You May Be Able to Tap Your Life Insurance Early If You're Terminally Ill. Here's How
If you've received a diagnosis of terminal illness, and need funds from a life insurance policy before you die, several options are available to help address those sad circumstances. None, alas, is a perfect choice for all who have only a short time to live.
One insurance transaction that’s often pitched to the terminally ill is what’s known as viatical settlement, which involves the sale of your policy outright before you die. But many policies also offer other alternatives to those who are cash-strapped and aren’t expected to live very long.
Here’s more on settlements and the other ways to tap your insurance if your time is short, along with advice on choosing the option that works best for you.
What is a viatical settlement?
This is a type of life settlement, the term used to describe the sale to a third party of a whole, universal or convertible term life insurance policy. The sales process for a viatical settlement is structured the same way as a life settlement — the policyholder gets a lump sum in exchange for the buyer taking over premium payments and collecting the death benefit.
Unlike life settlement, though, the viatical option is available only to people who are terminally ill, or have serious, chronic and debilitating conditions, generally coupled with a life expectancy of two years or less.
Viatical settlements came into being nearly four decades ago, in the early years of the AIDS epidemic. In that period, getting HIV represented a death sentence, and many of its victims had been actuarially projected to live much longer, according to Brian Barclay, president and senior managing director of Magna Life Settlements, a company that executes life and viatical settlements.
The settlements offered a way for early AIDS patients to use their policies to offset end-of-life medical costs and living expenses. As medical advancements made it possible for people to live much longer after contracting HIV, viaticals remained as an option for anyone who is terminally ill and holds an eligible insurance policy.
The advantages of viatical vs. life settlements
For all their similarities, life settlements and viatical settlements differ in two key respects that can make the latter the more lucrative option.
To begin, a viatical settlement can yield a higher price. Since the buyer theoretically will be paying premiums for no more than two years before they collect the death benefit, they’ll likely make a better offer than if the policyholder were expected to live longer. (However, as with a life settlement, you can expect a viatical settlement on permanent life insurance, such as a whole life or universal life policy, to yield an offer that's higher than the policy's cash value but below the value of the death benefit.)
In addition, the proceeds from a viatical settlement can receive more favorable tax treatment. While proceeds from a life settlement are taxed as income, those from a viatical settlement may not be. If the money is used to pay for qualifying healthcare expenses, for example, you might be eligible for favorable tax treatment, according to I.R.S. regulations.
Pros and cons of a viatical settlement
Getting money upfront for life insurance is a welcome option for a policyholder who's in need of expensive care at the end of their life, to cite just one financial challenge. But as with life settlements, those considering a viatical settlement for themselves or a loved one should carefully consider the ramifications of selling a life insurance policy to a third party.
Selling a permanent life insurance policy means that its death benefit will no longer be available for that person’s heirs. It also means the loss of a key financial safeguard. If the policyholder has outstanding debts, creditors or collection agencies could lay claim to the money they’re owed out of the sale proceeds. By contrast, a death benefit paid out to your heirs after you die is protected from such a claim.
In addition, the usual cautions about not rushing into a deal apply, particularly if the offer to buy the policy comes unsolicited or is accompanied by a high-pressure sales pitch. The AARP warns seniors and their families that unscrupulous operators might exploit the distress or panic that a terminal illness can trigger.
Alternatives to settlement
Fortunately, a settlement is by no means the only financial option if you have a dire health prognosis and need cash. “The unfortunate few who are battling severe medical issues have a couple of other options,” Barclay says.
A death benefit loan
If you have permanent life insurance, it’s possible you’ll be able to borrow against the cash value that's built up in the policy. Such loans have potential disadvantages, but they do give you access to cash without having to sell the policy. And while the loan would be deducted from the death benefit upon your death, and is subject to interest, it would allow you to leave the remainder of the policy’s proceeds to your heirs, free from possible seizure by your creditors.
Accelerated death benefits
Some permanent life insurance policies allow policyholders experiencing a terminal or catastrophic illness, or in need of long-term care, to access some of the policy’s death benefit while they are still alive.
The sum that can be tapped is typically limited to 80% of a policy’s face value, according to the AARP. Also, receiving accelerated death benefits lowers the benefit payout the policy beneficiary will receive after the policyholder’s death. The policyholder also remains responsible for making premium payments on their policy.
To qualify, one usually has to have a life expectancy of 6 months or less, or maybe 12 months, at most, Barclay says. “In some cases, that may be an option worth considering.”
Deciding how to tap your life insurance
The emotion that can follow a terminal diagnosis, on top of pressing financial needs, hardly creates ideal conditions for a careful financial decision on what to do with a life insurance policy. Nonetheless, you should proceed with due diligence as you wrestle with whether to sell a policy or access some of its money before you die.
The decision process should begin with seeking guidance from your financial advisor or attorney, as the non-profit Women’s Institute for a Secure Retirement (WISER) points out. If seeking a settlement is a strong possibility, shop around among several companies and/or brokers to find the best offer, and check with your state insurance department to verify that the company or broker you are considering is licensed. Finally, the Institute recommends “remembering that you don’t have to accept an offer [on your policy] and you can change your mind” after one is made.
As for taxes, the Ashar Group, another company that sells settlements, suggests that, even if the funds from a viatical settlement are to be used for long-term care, “it is important to discuss the tax implications with a qualified tax professional to determine whether the funds you receive will be subject to federal income tax.”
Finally, keep in mind that the alternatives to a settlement that provide cash before you die are not all-or-nothing propositions. As Dave Simbro, senior vice president of life and annuities at Northwestern Mutual, pointed out to the AARP, you "can both take some cash and leave some money behind."