How Are Viatical Settlements Treated for Tax Purposes?
Generally, viatical settlements are not treated as part of your income, so the lump sum payment you receive for selling your policy will likely not be taxed.
But it’s important to remember this could potentially vary depending on your specific circumstances and factors. The base requirements of a viatical settlement must be met. Life settlements, which are like viatical settlements, are typically taxed.
Federal and State Law
From a federal perspective, there should be no concern about a tax on viatical settlements in most cases. According to the U.S. Office of Personnel Management, a law that was passed in 1996 exempted qualified payments of viatical settlements from federal taxation.
This update was part of a larger change that exempted types of accelerated death benefits from federal taxation.
State laws and regulations surrounding viatical settlements can vary from state to state, so it may depend on where you live or where you sell your life insurance policy.
Status of the Insured
While viatical settlements for the terminally ill (those with less than two years to live) are usually not taxable, this may not be the case if you are chronically ill.
According to the National Association of Insurance Commissioners, to qualify for a settlement as chronically ill, you typically must be unable to perform at least two basic daily activities on your own, like eating or dressing yourself, or you must require supervision due to severe cognitive impairment.
The lump sum payment from a viatical settlement to a chronically ill seller may not be taxed if it is used specifically for paying for care of the seller. But it may be taxed if it is used for anything else. Essentially, the payout may be taxable depending on what the money is used for.
What States Regulate Viatical Settlements?
According to an article from the Life Insurance Settlement Association, 45 states regulate viatical settlements. The few that do not are Alabama, Missouri, South Carolina and Wyoming, as well as the District of Columbia.
All other states have some form of regulation around viatical settlements, including what companies or providers can engage in them in each state.
The same is true for life settlements as well, with Michigan and New Mexico only regulating viatical settlements.
States Without Viatical Settlement Regulations
- Alabama
- Missouri
- South Carolina
- Wyoming
Exact laws and regulations vary by state, with changes ranging from minor to major. It is important to remember to check which companies or providers are regulated in your state when looking for a viatical settlement.
Estate Tax Implications
It is unlikely that someone who sells their life insurance policy in a viatical settlement would be confronted with estate tax implications.
Remember that the lump sum payout of a viatical settlement will be less than the death benefit would have been, since the goal of the company that buys your policy is to make a profit.
People who seek viatical settlements often do so because they need immediate cash to pay medical bills or deal with some other unexpected expense. According to the Internal Revenue Service, the estate tax threshold for 2022 is more than $12 million.
It is highly unlikely that someone who would be interested in a viatical settlement or have need for one would also have an estate valuable enough to trigger the estate tax. It is also unclear if the payout from a viatical settlement would even be included in the estate tax since it is typically not taxable.
How Are Viatical Settlement Alternatives Taxed?
Some of the alternatives to viatical settlements are generally taxed. Life settlements, for example, can be taxed.
Life settlements operate similarly to viatical settlements, with a policy being sold to a third party in exchange for a lump sum payment. But unlike viatical settlements, the seller of the policy can be healthy.
According to the IRS, the death benefit that your beneficiary receives from your life insurance policy after you die is typically not taxable.
But if you surrender your life insurance policy, you may have to pay tax on some of the cash you receive that exceeds how much you paid in premiums.
