What Is a Life Settlement, and When Does It Make Sense?

By Marc Gilman

(800) 927-9326 |

Key Takeaways

• A life settlement is the sale of a life insurance policy to a third-party investor, typically for more than the policy’s cash surrender value.

• Ideal candidates are generally age 65 or older, though a younger insured with a significant health decline may also qualify.

• The sale is a taxable event — part of the proceeds are taxed as ordinary income, and the remainder as capital gains.

• If the policy has an outstanding loan, the buyer takes over responsibility for it along with the policy, which can make a settlement worth exploring even for a policy that feels underwater.

• A life settlement isn’t automatically the right move — if a policy is attractive enough for an investor to want to buy, it’s often attractive enough for the original owner to keep.

If you own an old whole life or universal life policy you no longer need — the kids are grown, the mortgage is paid off, the business that policy once protected has changed hands — the default assumption is usually to let it lapse or surrender it for cash value. There’s a third option worth knowing about: selling the policy outright to a third-party investor in what’s called a life settlement.

What Is a Life Settlement?

A life settlement is the sale of an existing life insurance policy from its owner to a third-party investor. The investor pays the policyowner an upfront lump sum — typically more than the policy’s cash surrender value, though less than its full death benefit — and takes over the policy going forward: paying future premiums and eventually collecting the death benefit when the insured passes away.

This is a legally established market. Its foundation traces back to a 1911 U.S. Supreme Court case, Grigsby v. Russell, which affirmed that a life insurance policy is the owner’s property and can be sold like any other asset.

Life settlement vs. viatical settlement. These terms are sometimes used interchangeably, but they’re not the same thing. A viatical settlement applies to an insured with a life expectancy of less than two years — someone who is terminally ill. A life settlement applies to someone with a longer life expectancy who is otherwise in reasonably normal health for their age. Viatical settlements are subject to different regulations than life settlements.

Who Qualifies for a Life Settlement?

A few factors generally need to line up:

• Age. Ideal candidates are typically age 65 or older, since life expectancy is the single biggest driver of an offer’s value. A younger insured with a serious health decline may still qualify, for the same underlying reason — a shorter life expectancy makes the policy more valuable to a buyer.

• Policy size. Most buyers look for a death benefit of at least $100,000. Smaller policies often aren’t worth a buyer’s fixed due-diligence costs.

• Policy type. The policy generally needs to be whole life, universal life, or a term policy that’s convertible into one of those. Standard term insurance that isn’t convertible, and premium-financed policies, typically don’t qualify.

• Minimum ownership period. Most states require the policy to have been owned for a minimum number of years — often around two — to prevent someone from buying a policy for the sole purpose of immediately reselling it. States generally carve out exceptions for a material life change, such as divorce or the death of a spouse.

What Determines How Much a Buyer Will Pay?

A life settlement offer is essentially a discounted cash flow calculation from the buyer’s perspective — what they expect to pay in future premiums, weighed against when they expect to collect the death benefit. A few factors move that number:

• Policy size — larger death benefits generally mean larger offers.

• Age and life expectancy — the shorter the life expectancy, the sooner the buyer expects to collect, and the more they’re typically willing to pay.

• Premium amount — lower ongoing premiums make the policy cheaper for the buyer to maintain, which tends to increase the offer.

• The broader rate environment — the return an investor can get elsewhere affects how much they’re willing to pay today for a future death benefit.

• Cash value — somewhat counterintuitively, a high cash value doesn’t boost an offer dollar-for-dollar. Buyers generally don’t want to “buy” a large pool of illiquid cash sitting inside a policy, since it typically earns less than their target return. Policies with lower cash value, held by an owner who doesn’t want the ongoing premium obligation, tend to be the more attractive candidates.

Industry-wide, life settlement offers have historically averaged somewhere in the range of 20% to 25% of the policy’s death benefit — though every offer is specific to that policy, so this is a rough starting point, not a quote.

What If the Policy Has an Outstanding Loan?

This is where a life settlement connects directly to the policy-loan conversation. If a policy has a loan against it, the buyer takes over responsibility for sustaining that loan along with the policy itself. That can make a life settlement worth exploring even for someone who feels like a large loan balance has made the policy more trouble than it’s worth — the settlement may still pay more than the net cash surrender value after the loan is repaid, putting more money in the original owner’s pocket than a straight surrender would have.

Is a Life Settlement Taxable?

Yes. Selling a policy is a taxable event, and it’s taxed in two layers under IRS Revenue Ruling 2009-13, as modified by the Tax Cuts and Jobs Act of 2017:

• The portion of the proceeds up to the policy’s cash surrender value, minus total premiums paid (the cost basis), is taxed as ordinary income — the same treatment that would apply if the policy were simply surrendered.

• Any proceeds above the cash surrender value are taxed as long-term capital gains.

