In their earlier stages of life, individuals purchase life insurance to provide security for their family. But after the children have left the nest and the insured individual has entered his or her golden years, the original need for the insurance may have changed. If the individual is single, there may be no need for the insurance at all. For financially strapped elderly individuals, the insurance policy may represent a source of badly-needed cash.

Generally, life insurance proceeds received under an insurance contract as a result of the insured's death is tax-free. However, if the contract is sold while the insured is still living, the proceeds in excess of the cost of the contract are taxable in the year received.

Viatical Settlement Exception – In a situation where the individual is either terminally or chronically ill and death benefits are assigned to a viatical settlement provider (one that regularly buys or takes assignments of life insurance contracts and meets the required standards), the proceeds would not be taxable. (Code Sec. 101(g)(2)(A))

• Terminally Ill - A person is considered terminally ill if he or she has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months of the date of certification. (Code Sec. 101(g)(4)(A))

• Chronically Ill - A person is considered chronically ill if he or she has been certified within the previous 12 months by a licensed healthcare practitioner as (Code Sec. 101(a)(2)(A)):
(1) Being unable to perform without substantial assistance at least two activities of daily living (e.g., eating, toileting) for at least 90 days due to a loss of functional capacity,
(2) Having a similar level of disability as determined by the IRS in consultation with the Dept. of Health and Human Services, or
(3) Requiring substantial supervision to protect him or herself from threats to health and safety due to severe cognitive impairment.

The term “chronically ill individual” does not include a terminally ill individual.

Thus, if there is no overriding reason to retain the insurance, it can be used to provide financially strapped seniors or individuals with a life-threatening illness, such as cancer, AIDS, heart disease, Alzheimers, or multiple sclerosis with a source of cash to meet their needs.

Even if the individual does not qualify for a viatical settlement, it can still provide a source of revenue that is only partially taxable, and with careful planning, the tax liability can be minimized.