Introduction

Selling a life insurance policy through a life settlement can provide liquidity in certain circumstances. However, it is not a routine financial transaction.

Common questions include:

• What are the risks of a life settlement?
• Is selling a life insurance policy a good idea?
• Can a life settlement affect Medicaid or taxes?
• What happens after you sell your policy?

A life settlement is regulated and structured. But it is also permanent. Before evaluating offers or beginning underwriting, it is important to understand the financial, legal, tax, and planning risks involved.

If you are unfamiliar with how life settlements work, begin here:
Read More: How It Works & Policy Options

This article outlines the principal risks that should be evaluated before proceeding. It is educational in nature and does not constitute legal, tax, or financial advice.

1. Permanent Loss of the Death Benefit

The most significant risk of selling a life insurance policy is the permanent transfer of the death benefit.

Once a life settlement closes:

• The buyer becomes the policy owner.
• The buyer becomes the beneficiary.
• The buyer receives the death benefit when the insured passes away.

The original beneficiaries no longer have a claim.

This structural change can affect estate planning objectives, business succession arrangements, charitable intentions, and family wealth transfer plans. In many cases, the policy was originally purchased to address a long-term planning goal. Selling the policy may resolve a short-term financial need but eliminate that original objective.

Unlike surrender, where the policy simply terminates, a life settlement keeps the policy active under new ownership. That distinction can carry emotional and relational implications, particularly if beneficiaries were expecting the policy proceeds.

Read More: Surrender vs. Life Settlement: Key Differences

2. Tax Consequences and Net Proceeds Risk

Life settlement proceeds are not automatically tax-free. Under IRS Revenue Ruling 2009-13, life settlement proceeds may be divided into:

• Return of cost basis
• Ordinary income
• Capital gain

The exact breakdown depends on premiums paid, cash surrender value, total settlement proceeds, and individual tax circumstances.

The risk is not simply that taxes apply — it is that failure to evaluate tax impact beforehand may materially reduce net proceeds. In some cases, what appears to be a large gross settlement may be significantly reduced after taxation.

Because taxation differs between surrender and sale, both scenarios should be analyzed before making a decision.

Read More: How Are Life Settlements Taxed?

3. Medicaid and Public Benefit Exposure

One of the most overlooked risks involves eligibility for Medicaid and other means-tested benefits. A life settlement typically results in a lump-sum payment. That payment may be counted as an asset for purposes of:

• Medicaid eligibility
• Long-term care planning
• Other public benefit programs

In certain situations, receiving settlement proceeds may temporarily disqualify an individual from benefits or require spend-down strategies. This risk is not inherent to the life settlement itself — it arises from how proceeds are treated under public benefit rules.

Because Medicaid regulations vary by state and can be complex, professional planning should occur before proceeding.

4. Disclosure of Medical Information

Life settlement underwriting requires medical review. This typically involves:

• HIPAA authorization
• Collection of medical records
• Physician reports
• Actuarial life expectancy analysis

Although privacy protections apply under federal HIPAA law and state insurance regulations, some individuals may find the disclosure process uncomfortable. It is important to understand that medical information is reviewed not for clinical care, but for actuarial modeling used in valuation.

The National Association of Insurance Commissioners (NAIC) has developed model regulations governing privacy, disclosures, and consumer protections in life settlement transactions.

Read More: How the Life Settlement Process Works

5. Ongoing Status Verification After Sale

After a life settlement is completed, periodic verification of the insured’s status may occur. In many states, the frequency and method of contact are regulated. Contact is typically limited to periodic confirmation — often once or twice per year — and must comply with privacy restrictions.

While this monitoring is administrative and standard within the secondary market, some individuals may not anticipate continued contact after selling the policy. Understanding this structure in advance helps prevent misunderstandings.

6. Irreversibility Beyond the Rescission Period

Most states require a rescission period following closing, often between 15 and 30 days. During that window, the seller may cancel the transaction and return funds.

After the rescission period expires, the transaction is generally permanent.

• The policy cannot usually be repurchased.
• Beneficiary designations cannot be restored.
• Ownership rights cannot be reclaimed.

This permanence distinguishes life settlements from temporary financial adjustments such as policy loans. The U.S. Government Accountability Office (GAO) confirms that life settlements are regulated at the state level through insurance departments, but regulation does not eliminate the structural finality of the transaction.

7. Suitability Risk vs. Eligibility

Qualifying for a life settlement does not mean it is appropriate. Eligibility is based on actuarial modeling and economic viability. Suitability depends on broader financial and planning considerations.

An individual may qualify economically but still determine that maintaining coverage aligns better with long-term estate or family objectives.

Read More: Who Qualifies for a Life Settlement?

Suitability analysis should consider:

• Current and projected financial needs
• Alternative liquidity sources
• Family expectations
• Long-term care planning
• Charitable or legacy goals

8. Emotional and Family Implications

Life insurance often represents more than a financial asset. It may symbolize security, responsibility, or long-term protection. Family members may view the policy as part of an expected inheritance or estate plan.

Selling the policy can alter those expectations. While policy owners generally control their policies, transparent communication may reduce potential misunderstandings. This is not purely a numerical decision.

9. Opportunity Cost of Alternatives

Before selling a life insurance policy, alternatives should be evaluated carefully. These may include:

• Reducing the policy face amount
• Accessing policy loans
• Utilizing accelerated death benefit riders
• Surrendering the policy
• Maintaining coverage

In some cases, restructuring coverage may preserve partial benefits while reducing premium burden.

Read More: Alternatives to a Life Settlement

10. Market-Based Valuation Variability

Life settlement offers are determined by market conditions and actuarial modeling. Valuation may be influenced by:

• Interest rate environments
• Investor demand
• Carrier financial strength
• Policy structure
• Mortality projections

Not every policy generates strong offers. Understanding how valuation works can help set realistic expectations.

Read More: Understanding the Secondary Market for Life Insurance

Are Life Settlements Inherently Risky?

Life settlements are regulated financial transactions. They are not inherently predatory or informal. However, they involve permanent structural changes that must be understood fully before proceeding.

The primary risks involve:

• Loss of death benefit
• Tax consequences
• Public benefit impact
• Privacy considerations
• Irreversibility

Whether those risks outweigh potential liquidity benefits depends on individual circumstances.

Frequently Asked Questions

Is selling a life insurance policy a bad idea?
Not inherently. The appropriateness depends on financial goals, estate planning objectives, tax impact, and personal circumstances.

Can selling a policy affect Medicaid eligibility?
Yes. Lump-sum proceeds may count as assets and impact eligibility.

Can I reverse a life settlement?
Most states provide a limited rescission period. After that, the transaction is typically permanent.

Do beneficiaries need to approve the sale?
Generally, the policy owner controls the policy. However, discussing the decision with affected parties may prevent conflict.

For more answers, visit our FAQ page.

Final Thoughts

Selling a life insurance policy is not simply a financial transaction — it is a structural planning decision. It may provide liquidity in certain situations. It may also alter long-term estate outcomes. Understanding the risks does not discourage evaluation. It ensures informed decision-making.

Ready to navigate these risks with professional guidance? Start an Educational Review with our team today.