Financial advisors and insurance agents are well versed on the topic of life insurance policies. In some cases, these policies can be the most important asset in a client’s portfolio — a way to ensure costly medical bills and other expenses are paid, and that family members have financial security in the future.
Still, staying on top of every nuance and variation in the world of life insurance is no easy task. Advisors and agents are required to monitor an ever-changing regulatory environment (not just on the federal level, but also on the state level). They must track the fine print of every policy, understand if and how life settlements are taxed, and craft custom approaches for each and every client.
As a result, there is some knowledge that even the most seasoned advisors and agents may not know — especially when it comes to the topic of alternatives to life settlements or viatical settlements.
1. Life Insurance Rider Options
A common misconception, even among professionals, is the belief that selling a life insurance policy is generally the best way to net the most cash for the seller. It’s important to note that the sale of a policy will often create taxable income — a potentially significant downside. Complicated transaction processes and the inefficiencies of the life settlement market also means that a policy holder may have to wait up to six months from initially discussing a sale before receiving the funds.
Providing faster access to funds, many industry representatives view accelerated benefit riders (which allow policy holders who are ill to access funds during their lifetime) as a tool with limited drawbacks. In fact, these riders are often very narrow in their availability and funds are typically only paid out to a person with a life expectancy of less than 12 to 18 months. Accelerated benefit advances are also generally limited to 30% to 60% of the policy’s face amount. For those that qualify, however, these riders can be a low-cost option to access funds quickly.
Another alternative to an all-cash life settlement is a newer hybrid transaction known as a retained death benefit sale. In this scenario, only a portion of the policy’s death benefit is sold. The insured receives a lump-sum payment and retains a portion of the death benefit, while the buyer agrees to pay all future premiums. Limitations include a lower upfront payment (the value of the immediate payment is reduced), less access to the policy, a capped long-term benefit (smaller benefits to heirs, even if the insured passes earlier than life expectancy), as well as potential tax implications.
2. Assistance With Premium Payments
Financing to pay life insurance premiums has been available as a tool for many years. Premium financing can be very useful for people who take out larger policies to help defray the cost of the yearly policy premiums. It’s important to note, however, that premium financing typically involves recourse and term-limited loans. That means that a borrower exposes their entire portfolio of assets to the lender. Repayment is required at a date certain.
When cash-flow issues make coming up with premium payments difficult, there may be a variety of options. The insured can choose to seek funds from relatives (particularly the beneficiaries under the policy) if they are liquid. Additionally, funds can be borrowed from other sources of equity, such as a 401(k), pension plan or stock portfolio on margin.
Accessing funds using one or more of the above scenarios will differ depending on each person’s position. The pros and cons of tapping into these alternative sources should also be carefully evaluated (including potential tax implications). For example, credit card loans can be costly and require monthly current payments, which may end up adding to the debt spiral. (In other words, the client borrows money to pay the premiums, but then needs to come up with money to pay the interest).
3. Third-Party Lending Solutions
Perhaps the biggest blind spot for those considering a life settlement is the availability of third-party lending solutions. The solutions are often more flexible and better-suited to an insured’s needs. Loan options can provide quick access to a significant portion of a policy’s death benefit – without the drawbacks mentioned earlier. In fact, in many loan transactions, the total amount received by the borrower and the borrower’s beneficiaries will ultimately be higher than the amount the borrower receives in a life settlement. Fifth Season Financial’s Funds for Living and Giving program (FLAG) is one such alternative.
A third-party lending program allows qualified individuals to tap into a portion of their life insurance policy value (i.e. net death benefit), with no restrictions on how the advance can be used. The policy is kept in place and remains active while the lender handles the remaining premium payments and out-of-pocket expenses. Ultimately, the advance is repaid using the proceeds of the policy, and in more than 90% of cases at Fifth Season Financial, funds remain to pass on to beneficiaries.
Getting funds may also be faster than using the life settlement process. Selling a policy can take several months. Completing the process at my company typically takes four to six weeks.
Of course, you and your clients should go over any arrangements involving taxes with qualified tax advisors.
Under current interpretations, however, since the policy advance is structured as a loan, it’s generally not treated as taxable income to the borrower. Further, because beneficiaries generally receive life insurance proceeds tax-free, there is typically no tax leakage or tax cost in this type of transaction. Additionally, the borrower retains flexibility in case things change. If, for example, the insured’s health status worsens, the insured can seek additional funds from the lender, or pay off the loan balance and sell the policy into the life settlement market at that time.
As every good financial advisor and insurance agent knows, there’s no policy or playbook that suits everyone. To qualify for the lending program at my company, for example, an individual must be diagnosed with an advanced stage illness (generally a life expectancy of less than eight years), such as a late-stage cancer, ALS, advanced heart disease, advanced diabetes or Alzheimer’s disease, and own a life insurance policy with a total death benefit of at least $50,000 (or $100,000 for group policies).
Adam Balinsky is president of Fifth Season Financial, a specialty lender that serves clients who are dealing with advanced-stage illness. The firm operates the Funds for Living and Giving (FLAG) program, which gives a client the ability to receive an advance on a life insurance policy.