What is a Life Settlement?

Mary McMahon
Mary McMahon

A life settlement is a sum of money paid to a person who surrenders a life insurance policy to a third party. The amount of the settlement is higher than the cash value of the policy, the amount the person would receive by canceling the policy and getting a payout from the insurance company. It is also lower than the face value, the money that will be paid out as a death benefit. The third party can hold on to the policy until it matures and collect the money, or bundle it for sale to another party.

Man climbing a rope
Man climbing a rope

Historically, when people decided to stop paying life insurance premiums or could not afford to maintain life insurance policies, their options were to allow the policy to lapse or to surrender it to the issuer in exchange for cash. The concept of the life settlement provides another option, where people can liquidate the policy for cash to cover medical expenses and other needs when they know they do not have long to live. A number of firms and brokers have risen up to capture the life settlement market.

Financial regulators have expressed some concerns about life settlements, and people considering this option should do their research with care. One concern is aggressive sales tactics, where people feel bullied or forced into the sale of a policy by salespeople. Another is the risk that people may not get the best value out of the policy. Comparison shopping is advisable and people may also be able to access options like getting an advance on life insurance from the insurance company, allowing them to retain the policy and bequeath the remainder of the death benefit to survivors.

There are also potential tax penalties with a life settlement. Like other assets, life insurance policies are taxable when they pay out and people may be faced with taxes for a life settlement. One option to address this problem in the United States is a 1035 exchange, where a person exchanges one life insurance policy for another without tax penalties. This is allowed by the Internal Revenue Service and accountants and insurance agents can provide people with more information.

People who need cash in a hurry to handle expenses should contact their insurance agencies first to see what kinds of options are available for using their life insurance policies for financing. They can also explore the possibility of a life settlement or another financial arrangement. Accountants and personal finance advisers can provide people with information about their options and may have recommendations specific to particular financial situations.

Mary McMahon
Mary McMahon

Ever since she began contributing to the site several years ago, Mary has embraced the exciting challenge of being a wiseGEEK researcher and writer. Mary has a liberal arts degree from Goddard College and spends her free time reading, cooking, and exploring the great outdoors.

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