Can You Use Life Insurance While Alive?
Learn how to leverage your life insurance policy's value to access funds and support your financial well-being while you are still living.
Life insurance primarily provides a death benefit upon the policyholder’s passing. However, certain types of life insurance policies offer features that allow policyholders to access funds or benefits while still alive. These “living benefits” can provide financial flexibility and support during various life stages or unexpected circumstances.
Understanding Cash Value Life Insurance
Cash value is a component found within permanent life insurance policies. Unlike term life insurance, which does not build cash value, permanent policies allocate a portion of premiums into a savings or investment component. This cash value grows over time, often on a tax-deferred basis, separate from the policy’s death benefit.
The accumulation rate of cash value varies depending on the policy type. Whole life insurance typically offers a guaranteed interest rate, providing predictable growth. Universal life insurance offers more flexibility, with cash value growth often tied to market performance but usually with a guaranteed minimum interest rate. Variable universal life insurance allows policyholders to invest the cash value in various sub-accounts, offering potential for higher returns but also greater risk. Generally, it takes a few years, typically 2 to 5, for the cash value to begin accruing significantly.
Accessing Cash Value Through Loans and Withdrawals
Policyholders can access cash value through loans or withdrawals. A policy loan allows borrowing money using the cash value as collateral. Loans do not require a credit check and offer flexible repayment terms, though interest accrues on the loan. If the loan is not repaid, the outstanding loan balance, plus any accrued interest, will reduce the death benefit paid to beneficiaries.
Alternatively, policyholders can make withdrawals from their cash value. Withdrawals permanently reduce the policy’s cash value and the death benefit. While there is no requirement to repay a withdrawal, it impacts the policy’s value and coverage. Another option is to surrender the policy entirely, terminating coverage for the policy’s cash surrender value (cash value minus any applicable fees).
Accelerated Death Benefits
Certain life insurance policies include Accelerated Death Benefits (ADBs), also known as Living Benefits riders. These provisions allow policyholders to receive a portion of their policy’s death benefit while alive, under specific circumstances. Common triggers for ADBs include a terminal illness diagnosis (often 12 to 24 months life expectancy).
ADBs can also be triggered by a chronic illness (inability to perform daily living activities) or a critical illness (e.g., heart attack, stroke, organ failure). Receiving an accelerated death benefit reduces the final death benefit paid to beneficiaries. The percentage of the death benefit accessible through ADBs varies, typically 50% to 75%.
Viatical Settlements
A viatical settlement is another method for accessing life insurance funds while alive. This involves selling a life insurance policy to a third-party company (a viatical settlement provider) for a lump sum. The payment is less than the full death benefit but more than the cash surrender value.
Viatical settlements are available to individuals with a life-threatening or terminal illness, often with a life expectancy of 24 months or less. After the sale, the viatical settlement company owns the policy, assumes future premium payments, and receives the full death benefit upon the insured’s passing. The process involves an application, medical review, and an offer.
Tax Implications of Using Your Policy
Understanding tax implications of accessing life insurance funds while alive is important. Policy loans are not taxable income as long as the policy remains in force. However, if the policy lapses or is surrendered with an outstanding loan, the amount of the loan exceeding the premiums paid into the policy (cost basis) can become taxable as ordinary income.
Cash value withdrawals are tax-free up to the amount of premiums paid (cost basis). Any amount exceeding this cost basis is taxable as ordinary income. Accelerated death benefits are tax-exempt for terminally ill individuals under federal law. For chronically ill individuals, these benefits may also be tax-exempt, subject to certain limits and conditions, such as the funds being used for qualified long-term care expenses.
Proceeds from viatical settlements are tax-free for terminally ill individuals, as they are an advance on the tax-free death benefit. For chronically ill individuals, the proceeds are tax-free to the extent they are used for qualified medical or long-term care expenses not covered by other insurance. If the individual is not terminally or chronically ill, or if the proceeds exceed these qualified expenses for chronically ill individuals, a portion of the settlement may be taxable.