Life Insurance as a Source of Funds for the Terminally Ill



An individual who is terminally or chronically ill and lacks funds to cover significant medical (e.g., experimental treatments) and other family expenses may find the solution through his or her life insurance policies. Although insurance policies have historically been held for the death benefits, some policies now include an accelerated death benefit (or living benefit) rider. Where accelerated death benefits are not an option, it may be possible to sell the life insurance policy to a viatical settlement provider. Either way, individuals can secure some much-needed cash while they are still living. Better yet, the proceeds will usually be tax-free.

The accelerated death benefit available is normally payable when certain conditions are met and is usually a percentage of the face amount. The use of the proceeds is typically not restricted to the payment of health costs. The cash value and face value of the policy are reduced when the benefit is paid.

If the life insurance policy does not have such a rider, it may be possible to negotiate with the insurance company to offer these benefits through a contractual arrangement. The insurer may be willing to cooperate since total death benefits are likely to be payable in the near future.

Viatication allows a terminally ill person to sell an existing life insurance policy for more than its cash surrender value but less than its net death benefit to someone who is buying it as an investment (i.e., the buyer continues to pay the premiums and receives the life insurance proceeds upon the death of the insured). Many companies currently either buy the policies themselves or serve as brokers to match buyers and sellers for a fee.

In identifying a potential seller, many viatical companies limit their selection to terminally ill individuals with a certain remaining life expectancy (e.g., 24 months or less). This is because the company wants to minimize its risk that the individual will outlive his or her life expectancy, resulting in a lower return from the purchase of the life insurance policy for the company.

The insured must determine whether it would be advantageous to sell his or her policy, considering (a) the individual’s cash needs, (b) the discount in the value of the death benefit, (c) the possibility the payments will disqualify the individual for Medicaid benefits, and (d) access to the payments by the insured’s creditors. (The cash value while it remains in a life insurance contract may not be subject to the claims of creditors.)

Amounts received under a life insurance contract (i.e., accelerated death benefits) on the life of terminally ill (or within limits, chronically ill) individuals are excluded from gross income for federal income tax purposes. A similar exclusion applies to the sale or assignment of any portion of a death benefit to a viatical settlement provider if the insured is chronically or terminally ill and the payments in question are funded by and diminish the life insurance policy’s death benefit. However, the exclusion does not apply if the accelerated death benefits are paid to someone other than the insured individual if the recipient has a business or financial relationship with the insured.

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