How Are Viatical Settlements Taxed?

Green Settlements Staff

What is a Viatical Settlement?

Viatical settlements allow terminally or chronically ill individuals to sell their life insurance policies for a lump sum. Typically, this sum is greater than what surrendering the policy would provide. It won’t equal the death benefit that the policy would otherwise pay out, but this extra cash can go a long way toward hospital fees and other end-of-life expenses.

Viatical Settlements vs. Life Settlements

Viatical settlements might sound like life settlements — and they should. In a sense, they are a specific kind of life settlement for a specific kind of policyholder. Here are some of the key distinctions:

  • Viatical settlements are exclusively for terminally and chronically ill policyholders. You do not need to be terminally or chronically ill to qualify for a life settlement.
  • Viatical settlements usually offer higher payouts than traditional settlements.

Perhaps most notably, viatical settlements and traditional life settlements are taxed differently. Viatical settlements are not subject to federal income taxes.

Viatical Settlement Tax Law

Does that mean viatical settlements offer tax-free payouts? Not exactly.

Most viatical settlement payouts are available tax free, so long as the policyholder meets these IRS requirements:

  • The policyholder is “terminally ill,” meaning they have a life expectancy of under 24 months.
  • If the policyholder’s life expectancy exceeds two years, they must qualify as “chronically ill.” Chronically ill is defined as being unable to perform at least two activities of daily living (eating, bathing, getting dressed, etc.)
  • The policyholder must sell their insurance to a licensed life settlement provider.
  • The provider must adhere to a series of guidelines established by the Viatical Settlements Model Act.

Things can get a little more complicated at the state level. For example, not every state requires providers to hold licenses. This won’t necessarily mean extra complications, but it makes it all the more important to research providers thoroughly and make a careful selection. As with any insurance decision, policyholders should take care to obtain up-to-date information around both state and federal policy.

While qualifying for a viatical settlement means adhering to some rules, there are no rules for spending the payout. That’s one of the primary reasons many policyholders select them. Though it’s common to use viatical settlement payouts to cover long-term care or address medical expenses, policyholders enjoy the freedom to spend that cash, and live their final months, however they choose.

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