Example. Say a policy has a cash surrender value of $78,000, total premiums paid of $64,000, and sells in a life settlement for $80,000. The $14,000 of internal gain (cash surrender value minus premiums paid) is taxed as ordinary income — no different than if the policy had just been surrendered. The remaining $16,000 above cash surrender value is taxed as long-term capital gains. Even after both layers of tax, the settlement typically nets more than a surrender would have, since the total gain is being spread across two different tax treatments rather than concentrated entirely as ordinary income.

Why Sell Instead of Just Surrendering the Policy?

A life settlement tends to be most valuable precisely when a policyowner has had a significant, adverse change in health — the same circumstance that makes it tempting to just keep the policy and let the death benefit pay out sooner. That’s worth sitting with: if a policy is attractive enough for an investor to want to buy it, it’s often attractive enough for the original owner to keep it. A life settlement makes the most sense for someone who genuinely doesn’t want the ongoing premium obligation — not simply as a way to cash out ahead of an expected claim.

For someone who has already decided they don’t want to keep paying premiums, and who was headed toward a lapse or surrender anyway, a life settlement is worth comparing against the alternative before finalizing that decision.

How Does the Process Actually Work?

A life settlement typically moves through a handful of stages:

1. Decision — evaluating whether a settlement is appropriate compared to the alternatives (keeping the policy, surrendering it, or borrowing against it).

2. Information gathering — a life settlement broker collects details on the policy and the insured’s health, and an independent life expectancy underwriter estimates life expectancy.

3. Application and offers — the broker submits the case to multiple life settlement providers to solicit competing offers.

4. Review — the policyowner typically has around 30 days to evaluate offers received.

5. Closing — if an offer is accepted, ownership transfer paperwork is completed, and funds are held in escrow until the insurance company confirms the ownership change.

6. Funding — once the transfer is confirmed, escrowed funds are released to the seller.

What Should You Watch For?

• Check for an accelerated death benefit rider first. Many permanent policies include a built-in rider that lets a terminally or chronically ill insured draw down part of the death benefit directly from their own insurer — tax-free under IRC §101(g) — without involving a third-party buyer at all. If your policy has one, it’s worth comparing before pursuing a settlement, since it keeps the transaction entirely between you and the company that issued the policy.

• Work through a broker, not a single provider. A broker solicits competing bids across multiple buyers; a provider you contact directly is just one buyer, with no incentive to tell you if a better offer exists elsewhere. The Life Insurance Settlement Association (LISA), the industry’s trade association, is a reasonable starting point for finding a broker rather than relying on any single company’s own claims about itself.

• Commissions are capped, but ask anyway. Most states cap life settlement broker commissions at 30% of the settlement value, and many brokers charge less. Any legitimate broker should disclose their fee structure upfront.

• Understand the privacy trade-off. A settlement requires releasing medical and insurance records to the broker and providers involved, and insureds are typically contacted periodically afterward to confirm they’re still living.

• Know your rescission rights. Policyholders generally have the right to cancel a signed life settlement contract within a set window — commonly 30 days from signing, or a shorter period after receiving the proceeds, whichever comes first. Exact timing varies by state.

• Understand what you’re giving up beyond the death benefit. Entering a settlement can also forfeit conversion rights or a waiver-of-premium benefit still available on the original policy, and unlike a death benefit paid to a beneficiary, settlement proceeds can potentially be reached by your creditors.

• Compare it to every alternative, not just a straight surrender — including a policy loan, a partial withdrawal, an accelerated death benefit rider, or simply keeping the policy in force if it still has real value to you.

Where Does Insurance Planning Fit In?

A life settlement is one more tool in a broader decision about what to do with a life insurance policy you no longer need for its original purpose — alongside a policy loan, a 1035 exchange into an annuity, or simply keeping the coverage in force. Which one actually makes sense depends on your health, your cash flow needs, the policy’s current loan and cash value position, and what you’re ultimately trying to accomplish. That’s worth reviewing together before any of these paths gets set in motion.

What To Do Next

If you’re weighing what to do with an older life insurance policy — including whether a life settlement might make sense for your situation — we’re happy to help you think through the options.

Phone: (800) 927-9326 Email:

Kitces.com, “A Financial Advisor’s Guide To Life Settlements,” guest post by Lingke Wang, co-founder of Ovid Life; Kitces.com, “How To Rescue A Life Insurance Policy With A Loan”; Kitces.com, “Why Cancelling An Existing Whole Life Or Universal Life Policy May Be A Bad Idea”; Investopedia, “Life Settlement: Meaning, Benefits, FAQs,” Julia Kagan; Internal Revenue Service, Revenue Ruling 2009-13, as modified by the Tax Cuts and Jobs Act of 2017; Internal Revenue Code §101(g); California Department of Insurance, life settlement disclosure requirements.