A viatical settlement is a type of life settlement that allows you to receive a substantial lump-sum payment for your life insurance policy while you’re still alive. Instead of keeping the policy (and your beneficiaries ultimately receiving the death benefit), you can sell it to get money for health care and other needs.
Learn how viatical settlements work, the pros and cons of these strategies, and alternatives to selling your life insurance policy for cash.
Definition of a Viatical Settlement
A viatical settlement is an arrangement in which you sell a life insurance policy to a settlement company before the insured person dies. The settlement company takes ownership of the policy and eventually receives the death benefit.
A viatical settlement is one way to access a significant portion of your policy’s value prior to death. You can use the funds for anything you want, but your beneficiaries will not receive the death benefit from your policy.
Legislation of viatical settlements varies by state, so it’s essential to check with yours to determine whether you qualify and for other important details.
Qualifying for a Viatical Settlement
To qualify for a viatical settlement (or for one to make financial sense), you must typically have been diagnosed with a terminal or chronic illness. In this case, a chronic illness would likely mean that you need help with at least two activities of daily living, such as eating and bathing, or suffer severe cognitive impairment.
Certain medical conditions satisfy that requirement, as does a diagnosis saying you have two years or less to live. For example, if you have advanced heart disease, end-stage kidney disease, or stage-four cancer, you might qualify.
How Viatical Settlements Work
Life insurance is a powerful tool for protecting loved ones. But in some situations, it’s better to receive the funds before the insured person dies. For example, your spouse and children might be financially secure, not need the death benefit, and prefer that you have plenty of money available for medical treatments, comfortable facilities, or a final family vacation everyone can enjoy together.
The amount you receive is a percentage of the policy’s death benefit. The shorter your life expectancy, the higher the percentage. To continue the example above, if you found out you had eight months to live, you could potentially use a viatical settlement to exchange a $100,000 policy for about 70% of the death benefit, or $70,000.
With a life expectancy of two years or less, you generally won’t pay income taxes on payments you receive from a viatical settlement as long as they’re received from a properly licensed viatical company. However, it’s critical to review your situation with a CPA.
For example, in some situations, the funds may need to go toward specific long-term care expenses to qualify as tax-free. This might be the case for a chronically ill patient who is unable to perform certain activities of daily living or experiencing cognitive decline.
Using a viatical settlement is a big decision, and it requires careful consideration.
- Consider discussing the idea with family members, who may expect a death benefit.
- Review the strategy and explore alternatives with your CPA and other financial professionals.
- Get quotes from multiple brokers or settlement providers.
- Contact your state’s division of insurance or financial services to verify that providers are properly licensed in your state.
- If you choose to move forward, apply for the settlement with the settlement company.
- Provide information about your insurance policy and your health to the settlement provider.
- If approved, the buyer places the payment funds in escrow until you transfer control of the policy to the buyer.
- You receive funds, which you can use for anything you want, and are no longer responsible for premium payments.
Costs of Viatical Settlements
You typically don’t pay upfront fees, but brokers and others behind the scenes may earn commissions from your transaction. Remember that the companies offering these solutions are for-profit businesses, and the difference in offer sizes is effectively a “cost.”
Shop around as you evaluate viatical settlements because each provider might offer different amounts.
How Much Is My Policy Worth?
To find out how much you can get from a viatical settlement, you need to apply for a settlement. Settlement companies evaluate your life insurance policy, your medical history, and other details to arrive at an offer amount.
Viatical Settlement Regulations
Most states regulate viatical settlements, and the rules vary from state to state. Check with your state’s insurance division to verify that any settlement company you’re evaluating is authorized to conduct business in your area. Laws often require settlement providers to disclose important information about your transaction as well as alternatives to using a viatical settlement—but it’s still up to you to ensure you’re getting a fair deal.
You may need to wait several years after purchasing a life insurance policy to use a viatical settlement. Some states require that your policy be at least two to five years old, so research your state’s requirements early in the process.
Viatical Settlements vs. Life Settlements
Life settlements are similar to viatical settlements because in both arrangements, you sell your policy for a lump sum, the buyer takes over the death benefit and premium payments, and you can use those funds during your lifetime. However, there are some crucial differences:
|Requirements||Viatical Settlements||Life Settlements|
|Terminal or chronic illness diagnosis||Yes||No|
|At least 65 years old||No||Yes|
|Taxes due on settlement proceeds||Typically no||More often yes|
Criticisms of Viatical Settlements
Pitfalls for Investors
Investors considering viatical settlements should be aware of several potential pitfalls. There’s no way to predict if or when your investment will pay off, making insurance policies difficult to value. If somebody lives longer than anticipated, you won’t receive payment when you expect it. As a result, you’ll end up with a lower return, and you may need to pay premiums for longer than anticipated—potentially causing you to lose money.
Besides the mathematical considerations, other risks exist. For example, the insurance company could go bankrupt or choose not to pay a death benefit, or the deceased’s family members could take legal action against you. Use caution unless you’re familiar with all of the possible risks.
Investing in viatical settlements can be extremely risky and result in losses.
Because of the risks involved, investments in viatical settlements are limited to accredited investors who satisfy specific income, asset, or other requirements defined under federal securities law.
Pitfalls for Policy Owners
There are a few items to be aware of if you’re considering a viatical settlement:
- The primary drawback for policy owners is that your beneficiaries will not receive a death benefit after you sell the policy.
- You could lose access to need-based benefits like Medicare if you no longer qualify once you receive the settlement.
- If you have or may have judgments entered against you, those funds could be accessed by creditors.
- If you have an outstanding loan against the cash value, you may have to pay it back before you sell the policy.
Alternatives to Viatical Settlements
There are other ways to access the cash value in your policy that may be more advantageous than selling it through a viatical settlement.
Accelerated Death Benefit
One of the most attractive alternatives may be an accelerated death benefit (ADB), which allows you to access a portion of your policy’s death benefit during your lifetime. An ADB feature may be included in your policy or may be an optional rider that costs extra.
With an ADB, you get funds directly from your insurance company instead of working with a third party. Plus, your beneficiaries still get a death benefit; you receive a portion of it during your lifetime and your beneficiaries receive the amount left once the ADB rider is exercised. In other words, the eventual death benefit they receive may be reduced by an amount greater than what you received to account for the early payout.
However, an ADB might be more restrictive than a viatical settlement. Your insurance policy could require that you have only one year of life expectancy, for example, but viatical settlements can provide funding earlier than that. Viatical settlements might also allow you to get a substantial amount more quickly than you can get from an ADB. Some policies set limits on how much you can draw each month, which may not be enough for your needs.
Similar to viatical settlements, ADBs can cause you to lose access to need-based benefits like Medicare.
If an ADB is not feasible and a viatical or other life settlement doesn’t appeal to you, another option is to borrow against your life insurance policy. If you have a permanent policy with a cash value (and you can borrow enough for your needs), this could be a solution. However, you’ll need to keep the policy in force if you want your beneficiaries to receive any death benefit and to avoid potential tax consequences. Keep in mind that the death benefit will be reduced by the amount of any unpaid loan.
- Viatical settlements enable you to sell a life insurance policy for a lump sum.
- Beneficiaries will not get the death benefit, but you can get money for health care and other needs.
- Before committing to a settlement, explore alternatives, including accelerated death benefit options with your existing insurance policy.
- Discuss your strategy with family members and financial professionals before you decide on anything.
- If you decide to move forward, compare offers from multiple providers.