Life Settlements vs. Cash Surrenders – What Are They and How Are They Different?
For various reasons, it is not uncommon for those approaching older age to take a look at their existing life insurance policy and see if it’s possible to get cash now. Internal and external factors can play a role in deciding what to do, such as:
- Unexpected medical expenses
- Rising costs of living associated with getting older
- The economy, value of the dollar
- Global pandemics
- Reducing overall expenses, such as canceling your life insurance policy
When staring down a potential personal financial crisis, two of the ways to leverage your life insurance policy for the most cash possible are life settlements and cash surrenders.
We’ll discuss what life settlements and cash surrenders are, their eligibility requirements, how they differ, and how you can come to a decision if one of them is right for you at this moment in time.
Overview – What is a Cash Surrender?
At its core, a cash surrender is the amount of money that you can withdraw from your policy if you were to voluntarily surrender it to your insurance company.
When the policy is surrendered, you no longer have to pay any premiums into it and you also forfeit the death benefit protection that it was affording. A cash surrender is different from borrowing or taking a loan against your policy, as those would allow you to take money out but keep the policy in force.
The cash value of your policy grows over time and may be much greater if your policy is 20 years old as opposed to 10.
The amount of money that you’ll get from a cash surrender is called the cash surrender value.
Your cash surrender value is determined by factors like how much you’ve paid into premiums, fees, and interest. When you pay the premiums on a cash value life insurance policy, such as a whole life policy, it’s distributed a few ways:
- Part of it goes into the death benefit that the policy provides
- Some is used to pay various fees associated with the policy
- Any reminder amount accumulates in account value within the policy.
To be eligible for a cash surrender, you typically need to have one of the more permanent life insurance policies, such as whole life. Additionally, you will have needed to pay into the policy long enough to make the equity in the policy worth more than the fees that can be incurred by choosing to cash out early.An alternative to a cash surrender is the option to sell your policy – which is also known as a life settlement.
Overview – What is a Life Settlement?
Life settlements occur when you sell your life insurance policy to a third party. Unlike a cash surrender, you are not forfeiting your policy, it’s premiums, or the death benefit, but rather transferring them to another party who in return will pay you to take over.
A few of the reasons that a person might choose a life settlement is retirement, unaffordable premiums, and emergency financial situations.
The third party is usually an institutional investor and the cash payment received by the policyholder, similar to other asset sales, may be subject to taxation.
One way to look at a life settlement is as a secondary market for life insurance policies. State regulations protect approximately 90% of US policy holders. Currently 43 states and Puerto Rico regulate various aspects relating to eligibility, disclosures, licensing, and so forth.
To be eligible for a life settlement, a few requirements typically need to be met:
- You’re 65 years or older
- There is a death benefit worth at least $100,000
For those that may not meet these requirements (or come just a tad shy), there are a number of life settlement companies that may allow you to still qualify – so it’s worth checking. The value of any policy is dependent on a number of factors from the size of the benefit to the age and health of the insured and, of course, the premium costs. Life settlements for those insureds with serious health conditions are called viaticals.
Two Key Differences Between a Life Settlement and Cash Surrender
A cash surrender happens between the policyholder and their insurance company, and a life settlement is between a policyholder and a third party.
When you choose to surrender your policy for a one-time payment from your insurance company, this transaction takes place purely between you and your insurance company. Comparatively, a life settlement happens when the policy itself is sold to a separate, third party.
Life settlements are typically worth more than a cash surrender.
If you qualify for a life settlement any offer for your policy will be larger than the surrender value of the policy. If this is not the case, you will be advised to surrender.
Which One is Right For You?
Determining whether you’d like to go with a cash surrender or life settlement comes down to your eligibility for either and how much each will pay.
If you’re at least 65 years old and have a death benefit of $100,000, you’ll definitely want to check to see if a life settlement is available. Likewise, if you’ve been paying into your policy for a long time and its whole life, then it would also make sense to see how much you would get for a cash surrender.
Whether you no longer need the coverage of your policy or just need cash now, either option is more likely to provide some cash in the near term compared to discontinuing payments and lapsing a policy.
The safest thing to do is to explore your options ahead of time if you think you may wish to discontinue your premium payments in the future – that way, you’ll know if you are able to receive any cash back for the policy, from either surrendering or selling.