Is a Life Settlement Right for Your Client?

For some clients, retirement isn’t a bed of roses. Living on a fixed income when inflation drives prices up can put some older clients in a tough spot. Your client might tell you about ads they have seen on TV for structured settlements, specifically life settlements, and wonder whether they get can get money from their life insurance policy before they die. As their accountant, you need to have all the facts to help them make an informed decision.


Certain companies will buy a person’s life insurance policy, list itself as the new beneficiary, take over the premium payments and wait for the policyholder to die. Life insurance is designed to pay off upon the death of the insured. Whole life insurance builds cash value with level premiums for the entirety of a person’s life. As long as the policyholder keeps paying the premiums, the policy can’t be cancelled, like a contract. Term life insurance, on the other hand, does not build cash value and runs for only a set number of years. A person will need to buy another policy if she wants to continue to have insurance coverage. This strategy can still work if the person owns a term life policy, but it needs to be converted to a whole life policy.

Older people living on a fixed income may find that they need cash and are sitting on a big payoff that takes place only after they no longer need it. 

How Life Settlements Work

Perhaps your client built up cash value in their policy and could really use cash now. A logical solution would be to borrow against the cash value of the policy, but they might want more money. Selling the policy to a third party provides an opportunity for the policy owner to immediately get more than the cash value but less than the face amount of the policy.

The ideal seller, from the buyer’s point of view, is someone aged 65 or older who owns a whole life policy with a face value over $100,000. These buyers usually are seeking people who are really old or really ill.  

When you consider health checks, the process of selling a life insurance policy is the opposite of buying one. Insurance companies want to insure healthy people. When selling a life insurance policy, the policyholder will need to provide a lot of medical information. Buyers are typically looking for people who are ill or won’t be alive much longer. If your client is elderly and in great shape, they might find that few buyers are interested in the policy. It’s a grim business.

Not So Fast…There Are Restrictions

Selling life insurance policies is a regulated industry. Brokers are expected to act as fiduciaries representing the client. According to Forbes, the commissions can be as high as 50 percent of the selling price, although the example provided by Forbes has a maximum of 30 percent of the payment, or 8 percent of the face value of the policy. 

As the policy owner, your client can choose not to go through a broker (and avoid their fees) by selling the policy directly to a licensed buyer. Your client should shop around since they don’t have a broker acting as a fiduciary.

Many states now require a minimum of two years before a policy can be sold after it has been written. Ten states have a five-year waiting period, while seven states are unregulated. Some states require the policy owner to be terminal or be in a condition that prevents them from performing certain daily activities. Those are called viatical, not life settlements.

Keep in mind that the money the seller receives may be taxable, and this can cause problems if they are collecting Medicare benefits.

Are There Alternatives?

Since you are providing financial planning advice for your client, you might want them to consider other alternatives. Accessing the cash value of the policy is one strategy. Doing a 1035 exchange between insurance products is another. It doesn’t create a taxable event, and the client could transfer their money into an annuity, providing income for their lifetime or a set period. When the period of payments is only for a set number of years, this is called an annuity certain.

Life insurance policies are often customized products. Your client’s policy might have an accelerated death benefit feature if they are seriously ill and not expected to live long.  If this option is available, it is usually for people who have less than a year to live. They can do cash withdrawals, but only to pay for medical costs.

Suppose your client would be in better financial shape if they simply didn’t have to pay premiums anymore. They might ask an heir who is also the beneficiary to make those payments instead.

If your client intends to give money to a favorite charity, they might have named the nonprofit as the beneficiary on the policy. If they want to stop paying the premiums to reduce their expenses, they could donate the life insurance policy to the charity while they are still alive. The charity then acknowledges their gift, continues making premium payments and collects the death benefit when the former policyholder dies.

The Bottom Line

If your older client is stretched financially, consider whether they own an asset such as a life insurance policy that could be turned into cash.

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