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Life Settlements Laid Out

If you're a senior with life insurance, you may have heard some pitches lately encouraging you to sell your policy in a transaction known as a "life settlement" or a "senior settlement." Here's a few things you should know about this relatively new idea.

Most importantly: Proceed with caution. NASD, the private-sector securities industry regulator, recently warned that the life settlement industry has been expanding rapidly, and competition among providers has become increasingly intense. That has generated some aggressive sales tactics and abusive practices. Be on the lookout, too, for high transaction fees.

Normally, if you have a life insurance policy you no longer want or need, you could surrender the policy for the cash value or allow it to lapse. A life settlement provides a third option. Life settlements allow you, the policyholder, to sell your life insurance to a third party and often collect more than you would if you canceled the policy before it matured or before you died.

This idea is a variation on viatical settlements, which allow the terminally ill to sell their life insurance policies for living expenses. Life settlements, in contrast, aim toward older policyholders who are not terminally ill but have a life expectancy between two and roughly 10 years.

In a life settlement, you get a lump-sum payment that depends on your age, health, and policy, among other factors. The institution that buys your policy pays any necessary premiums, holds the policy until maturity, and collects the benefit after your death. In some cases, the institution resells your policy to other investors.

You might be considering such a sale if your insurance or your financial situation has changed significantly. Maybe you can't afford the insurance, you need more money for living or health expenses, or you're in danger of letting the policy lapse.

If that's the case, life settlements aren't your only option. You might be able to exchange your policy. You'll need to look carefully at the tax consequences of that maneuver. Your policy might also permit accelerated death benefits, which allow some people with long-term illness to get benefits before dying.

If you think taking a life settlement might be the best move for you, NASD warns that you should be aware of some possible unintended consequences.

If you sell your policy, it will still be in effect. That might complicate things if you're planning to replace your old life insurance with a new policy. You may also end up paying higher premiums if your health has changed. Make sure you know exactly how a life settlement could affect you if you know you will still need life insurance.

A cash payment from a life settlement would also change your income significantly for the year. That will have an effect on your personal finances and any situation in which your income determines your eligibility for something, be it a federal program or a specific tax benefit. Investigate these secondary effects before making the leap.

You'll also need to shop diligently. The life settlement marketplace is quite new. Read the next article for advice on what you should find out before proceeding with a life settlement agreement. For basic information on life insurance, check out this section of the Insurance Center.

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Fool contributor Mary Dalrymple welcomes your feedback. The Motley Fool has a shiny disclosure policy.

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