Acceleration of Benefits

Accelerated Death Benefits. Life insurance policies may include a provision that permits the accelerated payment of benefits to a policy holder who suffers from a serious medical condition (such as cancer, heart or kidney failure, or AIDS) that will likely lead to his or her death within a specified time period such as 12 or 24 months. Because the amount advanced comes from the "pure" term portion of the policy, both term and cash value policies may be written with an accelerated death benefit provision.

When acceleration is available under a policy, the amount that may be advanced under an accelerated benefit provision typically would be limited to a specified percentage of the death benefit (such as 50 percent of the death benefit) or a specific dollar amount (such as a $250,000 maximum benefit acceleration). If such an option is exercised, amounts paid during the insured's lifetime are treated similarly to a policy loan; interest accrues on the amount advanced, and the policy holder still owns the policy and must continue to pay premiums.

Viatical Settlements. Viatical settlements should not be confused with the accelerated payment of death benefits by an insurance company to its insured. A viatical settlement occurs when a policy holder suffering from a terminal or chronic medical condition sells the insurance policy (at a discount from face value) to a third-party viatical settlement company, which is in the business of buying policies under such conditions.

If you are contemplating a viatical settlement, it is important to check with your state department of insurance to confirm that a viatical settlement company is licensed to do business.

When a viatical settlement is transacted, the policy holder typically retains no further interest in the policy, and is relieved of the need to pay future premiums. The viatical settlement company takes ownership of the policy and responsibility for paying any future premiums, and it will receive the payment of benefits from the insurance company upon the death of the insured.

Life Settlements. A life settlement, like a viatical settlement, is the sale of a life insurance policy by the policy holder (the insured) for less than the face value of the policy to a third party investor. As in a viatical settlement, the investor takes ownership of the policy and responsibility for paying any related future premiums, and makes its return on investment when it receives the death benefits under the policy upon the death of the insured.

The major difference between the life settlement and the viatical settlement is that the insured who is selling his or her insurance policy in a life settlement is not terminally or chronically ill. As a result, the investor is taking a greater risk that the insured will live longer - a factor that will be reflected in the pricing of the life settlement. Life settlements are typically designed for individuals who are over age 65 for whom the original reason for which the policy was purchased no longer exists. There are many companies that specialize in life settlement investments.

Tax Consequences of Accelerated Death Benefits or Viatical Settlements. If a person who is terminally or chronically ill receives accelerated death benefits or acquires the proceeds of a viatical settlement, the amounts received are treated as amounts paid by reason of the death of the insured. This means that the amounts received are not taxable income. The rationale for the exclusion is to ease the financial pressure on a person urgently needing cash to address a serious health care crisis.

• Terminal illness. A person is considered terminally ill is a doctor certifies that he or she has an illness or physical condition that can reasonably be expected to result in death within 24 months from the date of certification.
• Chronic illness. Chronic illness can include mental illness as well as physical illness or functional disability. A person is chronically ill if, within the previous 12 months, a doctor certified that he or she:
  • cannot perform, without substantial assistance, at least two of the activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity;
  • has a similar level of disability as determined by the IRS in conjunction with the Department of Health and Human Services; or
  • requires substantial supervision to protect himself from threats to health and safety due to severe mental problems.

If the benefits are paid to a chronically ill person for long-term care, any benefit amount in excess of the IRS per diem limit ($320/day for 2013) and the actual costs of such long-term care is not eligible for exclusion from taxable income. This limitation does not apply for the terminally ill person.

Tax Consequences of Life Settlements. If a person is not terminally or chronically ill at the time of the transaction, then the exclusion from taxable income does not apply. The proceeds of life settlements will be taxed, either as ordinary income or capital gain income. Similarly, if a person who is not terminally or chronically ill surrenders his or her life insurance policy to the insurance company for its cash value, a portion of the proceeds from that transaction will be taxed as ordinary income.