Should you sell your life insurance policy to help cover medical bills?
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A serious illness can bring unexpected expenses, including medical bills, long-term care costs, and lost income. If you have a life insurance policy, you may be able to withdraw a portion of the cash value, take out a loan against it, or surrender the policy entirely to receive its value. But if you have a terminal or chronic illness, there is another option that may bring in much-needed money to cover those expenses: a viatical settlement (âviaticalâ).
A viatical settlement lets a policyholder sell an existing life insurance policy to a third party for a lump-sum payment (or a series of structured payments) and receive cash when it may be needed most. Viaticals offer financial flexibility, but they also mean giving up some or all of a death benefit that would otherwise go to your beneficiaries. Hereâs what you need to know before you agree to a viatical settlement.
Key Points
- A viatical settlement involves selling a life insurance policy to a third party, generally when the insured person has a terminal or chronic illness.
- You receive cash for the policy, while the buyer takes over premium payments and receives the death benefit when you die.
- Viatical settlement proceeds are excluded from federal gross income when the transaction meets IRS requirements.
What is a viatical settlement?
A viatical settlement is a financial transaction in which a life insurance policy owner sells the policyâor an interest in its death benefitâto a third-party buyer. The seller is known as the viator. In a typical transaction, the buyer pays the policyholder an agreed-upon amount and assumes responsibility for future premiums. When the insured person dies, the buyer collects the death benefit.
Viaticals generally involve insured people with terminal or chronic illnesses, although the legal definitions and eligibility requirements vary by state. (Itâs also possible to sell a life insurance policy for other reasons; this transaction is called a life settlement and is compared below.)
The payment amount you (as viator) receive depends on several factors, including the policyâs death benefit, your estimated life expectancy, the premiums required to maintain coverage, and the buyerâs expected return. A viatical settlement generally pays more than the policyâs cash surrender value, but less than the full death benefit.
How does a viatical settlement work?
A viatical settlement often uses an outside companyâa viatical settlement providerâto manage the transaction, which involves the following steps:
- Review the policy. Determine whether your life insurance policy is eligible for sale. Both permanent and certain term life insurance policies may qualify.
- Provide medical information. The settlement provider evaluates your medical condition and life expectancy, generally using authorized medical records.
- Receive an offer. The provider calculates a purchase price based on the death benefit, expected future premiums, life expectancy, and other considerations.
- Complete the sale. If you accept the offer, you sign the settlement agreement and ownership or benefit rights are transferred according to the contract.
- Receive payment. Once the transaction is complete and the required conditions are met, you, as viator, receive the settlement proceeds in a lump sum (or several payments).
Depending on the transaction, a broker can help you find and compare offers from multiple settlement providers. Brokers typically receive commissions, which will reduce the net settlement amount.
History of viatical settlements
The modern viatical settlement industry developed during the HIV/AIDS epidemic in the 1980s. At the time, many people diagnosed with AIDS faced short life expectancies, large medical expenses, and difficulty continuing to work. Selling life insurance policies provided a way to pay for treatment and everyday living costs. Others with terminal diagnoses, such as terminal cancer, could also access these settlements.
As HIV/AIDS treatments improved during the 1990s, people began living longer, and medical advances changed the financial calculations for investors who had purchased policies based on shorter projected life expectancies.
By the late 1990s, the industry had expanded beyond people with terminal illnesses. A broader secondary market emerged, allowing older policyholders and others to sell coverage they no longer needed or could afford. This became known as the life settlement market.
Example of a viatical settlement
Suppose you are diagnosed with a terminal illness and need cash in order to settle your affairs. Say you own a life insurance policy with a $300,000 death benefit, but the policy has a cash surrender value of only $25,000. Letâs say your broker shops around and finds a viatical settlement offer of $180,000.
If you accept, you receive $180,000, minus any transaction costs. The buyer of the policy then assumes ownership and responsibility for future premiums. When you pass away, they will receive the $300,000 death benefit.
In the meantime, you can use the settlement proceeds for medical care, living expenses, or other financial priorities. However, your original beneficiaries will no longer receive the death benefit. Thatâs the trade-off.
Note that viatical settlement offers can vary quite a bit depending on the severity of the illness, life expectancy, and medical developments that could affect your prognosis.
Viatical settlement vs. life settlement
Both viaticals and life settlements involve selling an existing life insurance policy to a third party. In either case, the seller typically receives a lump-sum payment. The primary distinction is the insured personâs health and life expectancy.
| Feature | Viatical settlement | Life settlement |
|---|
| Typical seller | Person with a terminal or chronic illness | Typically an older adult who no longer wants or needs the policy |
| Primary motivation | Obtain cash during a serious illness | Access value from unwanted or unaffordable coverage |
| Life expectancy | Often shorter due to illness | Generally longer |
| Federal income taxes | May qualify for an exclusion | Some proceeds may be taxable |
| Death benefit | Generally transfers to buyer | Generally transfers to buyer |
Although the industry distinguishes between the two types of transactions, state insurance laws sometimes use the term viatical settlement broadly enough to encompass life settlements.
Viatical settlement vs. surrendering a life insurance policy
When you surrender a permanent life insurance policy, you terminate the coverage and receive its cash surrender value, if any, from the insurance company. The insurer determines the value based on the policyâs terms, including any applicable surrender charges and adjustments.
A viatical may provide more than the policyâs cash surrender value, but it also involves additional fees, medical evaluations, and other requirements. Unlike surrendering a policy, which terminates coverage, a viatical settlement transfers the policy to a buyer, who keeps it in force and eventually collects the death benefit.
Viatical settlement rules and regulations
States primarily regulate viaticals. Requirements can include licensing, consumer disclosures, privacy protections, and procedures for completing a transaction. Common regulatory protections include:
- Licensing requirements for settlement providers and brokers
- Disclosure of settlement terms, fees, and potential financial consequences
- Requirements for obtaining consent before accessing medical information
- Rules governing how and when settlement proceeds are paid
- Rescission rights that allow a seller to cancel a transaction within a specified period, such as 10 or 20 days
States may also restrict the sale of newly issued policies to discourage people from buying life insurance primarily for resale.
Are viatical settlements taxable?
Proceeds from a viatical are excluded from federal gross income when the insured person meets the IRS definition of terminally or chronically ill and the transaction meets the requirements for a qualifying viatical settlement.
However, you must meet certain requirements to be considered terminally or chronically ill.
- Terminally ill: A physician certifies that an illness or condition is reasonably expected to result in death within 24 months.
- Chronically ill: Youâre unable to perform at least two activities of daily living (ADLs) for at least 90 days without substantial assistance, or you require substantial supervision because of severe cognitive impairment.
If the transaction doesnât qualify for the exclusion, some of the proceeds can be taxable. If youâre unsure whether your settlement qualifies for the exclusion, consult a qualified tax professional before completing the transaction.
If youâre facing a serious illness and need cash, a viatical settlement is one of several options you might have. And although viaticals frequently offer a much higher payout than surrendering a policy, theyâre not âfree money.â Your settlement offer is only a percentage of the policyâs death benefit, and commissions and fees will typically reduce the net amount even more.
In other words, compare a viatical with any other available options, such as tapping the equity in your home via a loan, credit line, or reverse mortgage, and/or taking extra withdrawals from your retirement savings. Perhaps the first question you should ask is whether youâre at risk of outliving your savings and, if so, which assets you can tap without putting yourself in a worse position later. If you have enough assets to cover your remaining needs, the calculation is different: You can weigh what you need now against what you hope to leave to your heirs.
This article was most recently revised and updated by Miranda Marquit
