Life insurance is a financial safety net, especially for people with young families. As you age, though, your policy may become unnecessary or stop fitting your goals. If you’re considering selling it, you have two main options: a viatical settlement vs. life settlement.
Both transactions allow you to sell your life insurance policy to a third party. In exchange, you get a lump sum payment that’s more than the policy’s cash surrender value, but you forfeit the death benefit to the new owner.
The main differences are your health and age at the time of the sale. Viatical settlements allow people of all ages with terminal or chronic illnesses to receive cash for their policy. Meanwhile, a life settlement is usually available for people aged 65 or older.
Understanding the differences between these options, including how payouts and taxes work, can help you decide if a settlement makes sense for you.
What Both Settlements Have in Common
What is a viatical settlement, and how does it compare to a life settlement? Both involve selling your life insurance policy to a third party for an immediate lump sum. You’ll receive a higher payout than you would if you surrendered your policy to the insurance company. The third party also takes over your monthly premium payments. Later, they’ll receive your death benefit.
In both cases, there are typically no restrictions on how you use your payout. For example, you might use it to cover medical expenses, buy a home, or go on an international vacation.
While both settlements work in similar ways, they’re designed for different situations and have different tax implications. Viatical settlements are for people with terminal or qualifying chronic medical conditions, while life settlement eligibility is based on age.
Here’s a quick snapshot of the key differences:
Viatical Settlement |
Life Settlement |
|
Health requirement |
Terminal or a qualifying chronic illness | None |
Age |
No minimum age | Usually 65 or older |
Payout |
Typically higher than life settlements | Often lower than viatical settlements |
Tax treatment |
Generally tax-free for qualifying illnesses | May be taxed as income |
A third option sometimes gets confused with a viatical settlement: an accelerated death benefit. This is an add-on in some life insurance policies that allows eligible terminally or chronically ill policyholders to receive a portion of their death benefit while they’re still alive. Unlike viatical settlements, it lets you retain ownership but deducts the payout from the final death benefit.
Who Qualifies for Each Type of Settlement
Eligibility requirements are one of the biggest life settlement vs. viatical settlement differences.
Some states use “viatical settlement” to refer to both transactions. Generally, though, a viatical settlement doesn’t have any age requirements. Instead, eligibility is based on:
- Health: You may qualify for a viatical settlement if you have a medically diagnosed terminal illness. In some states, people with certain chronic illnesses are also eligible.
- Life expectancy: A viatical settlement is typically available to people with a life expectancy of two years or less.
- Death benefit amount: At least $100,000.
Here’s a classic viatical settlement example: Joyce is 62 years old when she gets diagnosed with terminal cancer. She decides to sell her life insurance policy to pay for an experimental treatment. Because her doctor estimates that her life expectancy is 15 months, she qualifies for a viatical settlement.
Meanwhile, the requirements for a life settlement agreement may include:
- Age: This option is typically available to people aged 65 or older.
- Health status: Providers (also known as buyers) often prioritize policyholders who have had a change in health status since their policy was issued, though that’s not always necessary.
- Death benefit amount: At least $100,000.
Requirements can vary by state and provider, so research your local requirements.
How the Payout and Tax Treatment Differ
Viatical settlements typically pay more than life settlements because the buyer can expect to receive the death benefit sooner. They may also provide faster payouts, which is helpful if you need to cover immediate medical expenses.
By contrast, life settlements often take longer to process and may require extensive paperwork and medical records. The payout is also usually smaller, though still higher than surrendering the policy.
Viatical settlement taxation is also more lenient. If you have a terminal illness, you generally don’t have to pay federal income taxes on this payout. The money may also be tax-free if you have a chronic illness and use it to pay for qualified expenses, such as long-term care.
How life settlement proceeds are taxed depends on your cost basis, or the total you’ve paid in premiums (minus insurance costs or withdrawals). This portion typically isn’t taxed. However, the IRS may tax any proceeds between your cost basis and the surrender value as ordinary income, while anything above the surrender value usually gets taxed as capital gains.
A tax professional can help you understand how both types of settlement will affect your tax burden.
How the Process Differs and What Stays the Same
Here’s how life settlements work step by step and where they differ from viatical settlements:
- Eligibility review: A life settlement company or broker checks your eligibility using the criteria outlined above. You may need to provide medical documentation and other paperwork. For a viatical settlement, the reviewer will focus more closely on your health and life expectancy.
- Policy valuation: The company assesses the value of your life insurance policy based on your medical records, premiums, life expectancy, and other factors.
- Offer: The company offers you a lump sum in exchange for taking over your policy.
- Transfer of ownership: You sign a formal agreement to hand over ownership of your policy to the buyer, who becomes the beneficiary.
- Payment: You receive your funds as a lump sum.
- Taxation: If you receive a life settlement, you may need to pay taxes on your payout. Meanwhile, qualifying viatical settlements are tax-free.
As the seller, you don’t get to decide if you get a viatical or life settlement. It depends on your health profile at the time of your sale. A broker will help you identify the right path for your situation.
Which Path Fits Your Situation and Your Family’s?
Deciding whether to sell a life insurance policy can be stressful, but you don’t have to do it alone. Your family and trusted advisors can support you as you weigh the potential benefits and drawbacks.
Reach out to Life Settlement Advisors to see if you qualify for a viatical settlement or life settlement. We’ll also help you determine how a payout may affect your financial future, including eligibility for means-tested benefits. Our no-cost, no-obligation evaluation will help you navigate what comes next.
