Life insurance is a valuable asset that can provide financial security to your loved ones in the event of your untimely death.
However, some individuals may find that they no longer need their life insurance policy or that they need money now.
If that is the case, viatical life settlements, life settlements, or living benefit riders can be helpful, which we will learn about in this article.
This article is written as general education, and should not be considered as personal financial advice. If you would like personal guidance with life insurance, you can schedule a time to talk with one of our experts.
Understanding the Basics
During the AIDS crisis many investment companies were purchasing life insurance policies from terminally ill insureds to provide much needed cash that many used for help with medical treatments.
These purchases are often referred to as viatical life settlements and still happen today for terminally ill people.
There are also ways to sell a life insurance policy to an external investor for those who aren't terminally ill, which is generally referred to as a life settlement.
Essentially, in a viatical or life settlement, the owner changes the ownership and beneficiary to the company for receiving a portion of the death benefit paid in cash.
In this arrangement, the viatical or life settlement company would assume any premium payments and would receive the death benefit upon the insured’s death.
Viatical settlements are used when the insured is terminally ill. Life settlements are used when an insured is generally healthy and no longer wants the policy.
With the emerge of settlement markets, insurance companies decided to introduce living benefit riders on life insurance policies to dissuade policy owners from selling their contracts to external third parties.
Living benefit riders usually provide a payout of a portion of the death benefit to the owner in the event that the insured has a terminal illness or is permanently confined to a nursing home.
The owner would continue to assume any premium payments and any remaining death benefit would then be passed to the beneficiaries at the insured’s death.
Consider Your Needs
Before deciding to sell your life insurance policy to a viatical/life settlement company or claim on a living benefit rider, it’s important to consider your own financial needs.
If you are in good health and anticipate living for many years, keeping your policy in place and paying the premiums may be more financially beneficial.
In this case, your beneficiaries will receive the full death benefit when you pass away and you may maintain access to any cash value and its possible future accumulation.
However, if you need immediate cash or no longer need the life insurance policy, selling it or claiming on your rider can be a helpful.
Understanding the Tax Implications
When you sell your life insurance policy or claim on a rider, there may be tax implications to consider.
The amount of taxes you may owe will depend on the option you choose and the specifics of your policy.
IRS code 101(g)(2) states that the amount paid by a viatical settlement company would be treated as a payout of the death benefit due to the insured’s terminal illness, and is therefore not taxable.
The IRS goes on to say that life settlements, because the insured is healthy, are not a payout of the death benefit, and may therefore possibly be taxable.
Living riders typically are typically not taxable when the insured is terminally ill or permanently confined to a nursing home.
Understanding the Costs
Selling your life insurance policy or claiming on a rider can be expensive, so it’s important to understand the costs involved.
The portion of the death benefit that the policy owner would receive is often calculated based on the amount of time the insured has left to live. The longer the life expectancy the less the payout, and transversely, the shorter the life expectancy, the larger the payout.
Policy owners need to understand that the amount of money they will receive if they sell or claim will be considerably less than the full death benefit amount.
Also, any future cash accumulation or death benefit increases will be given up in the event of the sale, or a claim may hinder the policy's ability to grow.
Selling your life insurance policy or claiming on a living benefit can be helpful in certain situations, but it’s important to carefully consider your options before making a decision.
If you are in need of cash there may be options inside of your policy through dividends, withdrawals, or loans to access the cash you need today and still keep the death benefit in place.
If you are no longer in need of the life insurance you may also want to consider surrendering (cancelling) your policy with the insurer instead of selling it.
Make sure you understand any taxes, surrender penalties, and costs that might exist no matter which option you choose.
Ensure you fully understand any agreement's details and exactly what you're giving up before signing on the dotted line.
Working with a financial advisor can help you determine the best course of action for your specific needs and circumstances.
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