At 74 She’ll Sell Her Life Insurance Policy to an Investor. The Price Can Beat What the Insurer Would Pay Her to Surrender It

The premium notice showed up again, and at 74, she’s tired of paying it. She bought the policy to protect the kids. They’re grown now, with homes and paychecks of their own, and her first thought is to call the insurance company and cancel. Before she does, she should hear from a second possible buyer: an investor.

The truth is that she’s far from alone, as households 70 and older hold 34% of U.S. household net worth, according to Federal Reserve data. Many of them still carry policies they bought decades ago.

Why an Investor May Pay More Than Her Insurer

This kind of sale is called a life settlement, where an investor buys the policy, takes over the premiums, and collects the death benefit when she dies. She gets a lump sum now, while the insurer’s offer is the cash surrender value. That’s the savings built up inside the policy, minus any fees, and it ignores her health. An investor prices the death benefit itself, based on her age, her medical records, and how many years of premiums they expect to pay. If her life expectancy looks shorter than the insurer’s tables assumed, the policy is worth more to a buyer.

That’s why offers often come in above the surrender value but well below the death benefit, because the investor has to cover years of premiums and still earn a return. Nobody can promise a number until the bids come in.

How the IRS Splits Her Check Into Three Layers

Her tax basis generally starts with the premiums she’s paid, reduced by certain tax-free amounts previously received from the policy. Outstanding policy loans can complicate the calculation. The 2017 tax law also changed the rules, so basis no longer gets reduced by the cost of insurance coverage received over the years (26 U.S.C. § 1016(a)(1)(B)). The IRS confirmed that treatment in Rev. Rul. 2020-5. 

The sale price is then taxed in levels:

1. Everything up to her basis comes back tax-free, because it’s her own money returning.
2. Anything above basis, up to the cash surrender value, is taxed as ordinary income, just like wages. A plain surrender is taxed the same way under IRS rules.
3. Anything above the surrender value is usually taxed as a capital gain, which typically gets a lower rate.

In one IRS example, an owner who paid $64,000 in premiums and sold for $80,000 ends up with a $16,000 gain under current rules. A bigger check means a bigger tax bill, but the extra above the surrender value usually gets the friendlier capital gains treatment. The settlement check is one of several quiet IRS rules that can reshape a retiree’s finances. We charted the rest in a free tax trap map.

Three Costs That Come With the Bigger Check

• Her heirs lose the death benefit for good. If the kids were quietly counting on it, they should hear about the sale before it happens.
• A stranger sees her health history. Arizona law, for example, requires the insured to consent to releasing medical records to the buyer and broker.
• Cash can cost her benefits. For Supplemental Security Income, Social Security already counts a policy’s cash surrender value as a resource, and the 2027 limit is $2,000 for an individual. Medicaid programs that pay for long-term care also test assets, and a lump sum sitting in the bank can push her over the limit.

State Rules, Broker Fees and a Cooling-Off Window

Life settlement rules vary by state. Many states license the brokers and buyers and give sellers a window to back out. Arizona lets owners cancel within 15 days of signing and receiving all disclosures, as long as they return the money.

The broker works for her but gets paid a commission out of the deal, and that commission can eat into what she takes home. She should ask for the fee in writing and get bids from several buyers. A single offer tells her very little.

Cheaper Exits That Keep Some Coverage

If the premium is the real problem, she has other options:

• Reduced paid-up coverage. She stops paying, and the insurance company converts her cash value into a smaller, fully paid policy.
• Let the cash value pay the bill. Some policies can use built-up value or dividends to cover premiums, at least for a while.
• Swap into long-term care coverage. Federal law allows a tax-free exchange of a life policy for a qualified long-term care insurance contract.

Ask the Insurer for One Number First

The first number she needs is the cash surrender value. She should ask the insurance company to put it in writing, along with her total premiums paid. That gives her a starting point for comparing offers. A settlement should leave her with more money after broker fees than she’d receive by surrendering the policy. The extra also has to justify losing the death benefit and sharing her health records.

If she’s in good health, offers may not clear that floor by much, and reduced paid-up coverage could serve her better. If her health has declined, a settlement is where that shows up in the price. The costliest mistake is surrendering first. Once the insurance company cancels the policy, she has nothing left to sell.

Contact [email protected] for any questions or corrections.