Selling a life insurance policy: What you need to know

Information Courtesy of USAA Life Insurance Company and USAA Life Insurance Company of New York

If you've owned a life insurance policy for a long time, there's a chance you've asked yourself if it's still worth it. Maybe you've paid off your debts, have adult children and are now living off retirement assets. Making premium payments for the "what if" — or a big payout to your beneficiaries — may not have the same financial impact as it once did.

So, when you see an advertisement claiming you can sell your life insurance policy for cash, you may be tempted. After all, a cash value component may have been an appealing feature of your current policy.

As with all financial decisions, there are risks to separating from your policy. Read on for important factors to consider.

What's the difference between selling and cashing out your life insurance?

Let's start with the basics:

Selling a life insurance policy means agreeing to let a third-party company or person buy your life insurance policy from you in exchange for a cash payment that's lower than the death benefit. They, in turn, take over the premium payments and become the beneficiary when you die.

For example, maybe you have a $250,000 life insurance policy that you'd like to sell. A life settlement provider offers you a certain percentage of that death benefit in cash, and in exchange, they take over your policy. That life settlement provider then pays your premium payments going forward and receives the $250,000 when you die.

Cashing out a life insurance policy is a feature available on permanent life insurance policies that accrue cash value. It means surrendering the policy back to the insurance company and receiving any remaining cash value in exchange for canceling the coverage.

How does selling your life insurance policy work?

When it comes to selling your life insurance policy, you have two basic choices: a life settlement or a viatical settlement.

• A life settlement is the truest form of selling your life insurance policy. Consider this category if you no longer want to pay premiums, need immediate cash or no longer have a life insurance need.
• A viatical settlement is a type of life settlement where you have the option to sell your life insurance policy in the event of a chronic or terminal illness.

In both cases, you'd work with life settlement providers or life settlement brokers who would help you shop around for the best offer. In either transaction, you'd then sell your life insurance policy to one of these third parties for a lump-sum payment, which is a percentage of the death benefit.

After the provider takes over the premium payments, they become the policy's beneficiary.

Eligibility requirements for a life settlement

To assess whether someone qualifies for a life settlement, providers assess the age of the insured, their coverage amount, health status and policy terms. Sometimes it can be difficult to qualify because the requirements are so specific.

In most cases, providers request a medical evaluation to better understand life expectancy. The lower your life expectancy, the higher the percentage of the death benefit you may be offered due to the likelihood of quick returns for the buyer.

Once the provider has reviewed your eligibility information, they may make an offer to purchase your policy. After you review the terms, you can decide if it's right for you. You don't have to accept their offer.

When might it make sense to sell your life insurance?

If you're one of the few who qualify, it might be tempting to receive cash on hand for a policy you've been paying into for years. If this is the case, there are several reasons you might consider selling.

• You're positive that you no longer need life insurance and that you won't need it in the future.
• You have a mounting financial hardship, and this is your last resort for cash.
• You have a life-threatening illness and need the cash more than your beneficiaries need the benefit.
• You can no longer afford the premium payments and won't receive anything if you surrender the policy.
• You can get far more cash through the settlement than you'll get from the cash surrender value.

The National Association of Insurance Commissioners is a great resource for facts and detailed information to help you decide. Check out their guidance on Selling your life insurance policy: Understanding life settlements.^{See note1}

What are the alternatives to a life settlement?

Because life settlements have difficult eligibility requirements, they're not a common choice. Still, you might find that you're eligible and want to know if you have alternatives. Consider the following.

Receive cash value from permanent life insurance.

In the case of permanent life insurance, cash value is your best option if you're considering canceling your life insurance policy.

Of course, this requires that you have permanent life insurance. Unless you have a return of premium feature, term life insurance does not offer a cash value upon cancellation or surrender.

Remember, buyers will only purchase your policy under specific conditions. There's only a small likelihood that a term policy will qualify.

Get part of the death benefit if you have a terminal illness.

An accelerated death benefit is a feature that allows you to receive part of the death benefit if you get a terminal illness before the policy's maturity date. Some policies may call it an "early benefit payment" or "terminal illness rider."

Keep in mind that you may have to pay taxes on the accelerated benefit payment. As part of your due diligence, be sure to compare this choice with your insurance provider to that of a viatical settlement.

Work with your insurance provider.

Before taking a life settlement, call your life insurance provider to discuss your options. There may be better alternatives, such as payment options or borrowing from your cash value.

While selling a life insurance policy can provide immediate cash, it's important to consider the risks and consequences that come with that decision.

In addition to talking with your life insurance provider to understand your options, consult with a financial advisor or attorney who can help you make an informed decision.