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Don't confuse STOLIs with life settlements

In July 2014, we wrote a series of posts about stranger-originated life insurance policies and the efforts of various states, including Florida, to regulate, even to eliminate STOLIs. With STOLIs taking so much of the spotlight, though, life insurance companies found it difficult to explain legitimate ways to turn a policy into cash.

A STOLI is a life insurance policy that has been obtained illegally by a third party. Scammers would approach senior citizens who needed cash and convince them to purchase life insurance policies that the seniors would then turn over to an investor. In two years, the scammers said, the seniors would receive a percentage of the policy's face value in a lump sum payment. Up front, the senior might receive some cash, but that was not always the case. Generally, too, the senior never saw the long-term payoff.

It was easy for consumers and the media to conflate STOLIs with the legal sale or transfer of a policy. To clear up any confusion, the Life Insurance Settlement Association wrote position papers, offered testimony to the Florida Office of Insurance Regulation and generally tried to spread the word that life settlements were not STOLIs.

There are two different kinds of life insurance: term and permanent. A term life policy has a set premium for a set period of time. If the insured does not die before the end of that time period (the policy term), the insurance company is off the hook.

With a permanent policy, though, there is no end date. That is, no end date other than the death of the insured. For the most part, as long as the premiums are paid, the insurer will have to pay the benefit.

A key advantage over term life is that a permanent life policy also has a tax-free savings component. Part of each premium is set aside for the owner's future use, and that money collects interest over time.

The policyholder may withdraw the basis -- the portion of the funds that come from the premiums -- without incurring a tax penalty. The interest does count as taxable income, though, so cashing out the full balance is a less attractive option.

If you are strapped for cash, though, and you have owned a permanent life insurance policy for some time, those funds could come in handy. You can withdraw all or a portion of the account, or you can borrow against it.

You can also sell it. This is where the idea of a life settlement comes in. We'll explain more in our next post.

Source: NerdWallet.com, "Before Death Do Us Part: Selling Your Life Insurance Policy," Alice Holbrook, May 5, 2015

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