Cashing Out Your Life Insurance Policy: A Guide

Quick answer

• Cashing out a life insurance policy often means selling it to a third party through a life settlement.
• This process is typically for individuals with significant health issues and substantial policy values.
• You may receive more than the policy’s cash surrender value but less than the death benefit.
• Understand the tax implications; life settlement payouts may be taxable.
• Consider consulting a financial advisor and a life settlement broker.
• It’s a complex transaction, so thorough research and professional guidance are crucial.

What to check first (before you buy or change coverage)

Coverage needs

Before considering cashing out, re-evaluate why you initially purchased life insurance. Is the original purpose still relevant? If you have dependents who still rely on your income, or significant debts that would burden your family, cashing out might leave them unprotected. Consider if your financial situation has changed such that the death benefit is no longer a necessity, or if you have accumulated sufficient assets to self-insure your beneficiaries.

Deductibles and premiums

When looking at a life settlement, the “cost” isn’t a deductible in the traditional sense. However, you need to understand the potential payout versus the premiums you’ve already paid and the policy’s cash surrender value. The life settlement company will offer a lump sum that is typically more than the cash surrender value but less than the death benefit. You also need to consider that once the policy is sold, no further premiums are paid by you, and your beneficiaries will receive nothing upon your death.

Exclusions and limits (general)

Life insurance policies, and subsequently life settlements, can have exclusions. Common exclusions might relate to the cause of death (e.g., suicide within the first two years of the policy). For a life settlement, the primary “limit” is the death benefit itself, as that’s the maximum amount a buyer could receive. The offer you receive will be a percentage of this death benefit, influenced by your life expectancy and the policy’s terms.

Claim process

The “claim process” for cashing out via a life settlement is different from a death benefit claim. It involves a sale of the policy. You’ll work with a life settlement broker who will solicit offers from various investors. The process includes medical underwriting to assess your life expectancy. Once an offer is accepted, legal and administrative steps are taken to transfer ownership and beneficiary rights to the buyer.

Bundling and discounts (general)

Life insurance policies themselves might offer discounts or be bundled with other insurance products. However, when considering a life settlement, the focus shifts from discounts to maximizing the payout for your existing policy. The buyer is essentially purchasing the future death benefit, and their offer will reflect their assessment of the policy’s value and your life expectancy. There are no “discounts” in the traditional sense for the seller in this transaction.

Step-by-step (simple workflow)

Step 1: Assess Your Current Situation

• What to do: Honestly evaluate your financial needs, health status, and the purpose of your life insurance policy.
• What “good” looks like: You have a clear understanding of why you’re considering cashing out and if it aligns with your long-term goals.
• A common mistake and how to avoid it: Assuming you must cash out due to financial pressure without exploring alternatives. Avoid this by first consulting a financial advisor to explore all options, including policy loans or modifications.

Step 2: Understand Your Policy’s Details

• What to do: Review your life insurance policy documents thoroughly. Note the death benefit, cash surrender value, premium amounts, and any riders.
• What “good” looks like: You know exactly what your policy is worth in cash today and what your ongoing obligations are.
• A common mistake and how to avoid it: Misunderstanding the cash surrender value or assuming it’s the only way to get money from the policy. Avoid this by calling your insurance provider directly to get an official statement of your policy’s current cash value.

Step 3: Determine Your Eligibility for a Life Settlement

• What to do: Life settlements are generally for individuals aged 65 or older, with significant health issues, and policies valued at $100,000 or more.
• What “good” looks like: You meet the general criteria for a life settlement, making it a viable option to explore further.
• A common mistake and how to avoid it: Believing a life settlement is available for any policy or any age. Avoid this by researching the typical requirements for life settlements before investing time.

Step 4: Research Life Settlement Brokers

• What to do: Find reputable, licensed life settlement brokers who act as intermediaries between you and potential buyers.
• What “good” looks like: You’ve identified brokers with good reviews, clear fee structures, and a history of successful transactions.
• A common mistake and how to avoid it: Choosing the first broker you find or one who isn’t licensed. Avoid this by checking state licensing boards and seeking recommendations.

Step 5: Obtain Multiple Offers

• What to do: Allow your broker to solicit offers from multiple life settlement providers.
• What “good” looks like: You receive a range of offers, allowing you to compare and negotiate for the best possible price.
• A common mistake and how to avoid it: Accepting the first offer without comparison. Avoid this by ensuring your broker presents all viable offers.

Step 6: Undergo Medical Underwriting

• What to do: You will need to provide detailed medical records and potentially undergo new medical examinations.
• What “good” looks like: Your health information is accurately and thoroughly presented, leading to a fair assessment of your life expectancy.
• A common mistake and how to avoid it: Withholding or misrepresenting medical information. Avoid this by being completely honest and providing all requested documentation.

Step 7: Review the Offer and Contract

• What to do: Carefully examine the final offer, including the net payout after fees, and read the settlement contract thoroughly.
• What “good” looks like: You understand all terms, conditions, fees, and the net amount you will receive.
• A common mistake and how to avoid it: Not understanding the fee structure or hidden costs. Avoid this by asking your broker to clearly break down all deductions from the gross offer.

Step 8: Consult with Professionals

• What to do: Discuss the offer and contract with an independent financial advisor and potentially an attorney.
• What “good” looks like: You have received unbiased advice on the financial and legal implications of the transaction.
• A common mistake and how to avoid it: Relying solely on the broker’s advice. Avoid this by seeking independent counsel to ensure your best interests are protected.

Step 9: Sign the Settlement Agreement

• What to do: If you accept the offer, you will sign the legal settlement agreement.
• What “good” looks like: All parties have signed the agreement, and the transfer process is officially underway.
• A common mistake and how to avoid it: Signing without fully understanding all legal ramifications. Avoid this by ensuring all your questions are answered during the review phase.

