Viatical Settlement Taxation

Viatical settlements are typically — but not always — non-taxable since they are considered an advance payment of a life insurance policy benefit. If you’re considering a viatical settlement, understand the nuances and tax implications before you take action.

Christian Simmons, writer and researcher for RetireGuide
  • Written by
    Christian Simmons

    Christian Simmons

    Financial Writer

    Christian Simmons is a writer for RetireGuide and a member of the Association for Financial Counseling & Planning Education (AFCPE®). He covers Medicare and important retirement topics. Christian is a former winner of a Florida Society of News Editors journalism contest and has written professionally since 2016.

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  • Edited By
    Lamia Chowdhury
    Lamia Chowdhury, editor for RetireGuide.com

    Lamia Chowdhury

    Financial Editor

    Lamia Chowdhury is a financial content editor for RetireGuide and has over three years of marketing experience in the finance industry. She has written copy for both digital and print pieces ranging from blogs, radio scripts and search ads to billboards, brochures, mailers and more.

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  • Reviewed By
    Ebony J. Howard, CPA
    Ebony J. Howard, CPA

    Ebony J. Howard, CPA

    Credentialed Tax Expert at Intuit

    Ebony J. Howard is a certified public accountant and freelance consultant with a background in accounting, personal finance, and income tax planning and preparation.  She specializes in analyzing financial information in the health care, banking and real estate sectors.

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  • Published: November 18, 2022
  • Updated: November 22, 2022
  • 3 min read time
  • This page features 4 Cited Research Articles
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How to Cite RetireGuide.com's Article

APA Simmons, C. (2022, November 22). Viatical Settlement Taxation. RetireGuide.com. Retrieved December 7, 2022, from https://www.retireguide.com/life-insurance/viatical-settlement/taxation/

MLA Simmons, Christian. "Viatical Settlement Taxation." RetireGuide.com, 22 Nov 2022, https://www.retireguide.com/life-insurance/viatical-settlement/taxation/.

Chicago Simmons, Christian. "Viatical Settlement Taxation." RetireGuide.com. Last modified November 22, 2022. https://www.retireguide.com/life-insurance/viatical-settlement/taxation/.

Key Takeaways
  • Viatical settlements are generally not taxable.
  • There are tax differences between settlements for terminally and chronically ill sellers.
  • Most states have regulations in place governing viatical settlements; details can vary from state to state.
  • Consult with a trusted tax professional to examine the specific tax implications of your settlement.

A viatical settlement is a financial transaction in which a terminally or chronically ill person sells their life insurance policy to a third party for a lump-sum payout they can use while still alive. Given the requirement for a terminal or chronic diagnosis, choosing a viatical settlement is a sensitive and personal decision that warrants careful consideration of all the consequences, including tax implications.

Are Viatical Life Settlements Taxable?

The IRS excludes viatical settlements from federal income taxation. They are not considered capital gains but a pre-payment of the policy’s death benefit, meaning your lump-sum payment is not subject to federal tax.

Most states have regulations in place regarding viatical settlements, however, and tax details can vary from state to state. It is important to discuss any state-based implications with a tax specialist.

A viatical settlement lump-sum payment is excluded from taxable income, but only a portion of a life settlement is similarly excluded. Other portions can be treated as ordinary income and/or capital gains, depending on the size of your plan and premiums.

Tax-Free Viatical Settlement Requirements

The seller in a viatical settlement is called the viator. If the viator is terminally ill, meaning with a life expectancy of 24 months or less, the settlement payout is not taxable since it is part of the death benefit instead of a capital gain.

A viator might be chronically ill, which can have different tax implications. A chronically ill viator cannot perform at least two functions of daily living — like eating, bathing or dressing — without help. Monies used to pay for the viator’s care are generally not taxable, but if the lump-sum payment is used for other reasons there is a limit on how much is excludable tax-free per day.

In addition, most states have regulatory requirements for buyers of life insurance policies designed to protect viators. If the buyer does not meet those requirements, the viator may face tax consequences. Therefore, it’s important to have a thorough tax discussion with the viatical settlement company you choose.

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Frequently Asked Questions About Viatical Settlement Taxation

Will I have to pay taxes on the lump-sum payment I receive?
Generally no, because viatical settlements are considered part of the death benefit, not capital gains. But to be sure of the specifics of your particular circumstances, consult an experienced tax advisor.
Are viatical settlements taxed the same way at the state and federal level?
Federally, viatical settlements are largely not taxable. Most states have similar regulations in place governing viatical settlements, though the fine details vary. The Life Insurance Settlement Association (LISA) maintains a list of state regulations accessible on it’s website.
How can I plan ahead for tax purposes?
It’s important to get advice from a trusted tax professional about your particular situation. A reputable viatical settlement company should also be able to explain any potential tax implications. As with any major financial transaction, you should carefully save all closing documents for use during tax season.
Are tax implications the same for policies held by individuals and corporations?
Viatical settlements for individual policyholders are typically non-taxable. However, corporate-held policies can be taxed. The life insurance provider should be able to provide details for the policies in question.
Are life settlements and viatical settlements taxed the same way?
Life and viatical settlements are taxed differently. A viatical settlement lump-sum payment is excluded from taxable income, but only a portion of a life settlement is similarly excluded. Other portions can be treated as ordinary income and/or capital gains, depending on the size of your plan and premiums. Consult a qualified tax professional for advice about your specific plan and needs.
Last Modified: November 22, 2022

4 Cited Research Articles

  1. Life Insurance Settlement Association. (2021, June 9). Regulations Overview. Retrieved from https://www.lisa.org/regulations-overview/
  2. National Association of Insurance Commissioners. (2009, July). Viatical Settlements Model Act. Retrieved from https://content.naic.org/sites/default/files/inline-files/MDL-697.pdf
  3. Internal Revenue Service. (n.d.). Information Reporting for Certain Life Insurance Contract Transactions and a Modification to the Transfer for Valuable Consideration Rules. Retrieved from https://irs.gov/pub/irs-drop/n-18-41.pdf
  4. Internal Revenue Service. (n.d.). Publication 525 (2021), Taxable and Non-Taxable Income. Retrieved from https://irs.gov/publications/p525#en_US_2021_publink1000229386