If you’re short on cash and paying premiums on a life insurance policy that you no longer want or need, you may have considered surrendering or simply walking away from the policy.
While you’d no longer be eligible for the death benefit that you’ve been paying for all these years, you’d at least no longer be on the hook for premiums. In some cases, you might also receive a small amount of your money back, known as the cash surrender value.
But there may be a third option: selling your life insurance policy to a third-party investor, a process known as receiving a life insurance settlement.
The life settlement industry is a $3.4 billion business. Generally speaking, you’ll walk away with far more cash from the sale than you would from surrendering the policy, according to the National Association of Insurance Commissioners.
But while it might seem like an easy way to pad your income, life insurance settlements can be fraught with pitfalls.
There are potential tax implications, you could risk having your government benefits reduced, and your beneficiaries may not receive any insurance payout upon your death.
Here’s what you need to know to make an informed decision.
When you may be eligible
You’re most likely to be able to sell your life insurance if you’re over 65, and own a permanent insurance policy—aka universal or whole life—with a death benefit of $100,000 or more.
You may also be able to sell a term life policy that has an option to convert to permanent insurance.
“Life settlement is one of the times when being older actually helps you,” says Felix Steinmeyer, co-founder and CEO of Mason Finance, a firm that offers life insurance settlement products.
The exact amount of cash you’d get from selling your life insurance depends on several factors, including the size of your monthly premium, how much cash value has accrued, whether there are any loans against the policy, and your age and health.
Generally speaking: the shorter your life expectancy, the larger the payout.
There’s also a similar kind of settlement, known as a viatical settlement, that is only an option when the policy-holder is terminally ill.
In all cases, the funds you receive from a life settlement will be less than your policy’s death benefit, but greater than the cash value in the policy.
The amount you receive will also be reduced if you use a broker for the transaction. Broker fees can be as much as 30% of your life settlement, according to research from Magna Life Settlements.
And your beneficiaries may not receive any part of the death benefit.
Also, while regular life insurance death benefits are normally tax free, life settlement proceeds are often taxed. You could become ineligible for Medicaid due to the financial gain from the sale of your policy.
Talk to a tax professional to understand the potential implications for your situation.
When a life settlement makes sense
If you’re cash-strapped, or need more funds to help to cover medical bills, long-term care costs, or other retirement expenses, the money from a life settlement could bring you financial relief.
Additionally, a sale could be completed in as little as a week.
And with a life settlement, your life insurance premiums become the investor’s responsibility, allowing you to use the money you were spending on premiums for other purposes.
Before selling your entire policy, however, you should also be aware of other alternatives you may have.
You may be able to sell only a portion of your life insurance coverage, which would allow you to keep a chunk of the death benefit payout for your beneficiaries.
You may also be able take a loan from your insurance policy.
Finally, check with your insurer to find out whether you might be able to opt for an accelerated death benefit. That would allow you to receive part of your life insurance money early, while you’re still living.