The aftermarket for life insurance operates in two areas - viatical and lifetime settlements - each with different tax implications.

Viatical settlements involve the sale of a policy insuring the life of someone who is either terminally or chronically ill. Proceeds are free of federal income tax and state income tax in some states (such as New York and California) since they are considered a death benefit.

Lifetime settlements are for people without the health problems required for viatical settlements, but with a life expectancy of 15 years or less. Often times, a policyholder may feel that the benefits from selling an in-force policy outweigh the need to keep the policy. For instance, the policyholder may choose a life settlement to remove the policy from his/her taxable estate (avoiding application of the three-year rule under Section 2035) in order to transfer additional assets tax-free to his/her descendants.

Alternatively, a policyholder may use the proceeds of sale to:

• Replace property donated to a charity
  
• Pay for the costs of health care
  
• Purchase long-term care insurance
  
• Replace a single-life policy with a joint and survivor policy
  
• Pay gift tax on lifetime gifts
  
• Purchased a more efficient, more affordable policy

In cases where a corporation is the policyholder, consideration should be given to selling unnecessary life insurance policies on employees' lives in the following situations:

• The company has been sold to a third party and the policies' original purpose was to fund a buy/sell agreement
  
• The insured key person retires or is no longer involved in the business
  
• The policy is part of litigation among partners
  
• The company must sell assets to raise cash or repay debt
  
• The policy was purchased to fund deferred compensation or other benefit programs that have now changed
  
• Facilitate the transfer of a business to the next generation
  
• Buy back stock from a partner or shareholder
  

When to consider a Life Settlement

• When the insured is 70 years of age or older
  
• When a policy is lapsing or being surrendered
  
• When there is a need for new life insurance, annuities, or long term care
  
• When the insured has outlived the beneficiaries
  
• When there is an estate tax change
  
• When a charitable organization who owns a donated policy cannot maintain premium payments
  
• When there is a change in the health status of the insured
  
• When there is a retiring key-man or a company / partnership selling
  
• When there is a liquidation of assets due to bankruptcy

Generally, the primary target audience for life settlemsnts is an insured who is 70 years of age or older, has a life expectancy of less than 12 years, and has owned a life insurance policy with a face value of $250,000 or more for not less than 2 years.