Step 10: Complete the Transfer and Receive Funds

• What to do: The life settlement provider will take over premium payments and become the policy owner. You will receive the agreed-upon lump sum.
• What “good” looks like: You have received the funds and the policy has been legally transferred.
• A common mistake and how to avoid it: Not confirming receipt of funds or the completion of the policy transfer. Avoid this by tracking the process and confirming the funds have cleared your account.

Common mistakes (and what happens if you ignore them)

Mistake	What it causes	Fix
Not understanding policy value	Accepting a low offer or missing out on potential cash surrender value.	Get an official statement of your policy’s cash surrender value from your insurer.
Ignoring health status impact	Receiving a lower offer than you might be eligible for, or being ineligible.	Be transparent and thorough with your medical information during underwriting.
Working with an unlicensed broker	Potential for scams, unfair pricing, or mishandling of your personal data.	Verify broker licensing with your state’s insurance department.
Accepting the first offer	Leaving money on the table; not getting the best possible price.	Ensure your broker obtains multiple competing bids from various settlement providers.
Not considering tax implications	Unexpected tax liability on the settlement payout.	Consult a tax advisor to understand the potential tax treatment of the funds received.
Failing to consult independent counsel	Agreeing to unfavorable contract terms or overlooking legal risks.	Engage an independent financial advisor and/or attorney to review the settlement agreement.
Misrepresenting medical history	Contract invalidation, legal disputes, or denial of payout.	Provide complete and accurate medical records; disclose all known conditions.
Not understanding the contract	Unforeseen fees, unclear terms, or unexpected obligations.	Read every clause, ask questions, and have an attorney review the document before signing.
Rushing the process	Making hasty decisions, missing crucial details, or accepting a poor offer.	Allow ample time for research, professional consultation, and offer comparison.
Forgetting about beneficiaries	Leaving your loved ones without financial support if that was the original goal.	Re-evaluate your beneficiaries’ needs and ensure alternative provisions are in place if necessary.

Decision rules (simple if/then)

• If you have dependents who rely on your income, then do not cash out your policy because it will leave them unprotected.
• If your policy’s cash surrender value is substantial and your health is excellent, then explore policy loans or surrendering the policy directly before considering a life settlement because these might offer better terms.
• If you are younger than 65 and in good health, then a life settlement is likely not an option because most providers focus on older individuals with significant health issues.
• If your policy death benefit is less than $100,000, then a life settlement is unlikely to be profitable for investors, and you probably won’t receive a competitive offer because the transaction costs outweigh the potential gains.
• If you have not consulted a financial advisor about your overall financial plan, then do so before considering a life settlement because it’s a major financial decision that impacts your future security.
• If you do not understand the fees associated with a life settlement, then ask for a detailed breakdown because hidden fees can significantly reduce your net payout.
• If you are considering a life settlement due to immediate financial hardship, then explore emergency financial assistance programs or debt counseling first because cashing out your life insurance may be a last resort.
• If your primary goal is to leave an inheritance, then do not cash out your policy unless you have secured alternative assets to fulfill that legacy because the death benefit is specifically for that purpose.
• If you are unsure about the tax implications of a life settlement, then consult a tax professional because the proceeds may be subject to income or estate taxes.
• If you find a life settlement broker who guarantees a specific payout amount upfront, then be cautious because payouts are contingent on underwriting and market conditions.
• If your policy is a term life insurance policy, then you cannot cash it out because term policies do not build cash value and are only active for a specific period.

FAQ

What is a life settlement?

A life settlement is the sale of an existing life insurance policy to a third-party investor for a lump-sum cash payment. This payment is typically more than the policy’s cash surrender value but less than the death benefit.

Can I cash out any life insurance policy?

Generally, only permanent life insurance policies (like whole life or universal life) that have accumulated cash value are candidates for a life settlement. Term life insurance policies typically cannot be cashed out.

Who typically sells their life insurance policy?

Sellers are usually older individuals (often 65+) who may have declining health and no longer need the death benefit for their original purpose, or who need funds for medical expenses, long-term care, or to supplement retirement income.

How much money can I get from a life settlement?

The amount varies significantly based on the policy’s death benefit, your life expectancy, the type of policy, and current market conditions. You will receive a percentage of the death benefit, determined by a life settlement provider.

What are the tax implications of cashing out?

The tax treatment can be complex. In some cases, the payout may be considered taxable income, while in others, it may be tax-advantaged. It’s crucial to consult a tax professional for personalized advice.

What is the difference between a life settlement and a viatical settlement?

Viatical settlements were historically for terminally ill individuals. Life settlements are a broader category, typically for individuals with a life expectancy of a few years, not necessarily terminal.

What happens to the policy after I sell it?

The life settlement investor becomes the new owner and beneficiary of the policy. They will be responsible for paying the premiums, and they will receive the death benefit when the insured person passes away.

Is it always better to sell my policy than to let it lapse?

Not necessarily. If you no longer need the coverage and the cash surrender value is low, letting it lapse might be a reasonable option. A life settlement is usually considered when the payout is significantly higher than the cash surrender value.

How long does the life settlement process take?

The process can take anywhere from a few weeks to several months. It involves medical underwriting, obtaining offers, legal reviews, and administrative transfers.

What this page does NOT cover (and where to go next)

• Detailed legal requirements for life settlements in specific states.
• Specific tax laws or regulations regarding life settlement payouts.
• Advice on selecting specific life settlement providers or brokers.
• Alternatives to life settlements, such as policy loans or accelerated death benefits.
• How to manage the funds received from a life settlement for long-term financial security.