Expatriate Tax Services LLC

Consider Selling Your Term Life Insurance

Published - June 25, 2008

This column usually covers the changes in United States tax law that invariably increase the amount of income tax an expatriate will pay or will discuss methods to minimize income tax. Today we are taking a different tack and will discuss how to turn a life insurance policy that has minimal cash value into a “cash cow”.

As one starts off in life with a young family and not much in the way of income, a term life insurance policy is usually the preferred method of being able to have a large amount of life insurance at a reasonable premium.

But a term policy is just that. It usually has a life of just one year and only renews if you pay the premium for the next year. If at any point in time you stop paying the premium the policy lapses and you no longer have life insurance and the policy likely has no cash value.

And as you get older the premiums increase significantly. And once you retire your income becomes fixed, while the annual premiums continue to increase. So one reaches a point where the annual premium is just too much to pay, and individuals allow the policy to lapse.

In the past few years a new business has developed around investors who are willing to buy your expiring policy, and pay the premiums on it until you die.

Life Settlement

A life settlement is a financial transaction in which a policy owner possessing an unneeded or unwanted life insurance policy offers the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.

Life settlements are an important development, in that, they have opened a secondary market for life insurance in which policy owners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.

Why would a policy owner sell his or her life insurance policy?

A life settlement may provide a better alternative than allowing an unneeded policy to lapse or to be surrendered for its cash value. Life settlements are considered for a variety of reasons, such as:

A policy is no longer wanted or needed (e.g. spouse dies, divorce, children

are grown and financially responsible, etc.)

Changes in estate, tax or financial plans or changes in law, etc. occurring

subsequent to policy issuance can cause an individual to consider lapse or

surrender of the policy

Funds are needed to pay long-term healthcare costs

Premium payments have become unaffordable as policy owners grow older

Investment in the insurance is no longer appropriate

Premium payment have become unaffordable as the policy owner grows older

Funds are needed to pay long-term healthcare costs

Who purchases life insurance policies in life settlements?

Today, multi-national banks, international corporate conglomerates, global insurance companies, pension funds, hedge funds and other major financial institutions- the same institutions that invest in life insurance companies- are purchasing life insurance policies through life settlements. Two of the largest insurance holding companies in the United States, Berkshire Hathaway and American International Group have been significant purchasers of life insurance policies.

Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for the client receiving a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.

Life settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to a third party.

What types of policies can be purchased?

Most life insurance policy types qualify for a life settlement, including universal, adjustable, variable, whole, survivorship, joint first to die, portable group and even term life (if convertible and assignable). Individuals, corporations, partnerships, trusts and charities can own policies.

How much will the owner be paid for his or her policy?

The amount to be paid to the owner of the policy depends upon a number of factors, including the face amount of the policy, the amount of premiums that will have to be paid to keep the policy in force, and the cash surrender value of the policy. Usually the owner will receive 15% to 25% of the face value of the policy

Are there any restrictions as to how I can use the settlement amount?

The selling policyholder is free to use the settlement as he or she chooses. Some owner use proceeds to purchase long-term care insurance. Others gift the money to family members, charities or fund investments. Still others use the money to enhance the quality of their lives.

What are the tax implications of a life settlement?

It is generally understood that the amount of the settlement that equals ones cost basis (usually the aggregate amount of premiums that have been paid) is not taxable. If one were to surrender one's policy, the amount in excess of one's cost basis up to the cash surrender value that one could get from the insurance company is taxed at ordinary income tax rates. The amount received in life settlement in excess of the cash surrender value is taxed as capital gain.

So before you decide to stop paying the premiums on your life insurance policy, you might want to consider selling it to an interested buyer.

Note: A portion of this column was adapted, with his permission, from a presentation given by Louis Farkas of Next Generation Financial Services