Can You Take Out Life Insurance Before You Die?

Life insurance primarily protects beneficiaries after a policyholder’s death. However, some policies also offer resources for the policyholder during their lifetime. Accessing these funds can provide financial flexibility for needs like unexpected expenses or long-term care.

Accessing Cash Value Through Loans and Withdrawals

Certain permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, accumulate cash value. This cash value grows over time on a tax-deferred basis, meaning earnings are not taxed until withdrawn. Policyholders can access this cash value through policy loans or withdrawals.

A policy loan involves borrowing money from the insurer, using the policy’s cash value as collateral. These loans do not require a credit check and are not considered taxable income as long as the policy remains in force. Interest accrues on the loan. If the loan and accrued interest are not repaid, the outstanding amount will reduce the death benefit paid to beneficiaries. If the policy lapses with an outstanding loan, the loan amount exceeding the policy’s cost basis can become taxable income.

A withdrawal directly removes funds from the policy’s cash value. This action permanently reduces the policy’s cash value and the death benefit. Withdrawals are tax-free up to the amount of premiums paid into the policy (the policy’s cost basis). Any amount exceeding this cost basis is considered taxable income and may be taxed at ordinary income rates. Policyholders initiate a loan or withdrawal by contacting their insurance company and completing a request form.

Utilizing Accelerated Death Benefit Riders

Accelerated Death Benefit (ADB) riders are features that allow policyholders to access a portion of their life insurance policy’s death benefit while still living. These benefits are triggered by specific, severe health conditions. Common qualifying conditions include a diagnosis of a terminal illness, often defined as having a life expectancy of 12 to 24 months or less. Chronic illnesses, such as the inability to perform activities of daily living, or critical illnesses like a heart attack, stroke, or cancer, also qualify a policyholder for these benefits.

The amount accessible through an ADB rider is a percentage of the policy’s death benefit, ranging from 25% to 100%. Any funds received through an accelerated death benefit will reduce the death benefit paid to the policy’s beneficiaries. Insurers may also charge administrative fees or reduce the benefit amount to account for the early payout and lost interest. To claim these benefits, policyholders need to provide medical certification of their condition to the insurance company and complete an application.

Understanding Life and Viatical Settlements

Life and viatical settlements involve selling a life insurance policy to a third-party investor for a lump sum. This transaction provides an alternative way for policyholders to access funds from their policy during their lifetime. Upon sale, the third-party investor becomes the new owner and beneficiary of the policy, taking over all future premium payments. The investor then receives the full death benefit when the insured passes away.

A viatical settlement is designed for individuals who are terminally or chronically ill, often with a life expectancy of two years or less. The proceeds from a viatical settlement are not subject to federal income tax if the policyholder is terminally ill, or if chronically ill and the funds are used for qualified long-term care expenses. Life settlements, by contrast, are for healthier individuals, often seniors over 65, who no longer need or want their policy.

The amount offered in a settlement is influenced by several factors, including the policy’s death benefit amount, the cost of future premiums, and the policyholder’s health and life expectancy. Viatical settlements yield a higher percentage of the policy’s face value than life settlements due to the shorter life expectancy of the seller. The proceeds from a life settlement may be subject to taxation if the payout exceeds the policyholder’s cost basis. The process involves engaging a licensed life settlement broker, submitting policy and medical records for evaluation, and then receiving and accepting an offer.

Surrendering a Life Insurance Policy

Surrendering a life insurance policy means terminating coverage in exchange for its cash surrender value. This action ends the policy’s death benefit, meaning no payout will be made to beneficiaries upon the insured’s death. The cash surrender value is the policy’s cash value minus any surrender charges or outstanding policy loans.

Surrender charges are fees insurers may impose for a certain period, often 10 to 15 years, after a policy is issued. Once a policy is surrendered, the policyholder receives the lump sum payment. The cash surrender value may be taxable if it exceeds the total premiums paid into the policy (the policy’s cost basis). Any amount received above this basis is treated as ordinary income for tax purposes. The process for surrendering a policy involves notifying the insurance company in writing and completing a surrender form.