As with any financial planning strategy, life settlements are not suited for every individual situation. Although states increasingly require that a life settlement should be disclosed as an option in all cases where lapsing the policy is being considered, there can be certain downsides to selling any life insurance policy.
The most significant consequence is that the beneficiaries of the originally issued life insurance policy are no longer afforded the death benefit of the policy when the insured passes away. If family dynamics are involved and a change of the beneficiary will trigger emotional or financial conflict, that fallout should be carefully weighed before entering into a life settlement. Depending on how long the insured survives, it’s possible that a policy may be sold for substantially less than what it would have paid out had the owner simply held onto it for a while longer. Should the insured pass within a short time of the sale of the policy, there may be some anxiety over the “missed opportunity” to benefit from the full death benefit by the former beneficiaries.
There are also potential tax implications attached to the sale of a life insurance policy. IRS Revenue Ruling 2009-13 specifies the possible tax consequences of selling a life insurance policy as a life settlement. Anyone selling a policy should seek a tax and legal opinion about the IRS Regulations in order to assess whether this is a consideration that would impact the financial benefit of a life settlement.
In addition, proceeds from the sale of a life insurance policy may be subject to claims of creditors, should such a circumstance be present. For individuals trying to manage a prior bankruptcy or other debt resolution issue, this should be considered before proceeding with a life settlement.
Finally, since life insurance policies are considered to be private property that can be bought and sold, personal information attached to a policy will be held by a third party after the transaction is completed. That means the insured individual's name and contact information will be made available to the new owners of the policy, who will track the insured person’s health status from time to time. This is another factor that should be considered by anyone exploring a possible life settlement.