How Are Viatical Settlements Taxed? A Guide to Viatical Settlement Taxes

September 26, 2023 | By Adam Lippman

How Are Viatical Settlements Taxed? A Guide to Viatical Settlement Taxes

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If you are diagnosed with a terminal illness, having access to your life insurance money could be life-changing. A Viatical Settlement can provide that access, allowing you to seek further medical treatment, improve your quality of life, or take that vacation of your dreams.

Although a Viatical Settlement is a big decision, there are many advantages, provided you understand all the implications, including the Viatical Settlement tax. Viatical Settlements are not taxed as a general rule. However, you could be liable for tax under certain circumstances, and you must know what they are to make an informed decision about your future.

Viatical Settlement Tax Estimator

What Is a Viatical Settlement?

A Viatical Settlement is when a terminally ill policy owner sells their life insurance policy to a third party. In return, they receive a lump sum payout they can use. It is a legally binding financial agreement in which the third party becomes the new owner and beneficiary of your life insurance policy.

Although your life insurance policy was intended to provide financial relief to your family after your passing, there are certain circumstances in which you may need to access its value, including paying for medical care. The decision to take a Viatical Settlement is personal, requiring careful consideration. You can expect to receive a percentage of the policy value, depending on your circumstances and life expectancy.

Before you decide if a Viatical Settlement is right for you, you should know everything about how it works and what you can expect.

When Is a Viatical Settlement a Good Option?

You may consider a Viatical Settlement for numerous reasons, including the following:

  • Medical care:¬†After receiving a terminal illness diagnosis, you may use your additional funds for urgent medical care.
  • Additional treatment:¬†If you have exhausted all traditional options, consider exploring experimental or alternative therapies. A Viatical Settlement can help you pursue those avenues.
  • Quality of life:¬†A Viatical Settlement can allow you to improve your quality of life, enjoy special moments with loved ones, and pursue your goals.
  • Insurance premiums:¬†Life insurance premiums can be a significant expense, and a Viatical Settlement allows you to relieve the financial burden of your monthly premiums without losing the entire policy’s value.
  • Term policy:¬†If your policy is approaching its expiration date and you do not need the coverage, a Viatical Settlement allows you to elicit value from it before it lapses.
  • Independent beneficiaries:¬†If the beneficiaries of your life insurance policy are financially independent and no longer rely on the payout from your life insurance, a Viatical Settlement can allow you to access those funds when you need them the most.
  • Significant expense:¬†When facing a life-threatening illness, you may want to make a large purchase, donate to a cause you care about, or provide loved ones financial assistance.
  • Bucket list:¬†Perhaps there is a vacation you have always dreamed of taking¬†or an experience you would love to enjoy. A Viatical Settlement could be the path to your once-in-a-lifetime experience¬†and a chance to create lasting memories with the people who matter the most.¬†

After receiving a terminal illness diagnosis, you may use your additional funds for urgent medical care.

Regardless of your reasons for considering a Viatical Settlement, consulting with an expert is essential. Together, you can review your financial needs and make an informed decision based on your unique situation.

What Are the Criteria for Qualifying for a Viatical Settlement?

Viatical Settlements require the seller or viator to meet specific criteria, including the following:

  • A qualifying life insurance policy:¬†You must have held your policy for a minimum of two years for most settlement providers. Some states require a minimum of five years. In addition, your policy must have a minimum value, often between $50,000 and $100,000.
  • A life expectancy of less than¬†two¬†years:¬†Your doctor or medical team will confirm your diagnosis and life expectancy.

How Are Viatical Settlements Taxed?

Generally, you do not pay taxes on Viatical Settlements. The Internal Revenue Service (IRS) excludes them from federal income taxation. There are some circumstances in which your settlement is taxable. Consider the following points on Viatical Settlement taxes:

Viatical Settlement Taxation

If you have a terminal illness, a life expectancy of less than two years, and a qualifying policy, you will have a tax-free Viatical Settlement. In this case, the payment on your Viatical Settlement is considered a death benefit, not a capital gain, which means it is exempt from tax. However, if you have a terminal illness and your life expectancy is more than two years, you would need to seek an alternative to a Viatical Settlement.

