The emotional stress of dealing with
one’s impending death due to a terminal illness like cancer, AIDS, etc., is
further compounded by the customary increase in medical bills and a likely
reduction in earning capacity.
A person owning life insurance
policies may have several options for reducing some of his or her financial
concerns.
Methods of
Reducing Financial Concerns
- Borrow against cash values: Permanent
type policies such as whole life, variable life, universal life, etc., build up
cash values over the years. The owner of the policy is usually able to borrow
money from the cash value, often at favorable interest rates. When death
occurs, the policy loans and any interest will be subtracted from the face amount
of the policy before payment is made to the beneficiary. If there is also a
“waiver of premium” provision the insured may be relieved of the monthly
premium payments, in certain circumstances.
- Surrender the policy: Policies
with accumulated cash values can be surrendered to the life insurance company.
However, this would generally not be desirable, since the face amount of the
policy is usually much higher than the surrender value and the time of death is
close. There may also be income tax consequences.
- Borrow funds from a third party: Other
friends, family members, and possibly the beneficiary of the policy may be
willing to lend money to the person who is terminally ill and then receive
repayment from the insurance proceeds.
- Accelerated death benefits: Some
life policies provide for payment of a portion of the face amount if the
insured becomes terminally ill. This is generally called a “living benefit” or
an “accelerated death benefit.” Even if it is not mentioned in the policy the company
may have extended the right to the policy owner; the availability of such benefits
should be investigated. Some companies require the owner to have a life
expectancy of from six to nine months or less. Terminally ill persons
(diagnosed by a physician as expected to die within 24 months) may receive
accelerated death benefits free of federal income taxes. Chronically ill
individuals may also exclude from income accelerated death benefits which are
used to pay the actual costs of qualified, long-term care. See IRC Sec. 101(g) for
more detail.
- Viatical settlements: Another
option is to sell one’s life policy to a third party[1] in
exchange for a percentage of the face amount. This is called a viatical
settlement. It comes from the Latin word “viaticum” which means “supplies for a
difficult journey.” These settlements may also be available with contracts that
have no cash value such as individual or group term life insurance policies.
Factors which will determine the amount of the settlement include:
- The insured’s life expectancy is a factor. In
general, the shorter the period, the more a viatical settlement company will
pay. Some companies will accept up to a five year life expectancy, but many
prefer a shorter term of years.
- The period in which the company can contest
the existence of a valid contract must have passed, as well as the “suicide
provision” (typically two years after issue). This period may begin again for
policies that have been reinstated after a lapse for nonpayment of premium.
- The financial rating of the company that
issued the policy is important. A lower rating can result in a smaller
settlement.
- The dollar amount of the premiums is a factor.
The buyer of the policy is likely to be required to continue making the
payments for the remainder of the insured’s lifetime.
- The size of the policy is a factor. Most
settlement companies have upper and lower limits; for example, a top limit of
$1,000,000 down to a low-end limit of $10,000.
- The current prime interest rate is important,
since the buyer will compare the settlement agreement to other types of
investments.
After
examining the above factors, a settlement company will generally offer the owner
of the policy between 25% and 85% of the policy’s face amount. The settlement
amount may be received free of federal income tax under conditions similar to
those described above under “accelerated death benefits.”
Other
Considerations
- If the terminally ill person is presently
receiving benefits that are dependent upon his or her “means” (income or
assets), like Medicaid, food stamps, etc., he or she must weigh the effect of a
viatical settlement on these benefits. Benefits may be terminated or reduced
until the settlement amount is “spent down.”
- If the policy also has an accidental death or
dismemberment rider, those rights should be specifically retained by the
insured in the viatical settlement agreement. The time between applying for a
viatical settlement and having the cash is generally three to eight weeks.
However, this will depend on how quickly the medical information and
beneficiary release forms are in the hands of the settlement company.
- Most viatical settlement companies stress the
confidential nature of the transaction but they require the named beneficiary
to release any possible claim to the proceeds. If the insured does not want the
beneficiary to know of the illness, he or she may change beneficiaries just
prior to completing the settlement. If the estate were named as beneficiary,
the insured (owner) would be the only one who would need to sign the release
forms.
- If death occurs before the viatical settlement
is completed, with the insured’s estate as the beneficiary, the life insurance
proceeds would be paid to the estate and may be subject to probate
administration.
- Viatical settlement of group insurance
policies will usually require that one’s employer be notified.
- Confidentiality may also be lost if the policy
is sold by the settlement company in the “secondary market” to individual
investors, since a new investor would want to know the health status of the
insured.
- An escrow account is generally used to make certain
that the payment of the agreed upon amount is made to the insured shortly after
the insurance company notifies the escrow company that the ownership of the
policy has been transferred to the viatical settlement company.
- Several viatical settlement companies should
be investigated in order to negotiate the best offer.
Typical Uses
for the Cash Received Include
- Cover out of pocket medical expenses.
- Finance alternative treatments not covered by
existing medical insurance.
- Purchase of a new car or finance a dream
vacation.
- To be able to personally distribute cash to
loved ones.
- Ease financial stress to perhaps further
extend life expectancy.
- Maintain one’s dignity by not dying destitute.
- Pay off loans.
The
sale of one’s life insurance policies can have far reaching effects and should
be done only after consulting with one’s attorney, certified public accountant
or other advisors.
[1] Effective January 1, 2018, the Tax Cuts and Jobs Act of 2017 established a new requirement to report certain information when a life insurance policy is acquired in a “reportable policy sale.” A reportable policy sale refers to the acquisition of an interest in a life insurance contract, directly or indirectly, if the acquirer has no substantial family, business, or financial relationship with the insured, apart from the acquirer’s interest in the life insurance contract.
