Can I Use Life Insurance While Alive?

Life insurance is commonly understood as a financial tool that provides a death benefit to beneficiaries after the insured individual passes away. While this remains a primary function, many policies offer avenues to access financial value or benefits while the insured is still alive. These options can provide liquidity or support during various life circumstances, shifting the perception of life insurance from solely a post-mortem asset to a potential resource during one’s lifetime. The availability and specifics of these living benefits depend significantly on the type of policy held and its particular provisions.

Accessing Policy Cash Value

Permanent life insurance policies, such as whole life or universal life, build a cash value component over time. This cash value grows from a portion of premiums paid, after accounting for policy charges and the cost of insurance. It represents a savings element within the policy that can be accessed by the policyholder during their lifetime.

One common way to access this accumulated value is through a policy loan. A policy loan involves borrowing money against the cash value, using it as collateral. Interest accrues on these loans, typically at a simple interest rate ranging from 4% to 8% annually.

Unpaid loan balances, including accrued interest, will reduce the death benefit if the insured passes away before repayment. There is no fixed repayment schedule, offering flexibility, but managing the loan balance is important to prevent policy lapse if the outstanding loan and interest exceed the cash value. Policy loans are generally not considered taxable income, as they are treated as debt. Policyholders typically contact their insurer to request a loan, with funds usually disbursed within a few business days to a few weeks.

Another method for accessing policy cash value is through withdrawals. A withdrawal involves directly removing a portion of the cash value from the policy. Unlike a loan, a withdrawal permanently reduces both the policy’s cash value and its death benefit.

For tax purposes, withdrawals are generally tax-free up to the amount of premiums paid into the policy, known as the “cost basis.” Any amount received exceeding this cost basis may be subject to income tax. Excessive withdrawals can significantly deplete the cash value, potentially leading to policy lapse if the remaining cash value is insufficient to cover ongoing policy charges. Initiating a withdrawal requires contacting the insurer and submitting a request.

Understanding Living Benefit Riders

Beyond accessing cash value, some life insurance policies include or offer optional “living benefit riders,” also known as accelerated death benefits. These provisions allow policyholders to access a portion of their policy’s death benefit while still alive, under specific health-related circumstances.

One prevalent type of living benefit is for terminal illness. This rider allows a policyholder to receive a portion of their death benefit if diagnosed with a medical condition expected to result in death within a specified period, typically 12 or 24 months. The funds received are often tax-free under current tax laws, provided certain criteria are met. This provides financial support for end-of-life care or other financial obligations.

Another common living benefit covers chronic illness. This benefit is usually triggered if the insured becomes unable to perform a certain number of Activities of Daily Living (ADLs), such as bathing, dressing, eating, toileting, transferring, or maintaining continence, or if they experience severe cognitive impairment. The amount accessible is often subject to a per diem limit, indexed annually by the Internal Revenue Service (IRS). Benefits received for chronic illness may also be tax-free up to this per diem limit if used for qualified long-term care expenses.

Critical illness riders provide a payout upon the diagnosis of specific severe medical conditions, such as a heart attack, stroke, or certain types of cancer. The tax treatment of critical illness benefits can vary and may be subject to taxation depending on how the funds are used and the specific terms of the rider. For all living benefit riders, the payout is an advance on the policy’s death benefit, meaning the amount paid out to beneficiaries will be reduced by the amount received through the rider. Claiming these benefits requires providing medical documentation to the insurer for approval.

Selling Your Life Insurance Policy

For policyholders who no longer need or can afford their life insurance, selling the policy to a third party offers another way to access its value while alive. This process is known as a life settlement, or more specifically, a viatical settlement if the insured is terminally ill. These transactions involve selling the ownership of the policy to an investor in exchange for a lump-sum payment.

In a life settlement, the policyholder sells their policy to a life settlement provider or investor. The investor then becomes the new owner and beneficiary, assuming responsibility for paying all future premiums. Upon the insured’s death, the investor receives the death benefit.

This option is typically for policyholders aged 65 or older, or those with declining health. The payout is usually more than the policy’s cash surrender value but less than the full death benefit. The gain from a life settlement, which is the amount received exceeding the total premiums paid, may be subject to income tax.

A viatical settlement is a specific type of life settlement reserved for individuals who are terminally ill, often with a life expectancy of 24 months or less. For terminally ill individuals, the proceeds from a viatical settlement are generally tax-exempt under federal tax law. The process involves a licensed broker, medical underwriting by the buyer, and transfer of policy ownership. Funds are typically received within several weeks to a few months.

Surrendering Your Policy

Surrendering a life insurance policy involves formally terminating the contract with the insurance company in exchange for its accumulated cash value. This action ceases all insurance coverage and eliminates the death benefit entirely. While a straightforward way to access funds, it results in the immediate loss of all future coverage.

When a policy is surrendered, the policyholder receives its “cash surrender value.” This amount is calculated as the policy’s accumulated cash value minus any applicable surrender charges and outstanding policy loans. Surrender charges are fees imposed by the insurer, particularly in the early years, to recoup initial expenses. These charges can be substantial, sometimes 10% to 20% or more of the cash value, and typically phase out over 10 to 15 years.

From a tax perspective, any amount received from surrendering a policy that exceeds the total premiums paid into it (the cost basis) is generally subject to income tax as ordinary income. For example, if a policyholder paid $50,000 in premiums and receives a cash surrender value of $60,000, the $10,000 gain would be taxable. To surrender a policy, contact the insurer and submit a request. Funds are typically disbursed within a few weeks.