Viatical settlement: selling a life insurance policy when you are terminally ill

A viatical settlement is the sale of an existing life insurance policy, by an insured person who is terminally or chronically ill, to a third-party buyer for a cash lump sum that is less than the death benefit but more than the surrender value. The buyer takes over the premiums and collects the death benefit. The seller — called the viator — gets money now, while it is still useful to them.

The feature that sets a viatical settlement apart from every other way of getting cash out of a policy is the tax treatment. Under section 101(g) of the Internal Revenue Code, a qualifying viatical settlement is treated as if the death benefit had been paid, which means the proceeds are excluded from gross income. Surrendering the same policy would produce taxable gain. Selling it as an ordinary life settlement would too.

That exclusion depends on conditions that are specific and not negotiable. This article covers who qualifies, what the buyer is actually pricing, how the tax rules work, and where the regulation sits.

What a viatical settlement is, and how it differs from a life settlement

Both transactions are sales of a life insurance policy on the secondary market. The difference is the health of the insured and, as a direct consequence, the tax result.

	Viatical settlement	Life settlement
Insured's health	Terminally or chronically ill	Generally older, not terminally ill
Typical driver	Illness-related costs, quality of life	Policy no longer needed or affordable
Tax treatment	Excluded from income if §101(g) conditions are met	Taxable above cost basis
Payout as % of face value	Usually higher, because life expectancy is short	Usually lower

Both sit alongside a third option most people overlook: many policies contain an accelerated death benefit rider that lets the insurer pay part of the death benefit early on the same terminal-illness grounds, without selling anything. That rider is usually cheaper than a settlement because there is no buyer's profit margin in it. Check the policy for one before you approach the market.

Who qualifies as terminally or chronically ill

The Code sets both definitions, and a physician has to certify them.

Terminally ill means the insured has an illness or physical condition that can reasonably be expected to result in death within 24 months of the certification. This is the clean case. There is no dollar cap on the exclusion — the entire viatical payment is excluded from income.

Chronically ill takes its meaning from section 7702B: the individual is unable to perform at least two activities of daily living without substantial assistance for an expected period of at least 90 days, or requires substantial supervision because of severe cognitive impairment. The exclusion here is narrower. It is subject to a per-diem limit that the IRS adjusts annually, and the proceeds generally have to be used for qualified long-term care services not covered by insurance. Do not assume the full amount is tax-free in a chronic-illness case; check the current per-diem figure and the use restriction with a tax adviser before signing anything.

A certification by a licensed physician is a documentary requirement, not a formality. Without it, the transaction is a life settlement and is taxed as one.

The buyer requirement that decides the tax result

This is the condition that most often catches people out. The exclusion under §101(g) applies where the policy is sold to a viatical settlement provider — a defined term, not a description.

If the state requires viatical settlement providers to be licensed, the buyer must hold that licence in the state where the viator lives. If the state does not require licensing, the buyer must instead meet the requirements of sections 8 and 9 of the National Association of Insurance Commissioners' Viatical Settlements Model Act, and the NAIC model regulations covering standards for evaluating whether a payment is reasonable.

The practical consequence: selling the policy privately — to a relative, an investor group, or anyone who is not a qualifying provider — can cost you the exclusion entirely, on a transaction where the exclusion was the main point. Before you engage with any buyer, confirm their licence with your state insurance department directly. The department, not the buyer, is the authority on whether that licence is current.

How the offer is calculated

A viatical buyer is pricing a fixed sum payable at an uncertain date. Three inputs drive the number:

Life expectancy. The buyer commissions a medical underwriting review, typically from a specialist life-expectancy provider, based on your medical records. A shorter expectancy means fewer premiums to pay and less waiting, so a higher offer. This is uncomfortable to think about and it is the single largest driver of the price.

Premiums the buyer must fund. Every dollar of premium between purchase and the death benefit reduces what the buyer will pay today. A policy with a low cost of insurance is worth more on the secondary market than an identical face amount with a high one.

The buyer's required return. The buyer discounts the expected death benefit back to today at a rate that compensates them for the risk that the insured lives longer than projected. That discount rate is where the buyer's margin lives, and it is rarely disclosed.

The arithmetic is the same discounting exercise that governs any purchase of a future payment stream. If you want to see how sensitive a valuation is to the discount rate applied, the mechanics in structured settlement discount rate transfer directly — a small change in the buyer's required return moves the offer far more than most sellers expect.

Because the buyer's assumptions are private, the only reliable way to test an offer is to get competing ones. Using a licensed viatical settlement broker changes the dynamic here: under the NAIC model framework, the broker represents the viator and owes a fiduciary duty to act in the viator's interest, whereas the provider is the buyer and represents itself. Brokers are paid from the proceeds, so ask for the commission in writing before engaging one.

