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Ask the expert: When terminal illness is the concern

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The question was: My client has been diagnosed with a terminal illness and so we are now considering what to do with the life policy. What are are options and considerations, including life settlements, to review?

The answer is: In a genuine instance of terminal illness, the question is whether viatication is the most efficient way of making use of the death benefit.

The alternatives, presumably, are allowing the policy to lapse, surrendering it, leaving it in force and raising cash by other means, and, if available, taking advantage of an accelerated death benefit (ADB) provision.

Allowing the policy to lapse is clearly the least desirable option. Under the circumstances, surrendering the policy makes little more sense. What of the other three possibilities? Leaving the policy in force is typically best if the insured has other assets that can be converted for use for final expenses, and wants to favor the policy`s beneficiaries. The death benefit could go to the beneficiaries rather than to strangers, the viatical settlement investors.

Viatical settlement companies scorn the ADB, as one might expect. They claim that ADBs pay less and slower than viatical settlements, and that it is a disadvantage that ADBs usually do not allow the insured to receive the full death benefit.

However, it may or may not be true that a viatical settlement achieves liquidity for more of the death benefit than an ADB. The planner must crunch the numbers, and it is absolutely essential to shop around for multiple viatical settlement offers. At this stage in its history, the industry is a seller`s market, and companies will try to outbid each other if there is competition.

Moreover, the planner should remember that even the best offer can be improved by combining it with an ADB. For example, suppose that a terminally ill insured has a policy with a death benefit of $200,000. The maximum withdrawal with an ADB is 50%, and the best viatical settlement offer received is 70%. Should the insured viaticate for $140,000 in cash?

The better course is to take the ADB ($100,000) and viaticate 50% of the policy ($70,000), for a total of $170,000, or 85%.

Of course, in a case of terminal illness, ?101(g) applies, so the argument that viatical settlements are preferable because they are taxed at capital gains rates does not apply. In this case, neither the ADB nor the viatical settlement would be subject to federal income tax (neither would necessarily be free from state taxes, but the capital gains argument applies only to federal taxes).

Thus, viatication could well be the best course for a terminally ill client, but it is necessary to examine all the alternatives first.

Planner and client should be aware of other considerations as well. For example, the funds received from viatication could compromise the viator`s eligibility for Medicare or SSI (a factor perhaps more important for critically ill viators). For another, depending on the law of the state of residence, viatical settlement funds could be subject to creditors` claims.

Source: This is an excerpt from AdvisorFX is an online service of the National Underwriter Company, Cincinnati, Ohio, which also publishes the Settlement Watch e-newsletter. Learn more about AdvisorFX here or sign up for a free trial here.


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