FOCUS ON: Life Settlement

What Is A Life Settlement?
A Life Settlement is the sale of a life insurance policy that gives a policy owner a cash settlement in excess of the current cash value. Prior to the inception of life settlements, the only option for a person would be to surrender a policy for its cash surrender value, if any. If the policy was term insurance, the only option would be to discontinue premium payments (causing the policy to lapse), or convert to a more expensive type of permanent insurance. With a life settlement, the insured can sell their life insurance policy for a significant gain over the cash surrender value.

Individuals who are age 65 and older, who are experiencing a major health condition change, and own a life insurance policy, are the usual candidates for a life settlement. With a life settlement, you trade ownership of a life insurance policy, in return for a lump sum cash payment. The amount paid is determined by the settlement company who will obtain an estimate of your life expectancy, and make an offer greater than the cash surrender value if you qualify. The new owner would assume the premium paying responsibility and beneficiary rights.

Usually, individuals who qualify for a life settlement will have a life expectancy between 2 and 12 years. Anything less is considered a viatical settlement. A "viatical settlement" applies to individuals who are terminally or chronically ill. The Health Insurance Portability and Accountability Act (HIPAA) of 1996 defines terminally ill as being diagnosed by a certified physician to have a life expectancy of under 24 months. A chronically ill person is defined as being permanently and severely disabled by an illness.

Under the 1996 HIPAA Law, part of the income received through a Life Settlement may be subject to Federal Income Tax. The proceeds are tax free up to the amount invested into the policy (i.e. premiums paid less any dividends or loans received by the owner). Proceeds beyond the invested amount would be considered profit and may be taxed at either ordinary and/or capital gain tax rates. However, if the sale is considered a Viatical Settlement, the proceeds will not be subject Federal income taxes. Some states have made Viatical Settlements free of income taxes as well.

Sounds Good? There Are Disadvantages.

• The sudden influx of cash from your life settlement or viatical settlement may affect your eligibility for Medicaid and other public assistance programs.
• To understand whether or not you should get a life settlement you must first understand your broader financial picture, and the role, if any, your life insurance plays in that picture.
• When a person has a life insurance policy and names his spouse or children as the beneficiary, they will get the benefit income tax free. With a life settlement or viatical settlement the beneficiary is the company who bought your policy. Unless you truly need the money, you could be giving up a valuable future asset for less than it is worth.
• A life settlement should not be used to buy another life insurance policy or to fund an investment.

Life Settlements are an innovative wealth and estate planning tool. However, you need to consider the impact a “Life Settlement” can have on your personal financial and estate planning situation. You should consider a life settlement or viatical settlement if you truly need cash. In other words, it is strictly a last resort.