State regulation and the protections it gives you

Viatical settlements are regulated at state level, principally by state insurance departments. Most states have adopted a version of either the NAIC Viatical Settlements Model Act or the NCOIL Life Settlements Model Act, and the two differ in detail. Common features across state regimes include:

• Licensing of providers and, in most states, brokers
• A rescission period after the contract is signed or funds are received, during which the viator can unwind the sale and return the money
• A waiting period after the policy was issued before it can be sold, intended to block stranger-originated policies — though states commonly waive it in genuine terminal-illness cases
• Disclosure requirements covering alternatives to selling, the effect on eligibility for public benefits, and the fact that the buyer will have access to medical information
• Escrow of the purchase price with an independent party until the policy ownership transfer is complete

The lengths of the rescission and waiting periods vary by state and by which model act the state adopted, so check your own state's rules rather than a general figure quoted online. Your state insurance department publishes them.

Two consequences worth planning for before you sell. First, the buyer will have a continuing right to contact you or your physician periodically to confirm you are alive. Second, receiving a lump sum can affect means-tested public benefits such as Medicaid or SSI — the money is an asset once it lands. If those benefits matter to you, take advice on that point before the sale, not after.

How the tax treatment compares to the alternatives

Assume a policy with a $500,000 death benefit, $60,000 of cumulative premiums paid and a $40,000 cash surrender value. These are illustrative figures only, used to show the mechanism.

• Surrender the policy: you receive $40,000. Gain is measured against basis, so with $60,000 of premiums paid there is no taxable gain here — but you have given up the death benefit for well under a tenth of its value.
• Qualifying viatical settlement: you receive the negotiated amount, and if the §101(g) conditions are met, none of it is included in gross income.
• Life settlement (not terminally or chronically ill): proceeds up to basis are a tax-free return of capital; the excess is taxable, split between ordinary income and capital gain. The Tax Cuts and Jobs Act removed the requirement to reduce basis by cumulative cost-of-insurance charges, and Revenue Ruling 2020-05 conformed the IRS's earlier guidance to that change — which increased basis, and therefore reduced taxable gain, for most sellers.

Sales of life insurance contracts also carry information-reporting obligations under section 6050Y, which is why buyers collect tax identification details at closing.

The broader principle — that the tax character of a payment depends on what it legally is, not what it feels like — runs through this whole area. The same logic decides whether a legal recovery is taxable, which we cover in are lawsuit settlements taxable, and it is worth understanding before you compare net figures on any offer.

What to do before accepting an offer

• Check the policy for an accelerated death benefit rider first, and ask the insurer what it would pay.
• Verify any buyer's licence directly with your state insurance department.
• Get more than one offer, and ask what life expectancy each is based on.
• Ask for every fee and commission in writing, expressed in dollars.
• Confirm the rescission period in your state and diarise the deadline.
• Take advice on the effect on any means-tested benefits, and on the §101(g) conditions specifically, before you sign.

If the policy is not the only asset in question — for example where a legal recovery is also involved — the interaction between the two matters, and settlement protection trust sets out how proceeds can be held without disrupting benefit eligibility.

Frequently asked questions

Are viatical settlement proceeds really tax-free?

They are excluded from gross income when the section 101(g) conditions are met: the insured is certified terminally ill by a physician, and the buyer is a qualifying viatical settlement provider — licensed in the state if the state requires licensing, or otherwise meeting the relevant NAIC model act and regulation standards. Miss either condition and the transaction is taxed as an ordinary life settlement. Chronic-illness cases are subject to a per-diem cap and a use restriction, so confirm your position with a tax adviser.

How much of the death benefit will I actually receive?

It depends almost entirely on medical underwriting, the premiums the buyer must fund, and the buyer's required return. Shorter certified life expectancies command higher percentages, because the buyer waits less and pays fewer premiums. No responsible figure can be quoted in the abstract — offers on similar policies vary widely between buyers, which is the argument for getting several.

What is the difference between a viatical settlement and an accelerated death benefit?

An accelerated death benefit is paid by your own insurer under a rider in the policy, and you keep the policy. A viatical settlement is a sale to a third party, who becomes the owner and beneficiary. The rider usually nets more per dollar of benefit because there is no buyer margin, but it may be capped at a portion of the face amount and may not be available on every policy.

Can I sell only part of the policy?

Some providers will buy a portion of the death benefit, leaving the balance with your existing beneficiaries. Availability varies by buyer and by policy type, and the pricing is not simply proportionate. Ask about it early if keeping some cover for your family matters — it is easier to structure at the outset than to renegotiate later.

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This article is general education about how viatical settlements work, not personal tax, legal or financial advice. The tax treatment described depends on conditions in the Internal Revenue Code that must be satisfied on the specific facts, state regulation varies, and the illustrative figures are worked examples rather than offers. Confirm your position with a qualified tax adviser, an attorney and your state insurance department before selling any policy.