How Life Insurance Payouts Work
Understanding the pitfalls of this type of life insurance payout.
When it seems too good to be true, it usually is – a life settlement may not be a term that is very familiar, but there is a growing effort to expand this practice in Canada.
A life settlement involves the sale of an insurance policy for a cash payout. It may involve a policyholder who is terminally ill or near end of life and in financial distress. A third party will purchase the person’s life insurance policy at a discount, sometimes for significantly less than the policy’s value. The purchaser continues to pay the premiums and then collects the policy’s proceeds when the insured dies – in short, profiting from their death.
While the trafficking of life insurance is illegal in most Canadian jurisdictions, including Ontario, a private member’s bill aims to amend the Insurance Act of Ontario allowing this practice. The Canadian Health and Life Insurance Association, opposed to Bill 219, Life Settlements and Loans Act, is raising concerns that this practice puts an extremely vulnerable population, including seniors, at risk of potential financial exploitation.
Life settlement fine print
When funds are needed to help cover costs, such as medical treatments or elderly care, it can be tempting to consider the equity in a life insurance policy. However, there are some things to consider:
Fees: It’s important to understand that there will be fees associated with life settlements. The company that purchases the policy will keep a percentage of the death benefit as their fee. If you are taking a loan out against a policy, interest will be charged on that amount. The amount of your settlement may also be subject to tax.
Inheritance: Life settlements have a major impact on estate plans. The sale of an insurance policy to a third party will affect the amount of inheritance that will be available to beneficiaries.
Privacy: There is a level of risk in selling a policy to a third party in that the policy could potentially be resold. Are you comfortable in knowing that your policy may flip from one company to another? It’s also important to clarify how your personal information is protected and kept confidential.
Alternatives to life settlements
Whether it’s having financial support in place for family due to an untimely passing or setting up the next generation with an inheritance as part of estate planning, life insurance is intended to provide security for the long term after you’ve passed. But when there are financial difficulties due to terminal illness or advanced age, it’s important to know that compassionate support options may be available.
Your advisor can help identify programs that may exist within an insurance policy to provide financial assistance to cover daily living expenses, medical bills, home repairs and other financial needs.
This financial assistance may be in the form of a loan against an existing policy for a set amount, based on advanced age or terminal illness. It’s important to realize that your insurance policy stays in effect as long as you continue to pay the premiums on the policy. Beneficiaries may still receive a payout depending on the amount left in the death benefit once the loan balance is deducted.
Financial difficulties at any time can bring untold stress, and when the reason is terminal illness or trying to care for an elderly relative, the strain can feel unbearable. Speak to your advisor - there are solutions that can help.