Additionally, buyers of insurance policies must meet regulatory requirements in several states. While these requirements exist to protect the viator, you may still be required to pay tax if the buyer fails to meet them. Always discuss the tax with your qualified tax professional in detail to ensure you understand the implications.

How Are Viatical Settlements Taxed?

Federal and State Law

In most cases, you have no legitimate tax concerns regarding federal law. However, as mentioned above, state laws vary depending on the state. The Life Insurance Settlement Association (LISA) has a detailed list of regulations you can check on their website. Here is a quick overview:

  • Forty-five states regulate Viatical Settlements.
  • Five states ‚ÄĒ Wyoming, South Carolina, South Dakota, Missouri, and Alabama ‚ÄĒ and the District of Columbia do not regulate Viatical Settlements.
  • State regulations vary but often include which companies or providers can participate in the settlement process.

When considering a Viatical Settlement, research your state laws, as the variations can be significant.

The Difference Between Taxation of Viatical Settlements and Life Settlements

Viatical Settlements and Life Settlements have different taxation requirements. A Life Settlement is also the sale of your life insurance policy in exchange for a lump sum but is designed for healthy older adults. While a Life Settlement has its advantages, it is essential to understand the differences in taxation. 

In general, Life Settlements can be taxed. The funds you receive are unrelated to a terminal illness and are considered capital gains. Viatical Settlements are less than the death benefit would have been but larger than Life Settlements and are typically not regarded as taxable income. 

Viatical Settlement and Taxation FAQ

If you are considering a Viatical Settlement, you already have much on your mind. We have answered some frequently asked questions to make the process as simple as possible:

1. How Do You Report a Viatical Settlement on Your Tax Return?

As with any significant financial transaction, save all closing documents to use during tax season. Although your Viatical Settlement is not taxable, you must still declare it and provide any accompanying documentation.

2. How Soon Will You Get Paid?

From the time you apply, it will take your settlement broker six to eight weeks to complete the appraisal and gather the relevant information from your medical team and insurance company. Once you have accepted an offer, some settlement providers will expedite the process, depending on your situation, so you can receive your funds in a few weeks.

3. Will You Have to Pay Taxes on Your Lump Sum Payment?

You likely will not pay taxes on your payment. However, as discussed, certain circumstances could leave you liable for tax. Discuss your specific situation in depth with your tax adviser and settlement broker.

4. What Types of Policies Qualify for a Viatical Settlement?

Almost any type of life insurance could qualify for a Viatical Settlement. Some quick points include the following:

  • Individual¬†universal¬†life policies are often more attractive to buyers.
  • You can sell group policies from an employer, provided doing so is not prohibited by the policy’s terms.
  • You can sell term life policies if it is possible to convert the policy to permanent life or if it is still within the level term period.

5. Do You Have to Pay Any Fees?

You will not have to pay fees to sell your life insurance policy.  

6. Can You Change Your Mind During the Settlement Process?

Going through a Viatical Settlement is challenging, and it is normal to feel uncertain. You can change your mind during the process, as you are not obligated to proceed. If you change your mind after the settlement has been processed and you have received your payment, there is a small window in which you can change your mind, known as a rescission period.

The laws in your state define the time you can rescind the transaction. After the rescission period has elapsed, the transaction is complete, and you cannot undo it.

7. Who Benefits From a Viatical Settlement?

As the policy owner, you benefit from a Viatical Settlement when you receive your lump sum payment. Once the transaction is complete, the buyer becomes the sole owner and beneficiary. They pay all future premiums on the policy and receive the death benefit when you pass away.

8. Who Negotiates a Viatical Settlement?

Working with a settlement broker can help you get maximum value on your insurance policy. Your broker will work to find buyers on your behalf and negotiate the best possible price.

