Accelerating Life Insurance Benefits
Life insurance policies are normally held for the death benefits. However, accessing the value of life
insurance prior to the insured’s death, by either accelerating the death benefit or selling the policy
(viatication), is becoming more common. In recent years, insurers and legislators have recognized a need
for this kind of planning and have provided the mechanisms for efficiently doing so.
Accelerated Death Benefits. Some insurance carriers now offer benefits during the life of the insured
when they are terminally or chronically ill. These benefits are usually called “living” or “accelerated”
benefits. The ability to receive life insurance benefits before death can alleviate the stress of mounting
medical expenses for the seriously ill, allowing them to focus on more important things, like family and
Living benefits usually are available by purchasing riders to cash value policies. However, some insurers
offer the benefit at no additional cost. The benefit is usually payable when evidence of a terminal or other
qualifying illness is presented to the carrier. The living benefit is usually a percentage of the face amount
and is not restricted by, or limited to, medical costs incurred. Of course, there’s no such thing as a free
lunch; taking living benefits reduces the cash value and face value of the policy.
Taxation of Living Benefits. Accelerated death benefits are excluded from income for terminally ill (and
within limits, chronically ill) individuals. For tax purposes, a terminally ill individual is one who has been
certified by a physician as having an illness or physical condition that reasonably can be expected to
result in death within 24 months of the date of certification. The tax definition of a chronically ill
individual is somewhat amorphous, but generally a critically ill individual requires substantial and
continuous assistance to meet the demands of daily living due to a loss of functional capacity or severe
The income tax exclusion does not apply if the living benefits are paid to someone other than the insured
individual if the recipient has a business or financial relationship with the insured. For a chronically ill
individual to exclude payments from income, the payments must be: (a) for costs incurred for qualified
long-term care services, or (b) made on a periodic basis without regard to the costs, in which case, the
total excludable payment is limited to $250 per day for 2006.
Viatical Settlements. Viatication is the sale of a life insurance policy to someone who is buying it as an
investment (i.e., the buyer is paying the insured now for the right to receive the life insurance proceeds
upon the insured’s death). Viatical settlement providers generally must be licensed in the states where
they do business or meet other legal requirements.
Taxation of Viatical Settlements. Viatical settlements for terminally ill or chronically ill individuals are
taxed under the same rules that apply to accelerated death benefits. When the insured is not terminally or
chronically ill (or when the policy is sold to a person or company who is not a qualified viatical settlement
provider), the proceeds are treated first as a return of the investment in the contract (basis) and then as
taxable income to the extent of any excess. Any taxable income is ordinary income to the extent the
proceeds exceed the owner’s investment in the contract up to the cash value of the policy. Any excess of
the proceeds over cash value is taxed as capital gain.
Though viatical settlements are becoming more common, they are expensive and can take a long time to
process. Seriously ill persons may be better served by looking first at borrowing against their home equity
or borrowing from friends or relatives with repayment coming from the insurance proceeds.