Viatical settlements are agreements between a life insurance policyholder (viator) and an entity (usually a viatical settlement company) to pay the viator some percentage of their policy upfront and then have the company receive the viator’s insurance payout once they die.
The rules surrounding these policies are not always obvious. Speak with an advisor to find out whether they are a good fit for you and how to proceed if you are considering going this route. (Learn More — Viaticals and Taxes)
Viatical settlements are not always tax-free, although they can be if the payment falls under HIPPA and your state also mirrors HIPPA’s exemptions (as many do). Broadly speaking, to be tax-exempt, the company has to follow certain guidelines, and the viator must be terminally ill as defined by specific guidelines. (Learn More — Will My Viatical Be Taxed?)
There are certain tax-related intricacies that almost always make it a good idea to contact an advisor to break down a policy. Generally, your payment can still be taxed if it isn’t going toward necessary medical expenses. It can also potentially trigger estate taxation, although this will likely only be the case for particularly wealthy viators. (Learn More — Reasons to Talk With an Advisor)
Viaticals and Taxes
A viatical settlement is an agreement between someone with a life insurance policy and another entity (usually a viatical settlement company) wherein the insurance policyholder (the viator) receives a sum of money while they are still alive and agrees that the other entity receives the payout from their insurance once they die.
Viatical settlements are often complex. Before you get one, consider all other options and discuss whether it is a good fit for your situation with a financial advisor.
While the allure of an immediate payout can be enticing, especially if you’re strapped for cash, remember that there is a reason companies make these deals. They often profit by a substantial amount once you die — in some cases, by triple digit percentage margins.
Assuming you determine that a viatical settlement is right for you, and you are using a reputable company, you can then address specific questions related to the deal. You will need to figure out whether your viatical payment will be taxed and by how much. The answer is sometimes more complicated than one might think.
Will My Viatical Settlement Be Taxed?
Viatical settlements are not universally tax-free, although they can be in some cases. They used to be taxed normally as income, but in 1996, the Health Insurance Portability and Accountability Act (HIPAA) was signed into law, which made many viatical settlements and related accelerated death benefits exempt from federal income tax.
Most states have similar laws in place that make these payments exempt from income tax, although this is not necessarily true across the board. Make certain your state does not tax viaticals, or you could land yourself or your family in legal trouble at a time in your life when that type of upset can be especially disruptive.
It should also be noted that for these settlements to be tax-free, you need to meet certain requirements. Your payment is only tax-free if your agreement falls under HIPPA and is made with a qualified viatical settlement provider. To qualify, the provider must:
- Be an entity (either person or company) that regularly purchases insurance policies covering the terminally ill.
- Be properly licensed to operate as the above in your state.
- Meet minimum payout requirements (or higher) wherein they pay a certain percentage of your life insurance policy’s value. The minimum is based on your life expectancy.
You should be certain any company you make a viatical settlement with meets the above requirements.
In addition, the viator must meet one of the following requirements to have their payment be tax-exempt under HIPPA.
- They must be unable to do at least two of the following without help for 90 days: Eat, clothe, bathe, dress, or control their bowels and bladder.
- They have a similar degree of disability as defined by the Secretary of the Treasury.
- They require high levels of supervision to keep them safe and protect their health due to cognitive impairment.
Reasons to Talk With an Advisor
The rules around viatical settlements are not easy for an untrained person to navigate. While it is not always the case, there are some individuals working for scam settlement companies that may mislead you so they can profit off your policy. Advisors can keep you from being tricked or simply from making any potentially costly financial mistakes.
Chronically ill people may sometimes find that their viatical payment is subject to taxes when they didn’t expect it to be. For example, if you receive too much money per day from your settlement, your payment is not going toward necessary long-term care. This may make it taxable.
As a very broad rule, payments going toward necessary treatments tend to be tax-exempt, but the same is not always true for the policy’s leftover payment.
Viatical settlements can trigger estate tax as the payment adds to your estate. To trigger estate tax, you must have an estate valued at $11 million or more, so this won’t affect most people.
Viatical settlements are not always the best choice. Financial advisors can lay out the numerous other options available; it is important to familiarize yourself with them before making any big financial decisions.
References
Viatical Settlements: Myths and Misconceptions. (May 18, 2011). Intangible Personal Property.
Viatical Settlement Definition. (February 11, 2018). Dotdash.
Are Viatical Proceeds Taxable? American Life Fund.
