If you're a retiree looking for a way to drum up additional cash to help pay for expenses, you may have considered a life insurance buyout. With this kind of transaction, which is also called a life settlement, you sell your life insurance policy for a lump sum and give up the future death benefit for your beneficiaries.

Curious how these buyouts work and if there are any potential drawbacks? Here's what you need to know about selling your life insurance policy.

What Is a Life Insurance Buyout?

If maintaining your life insurance is either unnecessary or too expensive, a life settlement is a cash-generating option for ending the policy. You sell the life insurance policy to a buyer, who will provide you a cash sum while also agreeing to take over premium payments. In exchange, the buyer will receive the full benefit upon your death.

The lump sum purchase will be less than the death benefit payout amount, since the investor is hoping to recoup more than the investment of lump sum plus the ongoing premium payments. However, if you have a whole life insurance policy, you can typically expect your buyout to be worth more than the cash surrender value — the amount your insurance company would pay you if you were to terminate your account.

What Buyers Look For

While there are no specific restrictions for life insurance buyouts, buyers prefer certain situations and life insurance types for investment. That means you're more likely to sell your life insurance policy if the death benefit is worth $100,000 or more. Similarly, whole life insurance policies are easier to sell than term life insurance policies. That's because the buyer is guaranteed a death benefit payout with a whole life policy, while there's the possibility that you'll age out of a term life insurance policy before you pass away.

The concern about recouping the investment is why policyholders who are over age 65 and who are in poor or uncertain health are able to sell their policies more easily. Young and healthy individuals who are interested in a life insurance buyout may find it impossible to locate a buyer, since any potential buyer will likely have to wait a long time to receive the death benefit.

How Selling a Life Insurance Policy Works

If you're interested in locating a buyer for your life insurance policy, you can find one through a broker or provider. Brokers work as intermediaries between you and the purchaser, soliciting multiple bids to help you get the best price for your policy. Providers, on the other hand, are direct purchasers. Selling to a provider cuts out the middleman.

When you've found a broker or provider, you'll need to give them the details of your life insurance policy as well as your health information and medical records. Potential buyers calculate your life expectancy based on your health information in order to formulate an offer for your policy. If you receive an offer, you can sell the policy and make the buyer the new policy owner.

Potential Pitfalls

While a life insurance buyout can offer retirees some needed income, it still has some downsides. These include:

• Difficulty finding a buyer: Not every life insurance policy will find a buyer.
• Taxes: Though a death benefit comes to your beneficiaries tax-free, you may have to pay income taxes on your lump sum payout.
• High commissions: The commissions paid to brokers or providers can eat up as much as 30% of your payment amount, according to FINRA.
• Loss of public assistance: The proceeds from your life insurance buyout could make you ineligible for public assistance (e.g., social welfare programs).

Should You Pursue a Life Insurance Buyout?

If no one is relying on your death benefit, selling your life insurance policy could be a source of much-needed cash in retirement. But before you choose a life settlement, make sure you're fully aware of the potential downsides of a buyout. That way, you can feel confident that you're making the right decision for your policy and your finances.