Viatical settlements for the terminally or chronically ill

A viatical settlement is the sale of a life insurance policy by someone who is terminally or chronically ill, in exchange for a lump sum that is less than the death benefit. The buyer pays the premiums and receives the death benefit when the insured dies. For a terminally ill seller who sells to a properly licensed provider, federal law generally treats the money as tax-free, which is the main difference from an ordinary life settlement.

What counts as "terminally ill" and "chronically ill"

The NAIC Viatical Settlements Model Act and federal tax law both use the same basic definitions:

• Terminally ill: an illness or condition that can reasonably be expected to result in death in 24 months or less. Federal law is in Internal Revenue Code section 101(g).
• Chronically ill: generally, unable to perform at least two of six activities of daily living (such as eating, toileting, transferring, bathing, dressing and continence) for a period of at least 90 days, or requiring substantial supervision because of severe cognitive impairment. A licensed health care practitioner must certify it.

A physician usually has to certify the diagnosis. Companies in this market use the same word, "viatical", for both illnesses, but the tax results differ (see below).

How it works

1. The owner contacts a provider or broker. A broker, who is deemed under the NAIC model to represent only the seller, can gather offers. A provider buys directly.
2. Medical review. The insured authorizes release of medical records and a life expectancy is estimated.
3. Offer and disclosures. The provider or broker must give written disclosures before the application is signed (details below).
4. Contract, escrow and insurer processing. The buyer's payment is typically placed with an independent escrow agent until the insurer confirms the change of owner and beneficiary.
5. Payment and rescission window. The seller receives the funds and can usually still cancel within a rescission period.

Offers are generally a percentage of the death benefit, based mainly on life expectancy, premiums required to keep the policy in force, and the face amount. A shorter expected life usually means a higher percentage. Any specific percentages you see advertised are not a promise; get several written offers.

Regulation and consumer protections

Viatical settlements are regulated by state insurance departments. The NAIC Viatical Settlements Model Act (#697) is the template, and its July 2009 edition provides, among other things:

• A viatical settlement provider or broker must be licensed in its state of residence, and the commissioner can suspend or revoke a license.
• The seller receives a signed disclosure stating that alternatives exist, including accelerated death benefits and policy loans offered by the insurer; that proceeds may be taxable; that proceeds could be reachable by creditors; and that receiving them could affect Medicaid or other government benefits.
• A right to rescind before the earlier of 60 calendar days after the contract is executed or 30 days after the proceeds are paid, by giving notice and repaying the proceeds. If the insured dies during that window, the contract is deemed rescinded. States set their own periods; check yours.
• Limits on contact after the sale: no more than once every three months if the insured's life expectancy is more than a year, and no more than monthly if it is a year or less.
• Confidentiality limits on sharing the insured's identity and medical information.
• Waiting periods that restrict settling a newly issued policy, with exceptions for illness, discussed in Stranger-originated life insurance (STOLI): what it is and why it is restricted. A terminal or chronic illness diagnosis is one of the recognized exceptions in the NAIC model.

To confirm a provider's or broker's license, contact your state's insurance department. Be cautious of anyone who is unlicensed, pressures you to sign, or will not put offers and fees in writing.

Tax treatment

Section 101(g) of the Internal Revenue Code lets amounts received on the sale of a policy on a terminally or chronically ill insured be treated as paid by reason of death, so they can be excluded from income, if the buyer meets the law's definition of a viatical settlement provider.

• Terminally ill insured. The exclusion is not limited in amount. The buyer must be regularly engaged in the business of purchasing policies on terminally or chronically ill people, and must be licensed in the state where the insured lives. If the state has no licensing requirement, the provider must meet sections 8 and 9 of the NAIC model act and the related NAIC model regulation (IRS Revenue Ruling 2002-82 discusses a state whose licensing is not yet in effect).
• Chronically ill insured. The exclusion is more limited and is tied to long-term care costs, using the long-term care per diem limit that applies to qualified plans ($430 a day in 2026 under IRS Rev. Proc. 2025-32).
• Sales that do not qualify are taxed under the life settlement rules in life settlements: selling your life insurance policy, which cover basis and the 2020 IRS update.

A tax professional can confirm whether your sale qualifies, because the facts (the license, the certification, how the proceeds are used) control.

Viatical settlement or accelerated death benefit?

Many policies and group plans already include an accelerated benefit that pays part of the death benefit to a seriously ill insured.

The NAIC model requires an accelerated-benefits arrangement to offer a lump-sum option and to disclose tax and Medicaid effects. See accelerated death benefit riders: how they work and how they're taxed. Check it first: it may be free or low-cost, and your family keeps what is left of the death benefit.

Questions to ask

• Is the provider and broker licensed in my state? What is the license number?
• What is the broker paid, and by whom?
• Is the offer final, and what fees come out of it?
• Will the funds be held in escrow until the insurer confirms the transfer?
• How will this affect my Medicaid or other benefits? See medicaid eligibility and life insurance cash value.
• Is the sale tax-free under section 101(g), and in writing?
• What can my family expect if I rescind or if I die during the rescission period?

The keep, surrender or sell your policy? helps compare keeping, surrendering and selling.

Key takeaways

• A viatical settlement sells the policy of a terminally or chronically ill person for a lump sum below the death benefit.
• Federal law can exclude proceeds from income for a terminally ill seller who sells to a qualifying licensed provider; chronic illness is more limited.
• State law requires licensing, written disclosures, escrow protections and a rescission period; the NAIC model gives up to 60 days from signing or 30 days from payment.
• Compare your insurer's accelerated death benefit and a policy loan before selling.
• Selling can affect Medicaid and other benefits, and your beneficiaries lose the death benefit.