include:
- Policy death benefit
- Estimated life expectancy of the insured
- Current and future premium requirements
- Policy cash value
- Policy guarantees
- Outstanding policy loans
- Policy type and contractual provisions
- Financial strength and characteristics of the issuing insurer
- Required return assumptions of potential buyers
- Competition among buyers
Because buyers may use different assumptions, offers for the same policy can vary.
This is one reason understanding how a policy is marketed and whether multiple potential buyers are considered can be important when evaluating a settlement.
What Are the Costs and Risks of a Life Settlement?
A life settlement can create liquidity from an asset the policyowner no longer wants to maintain, but there are meaningful tradeoffs.
The Death Benefit Is Given Up
Once the policy is sold, the original policyowner generally no longer controls the policy or receives its death benefit. Beneficiaries who would otherwise have received the proceeds may receive nothing from that policy when the insured dies.
Transaction Costs Can Reduce the Amount Received
Life settlement transactions may involve broker compensation, provider expenses, or other transaction costs. The policyowner should understand how parties to the transaction are compensated and how those costs affect the net proceeds.
The Transaction May Have Tax Consequences
A life settlement can result in taxable income. The amount and character of taxable gain depend on the facts of the transaction, the policyowner's investment in the contract, and applicable tax law.
Personal and Medical Information Is Shared
Evaluating a life settlement commonly requires access to medical and policy information. Policyowners should understand who will receive that information, how it will be used, and what privacy protections apply.
Future Insurance Options May Be Affected
Selling a policy does not necessarily mean the insured can later replace the coverage. Age, health, financial underwriting, available products, and the amount of insurance already in force can affect the ability to obtain additional coverage.
A policyowner who may need life insurance in the future should consider this before permanently transferring an existing policy.
How Are Life Settlements Taxed?
The federal income tax treatment of a life settlement can be more complicated than the tax treatment of simply surrendering a policy.
When a life insurance policy is surrendered, proceeds received in excess of the policyowner's investment in the contract are generally included in taxable income.
A sale of a life insurance policy to a third party can involve different tax rules and information-reporting requirements. The buyer, insurer, and seller may receive or provide tax reporting associated with a reportable policy sale.
Special rules may also apply to certain viatical settlements involving an insured who is terminally or chronically ill.
Tax Treatment Should Be Evaluated Before the Policy Is Sold
The gross settlement offer is not necessarily the amount the policyowner ultimately keeps. Tax basis, gain, transaction costs, policy loans, and the specific structure of the transaction can affect the economic result. Tax consequences should be reviewed with a qualified tax advisor before completing a sale.
What Should You Consider Before Surrendering a Life Insurance Policy?
Surrender is relatively simple, which can make it easy to overlook alternatives.
Before terminating a policy, it can be useful to determine:
- Why the policy is no longer wanted or needed
- Whether the original planning need still exists
- The current cash surrender value
- The current death benefit
- Whether policy loans are outstanding
- What future premiums are required
- Whether the death benefit or premium can be reduced
- Whether existing policy value can help support future premiums
- Whether a 1035 exchange or another policy change should be evaluated
- Whether the policy may have value in the life settlement market
An in-force illustration can be particularly useful when evaluating a universal life policy because it can show how the policy is projected to perform under current assumptions and different funding scenarios.
For some permanent policies, it may also be possible to reduce or stop future premium payments without immediately terminating the coverage, depending on policy values, guarantees, charges, and future performance.
What Are the Alternatives to Selling or Surrendering a Policy?
If the reason for considering a life settlement is that the policy no longer fits the owner's objectives, it can be useful to determine whether the policy itself can be changed before giving it up.
Potential alternatives may include:
- Keep the policy as currently structured: The existing death benefit may still provide meaningful value relative to the future premiums required.
- Reduce the death benefit: Depending on the policy, reducing coverage may lower the amount of premium required to maintain it.
- Change the funding strategy: Existing policy value or a different premium schedule may support the coverage differently.
- Use policy values: Depending on the contract and circumstances, accumulated value may be available through withdrawals or loans, although doing so can affect policy performance and taxes.
- Exchange the policy: A life insurance 1035 exchange may allow an existing contract to be exchanged for another qualifying policy without immediate recognition of gain, subject to applicable requirements.
- Convert term coverage: If the policy is convertible term insurance, available term life insurance conversion options may be worth evaluating before the conversion privilege expires.
- Sell the policy: If the coverage is no longer needed and the policy qualifies, a life settlement may provide an alternative to surrender or lapse.
Not every alternative is available with every policy, and changing one component can affect other policy values or guarantees.
This is why an independent life insurance policy review can be useful before making an irreversible decision.
Four Questions to Ask Before Selling a Life Insurance Policy
Do I Still Need the Death Benefit?
Consider whether family, estate, charitable, business, or other planning objectives still depend on the coverage.
What Is the Policy Worth Today?
Understand the cash surrender value, death benefit, loans, guarantees, premium requirements, and current policy projections.
What Alternatives Are Available?
Evaluate whether keeping, modifying, exchanging, reducing, surrendering, or selling the policy better fits the planning objective.
What Will I Actually Receive?
Compare the net economic result after considering the settlement amount, surrender value, taxes, transaction costs, and death benefit being relinquished.
The Bottom Line
A life settlement can provide an additional option for a policyowner who no longer wants or needs an existing life insurance policy.
But the decision should not begin with the question, “How much can I sell my policy for?”
It should begin with understanding why the policy was purchased, whether that need still exists, how the policy is performing, what it will cost to maintain, and what alternatives are available.
For some policyowners, surrender may be appropriate. For others, a life settlement may produce a better economic result. And in some cases, keeping or modifying the existing policy may provide more value than either option.
The objective is to understand those alternatives before making a decision that permanently gives up the coverage.
