There are three parties to a life insurance plan; the beneficiary, the owner of the policy, and the insured. It is important to note, though, that the owner is not always the insured. For example, a grandparent may be the owner of a policy insuring their son or daughter, while the grandchild is the beneficiary.
While most people obtain life insurance as a means to provide financial support for dependents in the event of their death, there are many cases where life circumstances call for a change of plans. An individual may need to access cash from their insurance policy for some reason, or may need to switch policies due to an inability to continue paying premiums. In some cases, an investor may want to purchase the beneficiary position from the policy holder as an investment. There are several strategies for policy holders to consider:
With whole life, the premiums that are paid into the policy accumulate over time as the ‘cash value’ of the life insurance policy. If someone decides that they want collect this money, they can request that the insurance company close the account and pay out the cash surrender value. This will result in the cancellation of the death benefit to the beneficiary.
If the premiums become unbearable, or if a whole life policy owner simply needs to access the cash, they may choose to cash out the policy, and then purchase term insurance instead. This strategy allows the policy owner to retain the death benefit, while putting cash in their pocket now and even potentially reduce their monthly premium. The risk to this strategy is that while whole life premiums are guaranteed to remain the same for the life of the insured, term life premiums are only guaranteed during the contract term. After a 10 year policy expires, the cost of keeping the same death benefit for another 10 years may increase substantially, and then even more so 10 years after that.
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The Internal Revenue Service allows you to exchange an insurance policy that you own for a new life insurance policy insuring the same person, without paying tax on the investment gains earned on your original contract—which can be a substantial benefit. This may be an alternative to consider before cashing out a policy. You can learn more about this type of exchange and which forms to use from the IRS website.
A viatical settlement is an arrangement where the owner of a policy sells the beneficiary position to an investor for immediate cash. Upon the death of the insured, the beneficiary collects the death benefit at a profit. Typically the insured individual is nearing the end and is interested in collecting cash for various reasons, including medical treatments or fulfilling last wishes. Most investors are licensed corporations who purchase the beneficiary position and also take over the premiums for the remainder of the policy.
For investors looking to move into the viatical settlements space, keep in mind that these arrangements can be high risk because of the unknown length of before the insured person’s passing. Every day we hear about miraculous stories where someone’s cancer was cured, or how someone with only 6 months to live is still alive 5 years later. As stated earlier, most investors in viatical settlements are companies that can properly diversify amongst many policies in order to lower overall risk.
One last point to bring up about investing in viatical settlements is ethics. Many people question the ethics involved in investing in someone’s death, especially when the quicker they pass the better the investor’s return.
Stranger Originated Life Insurance
Stranger Originated Life Insurance or STOLI is similar to a Viatical Settlement in that the beneficiary is usually a group of investors. Typically an elderly person between the age of 65 to 85 would be approached with ‘no cost’ insurance. The investors will pay a lump sum up front to the insured, and then cover all or most of the cost of the premiums. Upon the death of the insured the investors would collect a return. As of July 1st 2010 STOLI’s are no longer legal.
There are many ways to turn your life insurance policy or another’s life insurance policy into quick cash or potential long term cash returns. It’s important to understand the risks and the rewards of each strategy, though. Always seek the advice of seasoned experts when evaluated which choice may be right for you.