What you need to know about life insurance settlements

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Your monthly life insurance premium may become less and less attractive once you retire. It’s a scenario that Dan Simon, a retirement planning consultant at Daniel A. White & Associates in Middletown, Del., has seen quite often, even with his own parents. “The cost of insurance had risen so much that it was becoming unaffordable. They were wondering if we really needed to keep this blanket now that the kids are all grown up? »

If you stop paying your premiums, you lose your life insurance coverage and your heirs won’t get back any of what you paid. If you cancel a policy with a cash value, a reserve of money has built up in life insurance, the insurer sends you a check for this amount, although it is much lower than the death benefit indicated .

Over the past 20 years, a third option has become widespread: selling your policy to a company, a practice known as life settlement, with the buyer receiving the death benefit when you die.

“It’s a bit morbid when you think about it. A group buys tons of policies from people who have fallen on hard times and can no longer pay for their insurance,” taking advantage of the death of the seller, says Simon. “In theory, they want you dead tomorrow. If you live another 20 years, it’s a bad investment for them.

Selling a life insurance policy isn’t usually a good deal for you either, and there are better alternatives to explore. Simon finds that people usually turn to selling a font when they’re desperate. Usually it’s because they’ve spent their other retirement assets or they’re dealing with high medical bills. “It’s a measure of last resort, like taking a reverse mortgage. I rarely see them working well for people, and they could end up causing massive damage to their estate,” he says.

It’s a flea market

When you sell a life insurance policy, you’re unlikely to get anything close to the value of the death benefit, especially after factoring in fees. The amount you will receive depends on your age and health. “The older and sicker you are, the bigger the payout,” says Chris Orestis, president of Retirement Genius, a Portland, Maine-based retirement advice website.

Ovid, a life settlement company, says qualified applicants receive between 5% and 80% of their death benefit under a life settlement. If you are in good health, you generally need to be at least 65 to sell your policy.

“Any type of life insurance, including term life, may qualify for a life settlement with a typical policy size of $100,000 or more in death benefit,” says Orestis.

A specific type of sale, called viaticum settlement, applies to terminally ill policy owners who have less than two years to live. Compared to a lifetime settlement, the typical viaticum payout is higher but still only around 50% to 85% of the policy death benefit depending on your life expectancy at the time of claim. according to the Illinois Department of Insurance. These figures are before brokerage and transaction fees to complete the transaction. They reduce your total payment by about 5%, according to the company, says Aaron Maassel, owner and founder of Voyageur Advisory Group in Maumee, Ohio.

But FINRA, a non-profit regulator for the financial industry, warns that fees can reach 30% of the total payment. These days, you’ll probably get even less money from the sale.

Payments for life settlements have fallen recently due to rising interest rates, Maassel says.

Life insurance companies typically borrow to fund your buyout. Higher rates cost the company more to borrow, so they pay less for the policy.

Simon suggests selling a life insurance policy only if you don’t have any family members who could use the money, such as a surviving spouse or children.

Better Alternatives

In this case, however, there is no shortage of ways to manage a life insurance policy that you can no longer afford. In some cases, you may be able to reduce premiums while preserving the death benefit for your survivors, or even turn the policy into a source of income.

Check the policy for accelerated death benefits. If you need money because you have a serious or terminal illness, the police may reimburse you while you are alive. Many companies include what is called an accelerated death benefit rider. If you are diagnosed with an eligible illness, the insurer will pay you part or all of your death benefit. This money is tax-free for someone with a terminal or chronic illness. If the policy doesn’t pay out the full death benefit during your lifetime, whatever remains goes to your heirs.

Pay using cash value. If your policy has a cash value, these funds can be used to cover your future life insurance premiums. “It’s a way to extend the policy without paying out of pocket,” says Simon. He cautions, however, that reducing your cash value reduces the overall death benefit of the policy. Also, once you’ve spent all that cash value, you’ll have to start paying premiums again or the policy will expire.

Reduce the death benefit. Some life insurance companies offer policyholders the option of converting their policy to a policy with a smaller death benefit. The insurer considers any cash value and what you have already paid before reissuing a smaller policy that no longer charges premiums. “This allows a policy owner to retain a portion of their death benefit without making future payments,” Orestis says. You can also convert a lifetime permanent policy to a paid-up term policy with the same death benefit, but the coverage will have an expiration date, like five or 10 years.

Exchange for another life insurance policy. A 1035 exchange allows you to transfer money from one life insurance policy to another without paying taxes, says Simon. You can swap your existing policy for a cheaper one with a smaller death benefit this way. You will need to go through medical underwriting to set up the new policy, he warns. You can also upgrade to a policy with more desirable features. For example, Simon finds that when his clients retire, they often become less concerned about life insurance and more concerned about the high cost of retirement homes. Your current policy can help pay that bill. By using the 1035 exchange, you could get a hybrid policy that combines life insurance with long-term care coverage that pays part or all of the death benefit for the cost of that care. If you do not need long-term care, your heirs receive the full death benefit.

Convert to an annuity. A cash value life insurance policy can also be converted to an annuity through a 1035 exchange. “You won’t owe any taxes on the transfer, and you won’t have to pay future premiums for the annuity,” says Maassel. During this time, the annuity could earn you income. You can start collecting annuity payments whenever you want. Otherwise, the balance will continue to grow tax-deferred for your heirs. Maassel notes that some annuities offer an enhanced death benefit. If you die shortly after making the transfer, the insurer pays around 25 to 30% more to your heirs on top of what you have invested. Annuities are less liquid than the cash value of life insurance. “The company may allow you to withdraw 10% of your deposit as a lump sum, but otherwise penalties could apply,” Maassel explains. In addition, your heirs will have to pay income tax on any annuity balance that exceeds what you paid in insurance premiums, whereas a life insurance death benefit would be tax exempt on Income.

Ask your heirs for help. Ultimately, it is your heirs who will eventually benefit from your life insurance. If paying for it becomes too much for you, Simon recommends having a family conversation about what to do. Tell them, “We can’t swing that anymore. The advantage is for you guys. Do you want to take over the payment of the premium? This way, your family members and other heirs can decide if the payout fits into their own financial plans. In Simon’s case, he and his siblings decided not to. “I told my parents to withdraw their cash value and enjoy.”

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