Need More Retirement Income? Sell Your Life Insurance Policy!

April 8, 2009 by  
Filed under Financial

dollarbills150x131Did you know that there is now an “after market” for life insurance policies? If you are over age 65, there are companies that will buy your life insurance policy for more than the cash value. They will even buy term insurance, which has no cash value.

Who buys policies and why would they want them?

Institutional investments and pension funds buy policies to comprise a portion of the fixed income segment of their portfolio. The transaction is handled by life settlement companies that are legally bound to confidentiality and privacy. The pension fund that may buy your policy doesn’t know who you are or anything about you and could care less. For them, the transaction is all about the math.

Why would a person sell their life insurance policy?

Generally, the life insurance policy has outlived the need for which it was originally purchased. The kids are grown, education completed and the person’s 401(k) plan will provide for retirement.

In other cases, the sale averts a problem with the policy. For example…

Many Universal Life policies eventually reach a point where the original premium is no longer sufficient to carry the policy.
The premium required to carry a Universal Life policy to a certain age is dependent on mortality assumptions, insurance company expenses and interest rates. With the sharp decline in interest rates over the last few years, many UL policies now require a substantial increase in premium to keep them going.

Some policies have large loans. People may have tapped the cash value at some point and never paid themselves back. Some may have used the cash value to pay the premium.

My experience (over nearly 40 years) is most people do not pay the interest on the loan each year. If the policy owner doesn’t pay the interest, it is added to the principal. Over time, the loan and unpaid interest can eat up the entire cash value.

Eventually, the person finds themselves backed into a corner. They either pay the premium plus a huge interest requirement each year, pay the loan down or let the policy lapse.

Even if they do nothing, the policy will eventually collapse on itself for lack of sufficient cash value to pay the interest. When that happens, there are three bad results.

First, the insurance company sends the IRS with a report stating the gain. The gain is the excess of the total cash value (not counting the loan) over the total premiums paid.

Second, there is no money in the policy to pay the tax. It must come from other resources.

Third, the tax is ordinary income, not capital gain.

The third problem is a term policy that has reached the end of its term. It may have been a 10, 15, or 20 year level term. Despite what you may think, in the real world, many of my clients in their late 50’s or early 60’s who have a policy that is soon to expire, still want and need insurance coverage. When I go shopping on their behalf, I have to break it to them that the premium is substantially more than they were paying and/or their current medical condition (even for minor things) has put them a less favorable underwriting classification with a higher premium.

Selling a policy averts all these problems. There are a number of areas to which the funds received can be applied, which I’ll cover in a subsequent post. One application can quickly add substantial funds to a church’s endowment fund.

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Robert Cavanaugh, Platinum Author