An Overview of Life Settlements
You may have heard of a life settlement before, but maybe you’re not sure exactly what it is or even if you’d be eligible. You just know it’s something to do with your insurance policy, but what is it really?
Simply put, a life settlement is an option you can pursue when, for various reasons, you no longer want to hold on to your life insurance policy and you need cash now. It’s worth noting that it’s different from a cash surrender and other terms you may be familiar with, so we’ll go over exactly how it works and why people choose to pursue it instead of other options.
More specifically, here’s what we’ll cover with this overview:
- What is a life settlement and how does it work?
- How do you know if you’re eligible?
- The different types of life settlements.
- Differences between life settlements and cash surrenders.
- The factors determining the value of a life settlement and how much you will get.
- Is a life settlement right for you?
By the end of it, you’ll have a really good idea of how life settlements work and if they’re the right option for you.
What Is a Life Settlement? How Does It Work?
A life settlement is the sale of your existing insurance policy to a third party for a cash payment. The result is that the third party assumes the payment of premiums and they also become the beneficiary.
In the right scenario, it’s a win-win for both parties:
- You receive cash now and no longer have to make premium payments
- The purchaser receives the death benefit but has the responsibility of making payments
It can be a useful option to pursue for a number of reasons, including retirement, skyrocketing premiums or emergencies.
To have a better idea of when is the right time to pursue a life settlement, it’s a good idea to first look at eligibility for the different types.
How Do You Know If You’re Eligible for a Life Settlement?
While life settlements have become more flexible in recent years, there’s two primary factors that you should look at to determine general eligibility:
- The life insurance policyholder is 65 years or older
- The death benefit is at least $100k
The type of life settlement that you opt for will determine if additional eligibility requirements are necessary. We’ll go over these next.
The Different Types of Life Settlements
There’s a few different life settlements to be aware of, which differ due to eligibility requirements, potential payouts, and what works best for you. Here’s an overview of each of them.
Traditional Life Settlement
This is your “standard” life settlement option that is the most common.
The two main requirements here are that you are at least 65 years old and have at least a $100,000 death benefit.
These traditional life settlement benefits are also accompanied by a change in health status. However, if a policyholder is terminally ill, then a viatical settlement may be available.
Viatical Life Settlement
Similar to a traditional life settlement, viatical settlements allow a third party to assume payments and receive the death benefit while the policyholder receives a large amount of cash now.
The main difference is that viatical settlements have stricter eligibility requirements – but also potentially pay a lot more.
Consider someone who is diagnosed with a terminal illness. They may be facing high medical bills and expenses in order to cover treatment. In this sense, a viatical settlement may help them cover their costs and put money in their pocket now.
Since the policyholder is chronically or terminally ill, viatical settlements could provide a much higher payout than other options.
Healthy Life Settlement
One option that is growing in availability are healthy life settlements. It’s true that being healthy is no longer an obstacle to obtaining a life settlement.
The main difference is that the standard eligibility requirements are usually increased. As opposed to being at least 65 years old and having a $100,000 death benefit, healthy life settlements are usually for those that are at least 75 years old with a $250,000 death benefit.
Regardless of the type of life settlement, they are almost always a better option than a cash settlement.
What Is the Difference Between a Life Settlement and a Cash Surrender?
Whereas a life settlement occurs when you sell your life insurance policy to a third party – and they assume the death benefit and payments – a cash surrender is when you effectively cancel your policy and the insurance company returns the policy account value, less any fees.
Insurance companies benefit from cash surrenders because it means they no longer have to pay your death benefit after you have been paying into your policy for years.
On the other hand, when you opt for a life settlement with a third party, the insurance company still has to pay out your death benefit, which means there is a lot more money involved.
A cash surrender is simply canceling your policy and receiving the surrender value of the policy.
A life settlement keeps your policy active with a third party paying you and then assuming payments and retaining the future death benefit.
How Is the Value of a Life Settlement Determined?
There are a few factors to consider when trying to determine how much a life settlement will be worth. The primary factors include:
- Ongoing cost of the policy
- Length of time payments will be made
- Size of the policy benefit
In short, the value of a life settlement will fluctuate depending on your life expectancy and the ongoing expense of your life insurance premiums. A net present value is calculated using your individual actuarial underwriting, contract features on your policy and premium amounts.
Is a Life Settlement Right for You?
In any situation where you are considering a cash surrender or even just lapsing your insurance policy, it always makes sense to look at whether or not you would be eligible for a life settlement. If you meet the basic eligibility requirements – being at least 65 years old, having a $100,000 death benefit, or facing a chronic or terminal illness, then it is very much worth looking into a life settlement.
When we take out insurance policies, we do so with the intention of helping our loved ones who need it most – such as spouses or children. In cases where children become financially successful or a spouse is no longer around, it can make sense to reassess your life insurance policy and see if a settlement would make sense.
In other scenarios, a life settlement can be a great option if you simply need cash now. From covering existing bills to helping with unforeseen financial issues, a life settlement can be the best way to maximize the amount of money you can get from your life insurance policy while still being alive.