Issue No. 128, March 28, 2023

Should I Advise a Client to Sell a Policy at a Loss?

In a recent newsletter, where we reviewed the tax consequences of life settlements, we remarked that it is quite common for a policy sold in a life settlement to be sold at a loss (less than its tax basis) and produce no taxable gain. As a result of this statement, we fielded several questions from producers asking, “why would I tell my client to sell their policy at a loss?”

 

Unfortunately, this question indicates a fundamental misconception of what life settlements are all about. A life settlement is an alternative to lapsing or surrendering a policy, it is not an alternative to keep it. Life settlement investors only buy policies that offer them significant returns, so significant, in fact, that if a policyowner is able to and wants to keep their policy, it would be financially unwise to sell it in a life settlement.

 

However, once it is determined a policy is no longer wanted, needed or affordable and it is about to be terminated, then a life settlement should definitely be considered. The proper measure of gain or loss on a life settlement transaction is not based on how much was paid for the policy, but rather how much more the seller is getting compared to the alternatives: lapse or surrender.

 

Why would a policy no longer be wanted, needed or affordable? The most common reason is a change in the financial situation of the client making the policy unneeded or unaffordable. This could be a change in their estate or business situation, retirement, divorce, or death of an intended beneficiary.  Alternatively, sometimes the policy has under-performed and is no longer financially viable.

 

So, the answer to the question, “Why would I tell my client to sell a policy at a loss?” is quite simple: to avoid a bigger loss! A life settlement maximizes the salvage value of a policy that would otherwise be terminated.

 

Should you have clients with policies that are about to be lapsed or surrendered, please give us a call to discuss the alternatives. Remember, it can’t hurt to try – it can only hurt not to!

 

 

Robin S. Weinberger, CLU, ChFC, CLTC

(617) 451-3343

Peter N. Katz, JD, CLU, ChFC, RICP^®

 (860) 937-2936

Ria J. Johnson, CFP^®

(619) 920-4000

Rob Haynie

(954) 599-4433