Tax Advantages of a Viatical Settlement

Tax Advantages of a Viatical Settlement
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    A viatical settlement refers to the sale of a life insurance policy by a terminally or chronically-ill person.


The Viator sells the insurance policy to a licensed viatical settlement company in the resident state for a lump sum cash payment. This payment is used to cater for living expenses, medical care, or donations to charity. Viatical settlements enjoy some tax advantages under the federal law.

Income Tax Exempt

The Health Insurance Portability and Accountability Act defines terminal illness as any illness that cuts life expectancy to less than 24 months. Viatical settlement funds for chronically or terminally-ill individuals are exempt from federal income tax; as they are not considered part of their income. But for this to apply, the funds must go toward qualified long-term care services not compensated by insurance. Proceeds paid are tax exempt up to the annual limit of $80,300 or $220 per day.

All viatical settlement companies must be licensed by the state under the Internal Revenue Code. If licensing is not required, then the company must meet the requirements of the Viatical Settlements Model Act. This is regulated by the National Association of Insurance Commissioners. There are also other standards for determining a reasonable amount paid by the viator to the policy holder.

Estate Tax Exempt

Under the Federal Tax Act, a life insurance policy is the same as any other property controlled by an individual until the time of their death. When a life insurance policy holder decides that they don’t need it anymore, they sell it to a viatical settlement company. Then the tax department treats it as a gain on the property and thus subject to taxation like any other asset.

This rule, of course, changes for those who are terminally ill. In this case, the sale of the policy in exchange for cash removes the value of the policy from the taxable estate of its holder. As a result, they become exempt from the federal estate tax. There is a caveat, however. Under Code Section 101 (g), to qualify for the tax exemption, proceeds must be spent on long-term care services for the beneficiary.


Note that not all viatical settlements have similar tax consequences. Before filing for a viatical settlement, policy holders should have solid information about the tax codes in their respective states. There may also be extra federal restrictions in context of the state to be aware of as well.


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