Can I Get My Life Insurance Before I Die?

Life insurance policies are generally understood as financial tools providing a payout to beneficiaries upon the policyholder’s death. However, under specific circumstances and through certain policy features, individuals can access the value or funds from their life insurance while still alive. This capability offers financial flexibility, allowing policyholders to address various needs that may arise during their lifetime.

Accessing Your Policy’s Cash Value

Permanent life insurance policies, such as whole life or universal life, accumulate cash value. A portion of each premium payment is allocated to this cash value, which grows on a tax-deferred basis through earned interest or investment performance. This accumulated cash value offers policyholders a source of funds they can access during their lifetime. Whole life policies offer guaranteed fixed cash value growth, while universal life policies accumulate cash value based on current interest rates. Variable life policies invest funds in subaccounts, which operate like mutual funds, leading to fluctuating values.

Policyholders can access their cash value primarily through policy loans. Borrowing against the cash value means the policy remains in force, with the cash value acting as collateral. These loans do not require a credit check and often have competitive interest rates. Policyholders can borrow up to 90% or 95% of their accumulated cash value.

There is no strict repayment schedule for these loans, but any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. If the loan balance grows to exceed the policy’s cash value, the policy could lapse, potentially triggering a taxable event.

Another method for accessing cash value is through partial withdrawals. Unlike a loan, a withdrawal permanently removes funds from the policy, directly reducing both the cash value and the eventual death benefit. Withdrawals do not accrue interest and do not require repayment, offering a straightforward way to access funds. A significant withdrawal could lead to increased future premiums or even cause the policy to lapse if the cash value falls too low.

Policy surrender represents the complete termination of the life insurance contract. When a policy is surrendered, the policyholder receives the cash surrender value, which is the accumulated cash value less any applicable surrender charges and outstanding loans. This action ends the life insurance coverage, meaning no death benefit will be paid upon the insured’s passing. Surrender charges, which are fees for canceling the policy early, range from 10% to 35% of the cash value and are higher in the initial years of the policy, gradually decreasing over time. Some policies may also have a waiting period, from a few years up to 15 years, before surrender is an option.

Understanding the policy’s cost basis is important for any of these options. The cost basis refers to the total premiums paid into the policy. Keeping track of premium payments and any prior distributions helps determine the non-taxable portion of funds received. Policy statements provide current cash value and details regarding any surrender charges or loan terms.

Receiving Accelerated Death Benefits

Accelerated death benefits, often called living benefits or riders, allow a policyholder to access a portion of their life insurance policy’s death benefit while still alive. These benefits provide financial relief during challenging health circumstances, without requiring the policy to be surrendered entirely. The accessed amount is deducted from the final death benefit paid to beneficiaries.

Eligibility for accelerated death benefits is triggered by specific medical conditions. Common qualifying conditions include a diagnosis of terminal illness, defined as having a life expectancy of 12 to 24 months or less. Chronic illness, characterized by an inability to perform at least two activities of daily living (such as bathing, dressing, or eating), or severe cognitive impairment, is another trigger. Some policies also offer critical illness riders, providing a payout upon diagnosis of specific severe conditions like a heart attack, stroke, or cancer.

Once a qualifying condition is certified by a medical professional, the policyholder can access a percentage of their death benefit, ranging from 25% to 100%, depending on the insurer and policy terms. The payout can be received as a lump sum, providing immediate financial liquidity, though some policies may offer periodic payments. The funds received can be used for any purpose, including medical expenses, long-term care costs, or improving quality of life. While some insurers include these riders at no additional premium, others may charge a small fee, or deduct an administrative charge from the benefit amount if utilized.

Selling Your Life Insurance Policy

Selling a life insurance policy to a third party is another way to access its value while still alive, through a life settlement or a viatical settlement. A life settlement involves selling an existing policy for a cash sum greater than its cash surrender value but less than the full death benefit. This option is available to policyholders aged 65 or older, who may no longer need or want their policy, or find premiums unaffordable.

Eligibility requirements for life settlements include a policy face value of at least $100,000 and the insured being at least 65 years old, with healthier individuals qualifying at older ages. A viatical settlement is a specific type of life settlement designed for individuals who are terminally or chronically ill, with a life expectancy of two years or less. The payout from a viatical settlement is a higher percentage of the death benefit compared to a life settlement, reflecting the shorter expected payout period for the buyer.

In both types of settlements, the buyer, an institutional investor, assumes ownership of the policy, takes over all future premium payments, and receives the death benefit when the insured passes away. The process of selling a policy begins with an application and the submission of detailed documentation, including medical records and policy information. A life expectancy assessment is conducted, which is a factor in determining the policy’s market value.

Buyers then submit bids, and the policyholder can choose to accept or decline an offer. Payouts for life settlements range from 10% to 25% of the policy’s face value, and can be significantly more than the cash surrender value, sometimes 4 to 6 times greater. Broker fees, if a broker is used, are a percentage deducted from the settlement proceeds.

Tax Implications of Early Access

Accessing life insurance funds before death carries various tax implications, depending on the method chosen. Understanding these consequences is important for financial planning.

Policy loans taken against the cash value are not treated as taxable income. However, if the policy lapses or is surrendered with an outstanding loan balance that exceeds the policy’s cost basis, the amount of the loan exceeding the basis can become taxable. The cost basis, representing the total premiums paid into the policy, is a factor in determining tax liability.

Cash withdrawals from a policy’s cash value are tax-free up to the amount of the policy’s cost basis. Any amount withdrawn that exceeds the cost basis is considered taxable income. When a policy is surrendered, any amount received as cash surrender value above the policy’s cost basis is subject to taxation as ordinary income.

Accelerated death benefits received by a terminally ill individual are tax-free under federal law, provided certain conditions are met, such as a physician’s certification of a limited life expectancy (e.g., 24 months or less). For chronically ill individuals, these benefits may also be tax-free if the proceeds are used for qualified long-term care expenses, up to certain limits.

The tax treatment of life settlements differs from viatical settlements. Federal tax treatment of life settlements was clarified by the Tax Cuts and Jobs Act of 2017 and IRS Revenue Rulings. Proceeds from a life settlement are taxable.

The amount received up to the policy’s cost basis is tax-free. Any proceeds exceeding the cost basis but not exceeding the cash surrender value are taxed as ordinary income. Any portion of the payout that exceeds both the cost basis and the cash surrender value is taxed as a capital gain.

In contrast, proceeds from a viatical settlement are tax-free for terminally or chronically ill individuals, similar to accelerated death benefits, as they are considered an advance on the death benefit.

Consulting a qualified tax advisor is advisable to understand the specific tax implications for any early access to life insurance funds.