For many life insurance holders, life settlements might be an attractive option to get cash for or just simply get rid of their policies. But as one financial expert notes, that’s not always the best option.
“[T]he sale of a policy will often create taxable income,” wrote Adam Balinsky, president of US-based specialty lender Fifth Season Financial, in an article for ThinkAdvisor. He also cited complicated transaction processes and inefficiencies in the life settlement market, which could spell a six-month-long wait between a policyholder initially discussing a sale to finally receiving compensation.
Accelerated benefit riders are one alternative tool seen to have limited drawbacks. Allowing ill policyholders to access funds during their lifetime, such riders are often narrow in their availability; according to Balinsky, funds are typically paid out when the person in question is expected to live for fewer than 18 months more. Though accelerated benefit advances are generally capped to 30% to 60% of the policy’s face amount, Balinsky said they can be a low-cost option to quickly access funds.
Another alternative to an all-cash life settlement is a retained death benefit sale. As Balinsky explained, that hybrid transaction involves selling only a portion of the policy’s death benefit; the insured gets a lump-sum payment and keeps a portion of the death benefit, while the buyer agrees to cover all future premiums. But such transactions result in a lower upfront payment, less access to the policy, a capped long-term benefit that leaves heirs with smaller benefits, and potential tax implications.
“Perhaps the biggest blind spot for those considering a life settlement is the availability of third-party lending solutions,” Balinsky said, noting that they are often more flexible and better-suited to the needs of the insured. Aside from providing quick access to a significant portion of a policy’s death benefit, he said many loan transactions offer an ultimately higher total amount to the borrower and the borrower’s beneficiaries compared to what they can receive in a life settlement.
“The policy is kept in place and remains active while the lender handles the remaining premium payments and out-of-pocket expenses,” Balinsky said, adding that the advance ultimately gets repaid from the proceeds of the policy. While he cautioned advisors and clients to consult with tax professionals, he noted that such loan transactions are generally not treated as taxable income.
“Additionally, the borrower retains flexibility in case things change,” he wrote. “If, for example, the insured’s health status worsens, the insured can seek additional funds from the lender, or pay off the loan balance and sell the policy into the life settlement market at that time.”