Many seniors are using life-insurance policies to raise cash. If you, too, are considering selling a policy through a life-settlement broker, consider the following questions:
1. Do I still need the insurance? If you're 65 or older, or if you have health issues, you may be unable to replace the insurance (or unable to afford to). So think about why you got the policy in the first place. If you still have a mortgage in retirement or are supporting or educating children or grandchildren, you should probably keep the insurance.
2. What's the net payout? The key is what you'll keep after taxes. A life settlement is the sale of an asset, a taxable event. The tax specifics are up in the air in Congress and the courts. So most sellers make a three-tiered tax calculation: First, you don't owe taxes on the premiums you've paid through the years (minus any outstanding policy loans). Second, you owe ordinary income taxes on the difference between premiums paid (your basis) and the cash value. Third (and this is the big break), you pay capital gains on the amount by which the payout exceeds the cash value which is likely to be most of the haul.
3. Is there a way to save on the cost of insurance? If you need insurance in old age but can no longer afford it, you may have other options besides a settlement. Universal life, for example, has built-in flexibility in what you pay. If you have ample cash value, you may be able to skip or reduce your premiums for a while without danger that the policy will lapse.
4. Would a policy loan work instead? If you need cash and want to keep the insurance in effect, you can take a policy loan up to almost the amount of the cash value. You won't get nearly as much as in a life settlement, but your beneficiaries will still get the bulk of the death benefit tax-free when you die (the benefit payment is reduced by the loan principal and accrued interest). There's no tax on loan proceeds and no requirement to repay the money, as long as you don't let the policy lapse.
5. What about family members? If you are ill and have only a year or so to live, it would be crazy to sell the policy for any amount (or to let a family member with power of attorney do so). Your insurer may offer accelerated death benefits, freeing up money while you're still alive. Your heirs might pitch in to help pay the premiums or lend you the money because they'll end up with a much bigger and tax-free payout if you maintain the coverage.
Kimberly Lankford is a contributing editor to Kiplinger's Personal Finance magazine. Send your questions and comments to [email protected].