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Life insurance policies are usually meant to help your loved ones manage their financial burdens after you die. If you're willing to give up that death benefit, viatical settlements can make policies useful while you're still alive, by giving you cash upfront in exchange for your future life insurance payout.
Losing your death benefit can have a big impact on the people you leave behind, so viatical settlements aren't something to take lightly. With many policies now offering life insurance riders to help support you while you're still alive, you may no longer need to sell your policy.
What is a viatical settlement?
In a viatical settlement, you sell the benefit of your life insurance policy when you have very little time left to live due to illness or injury, often less than two years. You can sell any type of life insurance — term, whole, universal, etc. — but you'll need to find a buyer in the market for that type of policy.
Sales of a life insurance policy are generally called life settlements, and when they take place near the end of life, they're called viatical settlements.
Viatical settlements are different from policy options that allow you to tap part of your death benefit while you're still alive, though they often apply in the same situations. The most common version of this is the accelerated death benefit rider, which allows you to take a portion of your death benefit if you're diagnosed with a serious or terminal illness.
For some people, the absence of an accelerated death benefit provision or the need for more money than the benefit provides can lead them to sell the future benefit of their policy.
How much does a viatical settlement pay?
The payment you get from a viatical settlement will be somewhere between the value of the policy's death benefit and any cash value the policy has accrued.
For instance, consider a hypothetical permanent life insurance policy that will pay out $1 million when you die. Over the years, this policy might have built a cash value of $150,000, allowing you to get cash from your life insurance by borrowing or withdrawing some of this value.
If the $150,000 isn’t enough, you might be able to get a viatical settlement of $500,000 by giving up the policy.
The actual amount paid depends on all the values involved and the life expectancy of the seller. As a rule of thumb, the longer you have to live, the less you'll be paid. Taking a viatical settlement also means the life insurance beneficiaries you originally chose will get nothing from your policy when you die.
Compare that payment to an accelerated death benefit rider, which might allow for monthly payments over a two-year period. Your $1 million policy might allow for $250,000 in total payments and, when you die, your beneficiaries would still get $750,000 — the original $1 million minus your $250,000 in accelerated payments.
Amounts will vary depending on your policy's value, your health, the type of policy you have and even what state you live in. Accelerated death benefit riders usually allow you to withdraw 25% to 95% of your policy's value. Viatical settlements typically range from 55% to 80% of the policy's value.
Viatical settlement basics
In most states, taking part in a viatical settlement requires both you and the buyer (the "viatical settlement provider," which is usually a company) to meet requirements, including rules about your health. Like an accelerated death benefit, most settlements require you to be chronically sick or suffering from a terminal illness.
To get the best possible tax treatment of your payment, you’ll need to sell to a company within your state. Viatical settlement taxation can be complex, and anyone considering a settlement should talk to an independent financial advisor.
In many cases, your policy will need to be a certain age before you can sell it. States that regulate viatical settlements often require that you've held the policy for at least two to five years before you sell it. This is so you don't buy a policy to sell immediately after receiving a terminal diagnosis.
Alternatives to viatical settlements
In many cases, an accelerated death benefit will replace the need for a viatical settlement. The process for claiming an accelerated benefit is relatively straightforward. The rider is available on most insurance policies and the benefits are often not much smaller than a settlement would offer.
If you own life insurance with cash value, you can also consider borrowing against your policy. A life insurance loan keeps your coverage in place, generates immediate cash and leaves something behind for your beneficiaries.