A Quick and Easy Guide to Viatical Settlement Taxation

May 2, 2023 | Article, Guide

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Choosing to take a viatical settlement can be a challenging and emotional decision. When you or a loved one is diagnosed with a terminal illness, the last thing you want to think about is taxes. However, it’s important to understand the tax implications when using a viatical settlement to take cash out of a life insurance policy so you can make an informed decision that’s right for you.

What is a viatical settlement?

A viatical settlement is an option for policyholders who have been given under two years to live due to a terminal illness. This type of settlement allows you to sell the policy for cash to a third party if it meets certain requirements. The proceeds can be used for anything however, the money is often used for: medical treatment, home care professionals, and living expenses.

Learn more about the ins and outs of viatical settlements:

Read Our Guide

Are viatical settlement proceeds taxed?

Viatical settlements are typically not taxed. The settlement proceeds are considered an advance on the life insurance benefits, which are not taxed. However, there are certain conditions both you and the purchaser must meet in order to maintain tax-free status.

The purchaser must:

Have a history of regularly purchasing life insurance policies from terminally ill policyholders.
Be licensed in the state where the insured lives or follow the disclosure guidelines in the Viatical Settlements Model Act if the state does not require licensing.

It’s crucial to do your due diligence on any viatical settlement company or broker you are considering. Our checklist makes it easy:

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The policyholder (also called the seller or viator) must:

Be an individual* who is terminally ill (given 24 months or less to live) or be an individual who holds a policy on someone who is terminally ill.

*This means that if an employer or company has a life insurance policy on an individual, the proceeds will be taxed.

Health Insurance Portability and Accountability Act (HIPAA)

Did you know?

The federal law that exempts qualified viatical settlements from taxation was passed in 1996.

Remember, state laws can also determine whether or not you will be taxed on viatical settlement proceeds. Laws vary from state-to-state and can change each year. Always check your state laws or consult with a professional before making any decisions.

What if I’m chronically ill, not terminally ill?

A policyholder is considered chronically ill when they cannot perform two or more activities of daily living (ADLs) such as eating, grooming, bathing, walking, etc. These individuals may have an open-ended or unknown life expectancy, however, as long as the proceeds of the settlement are used to cover medical needs or long-term care, they are not taxed. If a person chooses to use the money for something other than healthcare expenses, it is taxed.

How much are viatical settlements taxed?

If you do not qualify for a tax-free settlement, the amount you are taxed will be determined by why you don’t qualify. If the IRS decides to treat your settlement as a life settlement, you would have to pay taxes on the amount received minus the premium payments made.

It’s important to consider viatical settlement taxation treatment before making any decisions about your life insurance policy. Contact the experts at PolicyBank® and we can walk you through the process.