9. Is a Viatical Settlement Protected From Creditors?

The proceeds of your Viatical Settlement may be subject to creditor claims. It is best to discuss any debt with your financial advisor or settlement broker for insight into your specific situation.

10. Are Viatical Settlements Regulated?

Viatical Settlements are regulated in most states, and the state’s Department of Insurance handles the licensing and oversight. Your broker can talk you through the regulatory requirements in your state.

How to Get a Viatical Settlement

A successful Viatical Settlement transaction consists of several moving parts. The process works as follows:

Evaluation: Your settlement broker will then evaluate your documentation and assess the value of your policy based on factors such as your age, health, medical condition, and premiums. This evaluation aims to provide a fair assessment of your policy and situation to determine your policy's value accurately.

  • Qualification:¬†First, you must meet your provider’s criteria to qualify for a Viatical Statement.¬†
  • Application:¬†As the policy owner, you will apply for a Viatical Settlement and submit the necessary documents to your chosen provider, including your medical records, details of your insurance policy, and any other relevant documentation your provider requests.¬†
  • Evaluation:¬†Your settlement¬†broker¬†will then evaluate your documentation and assess the value of your policy based on factors such as your age, health, medical condition, and premiums. This evaluation aims to provide a fair assessment of your policy and situation to determine your policy’s value accurately.¬†
  • Offer:¬†Your settlement broker will solicit multiple offers based on the evaluation.¬†¬†
  • Sale:¬†If you accept the offer, you will sign a contract to sell your life insurance policy to the settlement provider. Your provider is now the owner and beneficiary.¬†
  • Payment:¬†You will receive the agreed-upon amount when the sale is complete. You can use this amount as you see fit, provided you understand the tax implications.¬†

Your settlement provider will then own your policy, pay your premiums until you pass away, and collect the death benefit from the life insurance company.

The transaction involves you, your insurance company, and your settlement provider. Working with a trustworthy settlement broker is essential to ensure fair and competitive payment.

Viatical Settlement Tips and Tricks

If you have decided a Viatical Settlement is worth exploring, remember these tips and tricks to ensure you get the best result possible:

  • Consult a tax advisor:¬†While a Viatical Statement is typically not taxed, these transactions can have nuanced tax implications that could result in unforeseen circumstances. A trustworthy tax advisor can help you navigate the process.
  • Verify your settlement provider:¬†If you sell your life insurance policy to an organization unlicensed by the state, you could be liable for tax if your state requires providers to be licensed.¬†
  • Work with a trusted settlement broker:¬†Your broker represents you, not the insurer or settlement provider. They have a fiduciary duty to act in your best interest, which includes getting maximum value on your settlement.¬†
  • Make buyers compete:¬†Your broker will gather¬†multiple offers from potential buyers¬†to ensure a fair and competitive payout.¬†
  • Check your debt:¬†If you have outstanding debt, check if creditors can claim your cash settlement before making your final decision.
  • Understand access to health information:¬†Your settlement providers are permitted to check your health condition, so ensure you know who will have access and are comfortable with the situation.
  • Answer truthfully:¬†When you fill in your application form, double-check that you have answered all questions accurately, especially those related to your medical condition.
  • Stay in contact:¬†Someone may contact you periodically to check in and determine your health status. Determine how often you can expect this communication and ensure you are comfortable with disclosing your health status.

Let Settlement Benefits Association Walk You Through the Viatical Settlement Process

Let Settlement Benefits Association Walk You Through the Viatical Settlement Process

Deciding to sell your life insurance policy is a significant decision. When you do, you want to know you are working with a settlement broker you can trust. Settlement Benefits Association was founded in 2002, and our experience and dedication to helping individuals maximize their life insurance means you get our best people on every case. Our job is to bring you the highest offer on your life insurance so you can spend your money however you choose.

Use our visual valuator to see if you qualify for a Viatical Settlement, or contact us for more information, and one of our dedicated specialists will be in touch to start the settlement process. Let Settlement Benefits Association help you get the best value on your life insurance when you need it the most. 

Always discuss any taxation with your qualified tax professional.

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