Can I Use My Life Insurance While Alive?

Many individuals view life insurance primarily as a financial safeguard for loved ones after passing. However, certain policies offer “living benefits,” allowing policyholders to access funds during their lifetime. These benefits transform life insurance from solely a death payout mechanism into a versatile financial tool. The availability of these benefits depends on the specific policy type and its features.

Understanding Policies with Living Benefits

The ability to access life insurance funds while alive primarily stems from the policy’s structure. Term life insurance, which provides coverage for a specific period, generally does not accumulate cash value and offers no living benefits. Its sole purpose is to pay a death benefit if the insured passes away within the specified term.

In contrast, permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, typically include a cash value component. A portion of each premium payment is allocated to this account, which grows over time on a tax-deferred basis. This accumulated cash value can become a substantial financial asset accessible during the policyholder’s lifetime. The growth rate varies by policy type; whole life often offers a guaranteed interest rate, while universal and variable policies may have growth tied to market performance or specific indices.

Accessing Your Policy’s Cash Value

Policyholders with permanent life insurance can access their accumulated cash value through several methods.

Policy Loans

One common approach is taking a policy loan, where the cash value serves as collateral. These loans typically do not require a credit check or a formal application process, offering a convenient way to access capital. While interest accrues on the loan, repayment terms are often flexible. Unpaid loans will reduce the death benefit.

Cash Withdrawals

Another method is making a direct cash withdrawal from the policy’s cash value. Withdrawals reduce the policy’s cash value and can also decrease the death benefit payable to beneficiaries. For tax purposes, withdrawals are generally income tax-free up to the amount of premiums paid into the policy, known as the cost basis. Any amount withdrawn that exceeds the total premiums paid may be considered taxable income.

Policy Surrender

Finally, a policyholder can surrender the entire policy for its cash surrender value. Surrendering the policy means terminating the life insurance coverage entirely in exchange for the accumulated cash value, minus any surrender charges or outstanding loans. This action eliminates the death benefit and can trigger tax implications if the cash surrender value received exceeds the premiums paid into the policy. The decision to surrender a policy should be carefully considered, as it ends all coverage.

Utilizing Accelerated Death Benefits and Riders

Beyond accessing cash value, certain life insurance policies offer living benefits through specific riders, often called accelerated death benefits. These riders allow policyholders to receive a portion of their death benefit while still alive, typically under qualifying health circumstances. Unlike cash value access, which draws from the savings component, these riders advance funds from the policy’s primary death benefit.

Terminal Illness Rider

A common type is the terminal illness rider, which provides a lump sum payment if the policyholder is diagnosed with a medical condition expected to result in death within a specified period, often 12 to 24 months. These funds can be used for medical expenses, end-of-life care, or other financial needs. The payout reduces the death benefit that would otherwise be paid to beneficiaries.

Chronic and Critical Illness Riders

Chronic illness riders provide financial assistance if the insured becomes unable to perform a certain number of daily living activities, such as bathing or dressing, or experiences severe cognitive impairment. These benefits are often paid out monthly and are intended to help cover long-term care costs. Similarly, critical illness riders provide a lump sum upon diagnosis of specific severe conditions, including cancer, heart attack, or stroke. Both chronic and critical illness payouts also reduce the policy’s death benefit.

Key Considerations When Accessing Funds

Accessing funds from a life insurance policy, whether through cash value or accelerated death benefits, carries important implications that policyholders should understand.

Impact on Death Benefit

A primary consideration is the impact on the policy’s death benefit. Any amount borrowed, withdrawn, or advanced through a rider will directly reduce the sum eventually paid to beneficiaries. If a policy loan is not repaid, the outstanding balance, including accrued interest, will be subtracted from the death benefit.

Tax Implications

Tax implications also warrant careful review. While the growth of cash value is generally tax-deferred, and policy loans are typically not considered taxable income, certain scenarios can trigger a tax liability. For instance, if cash withdrawals exceed the total premiums paid into the policy, the excess amount may be taxable as ordinary income. Additionally, if a policy lapses or is surrendered with an outstanding loan, the gain (the amount exceeding premiums paid) may become taxable. Policies classified as Modified Endowment Contracts (MECs) also have different tax rules for loans and withdrawals, potentially incurring taxes and penalties.

Risk of Policy Lapse

There is also a risk of policy lapse if not managed carefully. Outstanding loans, significant withdrawals, or depletion of cash value can lead to a policy lapsing if the remaining cash value is insufficient to cover policy charges or if premiums are no longer paid. Policy loans accrue interest, and if this interest is not paid, it can be added to the loan balance, further reducing the cash value and increasing the risk of lapse. Policyholders should review their individual policy documents to understand the specific terms, conditions, and eligibility criteria for all living benefits and riders.