With the current economic crunch, many seniors are finding it harder and harder to make ends meet. One option we have written about before in our blog are reverse mortgages (Considering a Reverse Mortgage? Be VERY Careful, July 7, 2009). We recommended they be considered only as a last resort. Another relatively new option for some seniors to raise needed cash involves what are called “Life Settlements”.

A Life Settlement involves selling a cash value life insurance policy to someone other than the issuing insurance company. The party buying the policy is buying the right to your death benefits when you die. You can typically receive more than the cash value of the policy but less than the face value of the policy. Life Settlements typically are available to people who have life expectancies between two and ten years. The amount you can receive depends on your age, health and the terms of your life insurance policy.

While the promise of significant cash may be tempting, this new market has become quite intense with many participants, in some cases, vying to take advantage of seniors who may not be able to properly evaluate an offer. It is important, therefore for you to do your homework before selling a life insurance policy.

Here are some things you need to consider:

(1) Do you no longer need your policy? If you will need to replace your existing policy, you need to be sure you are still insurable and that purchase of a new policy will be cost effective. Life Settlements can trigger significant taxes if the amount you receive exceeds the total of premiums you paid. If you need to reduce the cost of your current policy, you may want to consider replacing it with another policy through what the IRS calls a 1035 exchange which can be done tax-free.
(2) Consider other, less costly alternatives, You may be able to borrow against your policy, or, depending on your policy’s terms and your health status, you may be able to receive accelerated death benefits. You may be able to downsize your home or possibly consider a reverse mortgage (not our favorite option).
(3) Shop around. It’s difficult to determine what a fair price is for your policy. What commissions will be received. Often, commissions can be as high as 30%.Get several quotes. If your state so requires it make sure the life settlement company or broker you are dealing with is properly registered. Check with your state insurance commissioner to see what regulations your state has and what information the state can provide.
(4) Ask the buyer how you can protect your privacy. What is their privacy policy and how will they protect your personal information.
(5) Review what your tax liability will be as a result of the sale. As we already noted, proceeds in excess of the total premiums you paid for your policy are taxable as ordinary income.