Can You Use Your Life Insurance While Alive?

Life insurance is commonly understood as a financial tool that provides a payout to beneficiaries after the policyholder’s death. However, certain types of life insurance policies offer provisions allowing policyholders to access financial value or receive benefits during their lifetime. These options provide financial flexibility in various circumstances.

Accessing Policy Cash Value

Permanent life insurance policies, such as whole life and universal life, build cash value over time. This accumulated cash value grows on a tax-deferred basis and can serve as a financial resource while the policyholder is still alive. Policyholders have several methods to access this value.

One common method is taking a policy loan. Policyholders can borrow against their cash value, with the policy itself serving as collateral. Interest typically accrues on the outstanding loan balance, and this interest rate can vary depending on the policy terms and current economic conditions. Unpaid loans, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s death.

Policyholders may also choose to make withdrawals from their cash value. Withdrawals directly reduce the policy’s cash value and, consequently, the death benefit.

The most definitive way to access cash value is through policy surrender. Surrendering a policy means the policyholder terminates the coverage entirely. In exchange, the insurer pays out the accumulated cash surrender value, which is the cash value minus any surrender charges, outstanding loans, or administrative fees. This action permanently ends the life insurance coverage, and no death benefit will be paid to beneficiaries in the future.

Utilizing Accelerated Death Benefits

Accelerated Death Benefits (ADBs), sometimes referred to as “Living Benefits,” are provisions included in many life insurance policies that allow policyholders to receive a portion of their death benefit while still alive. These benefits are typically triggered by specific, severe health conditions.

Common qualifying events for ADBs include a terminal illness, where a medical professional certifies a life expectancy of typically 12 to 24 months. Another qualifying condition is chronic illness, which often involves the inability to perform a certain number of Activities of Daily Living (ADLs), such as bathing, dressing, eating, or continence, or requiring substantial supervision due to cognitive impairment. Critical illnesses, such as a heart attack, stroke, or diagnosis of a serious cancer, can also trigger ADBs in some policies.

When an ADB is utilized, the insurer typically pays out a percentage of the death benefit, which can range from 25% to 100%, depending on the policy’s terms and the severity of the illness. This payout reduces the remaining death benefit that will be paid to beneficiaries upon the insured’s death. Eligibility for ADBs and the specific amounts available vary significantly by insurance policy and insurer. Policyholders must carefully review their policy documents to understand the precise conditions and limitations.

Considering Life and Viatical Settlements

Beyond accessing cash value or accelerated benefits, policyholders can also consider selling their life insurance policy to a third party through a settlement. This option provides a lump sum payment that is typically greater than the policy’s cash surrender value but less than the full death benefit. Settlements transfer ownership of the policy and the right to its death benefit.

A viatical settlement involves the sale of a life insurance policy by a terminally ill policyholder, typically one with a life expectancy of two years or less. In this arrangement, a third-party buyer, known as a viatical settlement provider, pays the policyholder a lump sum cash payment. The provider then becomes the new owner and beneficiary of the policy, assumes responsibility for paying all future premiums, and collects the full death benefit when the original insured passes away.

A life settlement is the sale of a life insurance policy by a policyholder who is generally healthy or chronically ill, typically aged 65 or older. Similar to viatical settlements, a third-party life settlement provider purchases the policy for a cash payment. The provider then takes over premium payments and receives the death benefit upon the insured’s death. This option is often explored by older adults who no longer need the coverage or require funds for retirement or other expenses.

The process for both viatical and life settlements generally involves working with a licensed broker or provider. These entities evaluate the policy, the insured’s health status, and other factors to determine an offer. The policyholder then assigns ownership of the policy to the buyer in exchange for the agreed-upon lump sum.

Tax Considerations and Impact on Death Benefit

Accessing life insurance value while alive carries various tax implications and invariably affects the death benefit ultimately paid to beneficiaries. Understanding these financial consequences is important for policyholders considering these options.

Policy loans are generally not considered taxable income as long as the policy remains in force. However, if the policy lapses with an outstanding loan, the loan amount exceeding the cost basis (premiums paid) may become taxable. Withdrawals from cash value are typically tax-free up to the amount of premiums paid into the policy, often referred to as the cost basis. Any withdrawal amount that exceeds this cost basis is usually considered taxable income. Surrendering a policy for a cash surrender value greater than the total premiums paid will result in the excess amount being taxed as ordinary income.

Accelerated Death Benefits are generally excludable from gross income and thus tax-free if the policyholder meets specific criteria for being terminally or chronically ill under federal tax law, such as Internal Revenue Code Section 101. For chronically ill individuals, there may be limits on the amount that can be received tax-free, often tied to per diem limitations for long-term care services.

Proceeds from viatical and life settlements can be partially or fully taxable. For viatical settlements, if the policyholder is certified as terminally ill, the proceeds are generally tax-free. However, for life settlements, the portion of the proceeds that exceeds the policyholder’s adjusted cost basis (premiums paid minus any prior tax-free distributions) is typically taxable as ordinary income. Any amount received above the cash surrender value but less than the death benefit might be taxed as capital gains. Regardless of the method chosen—policy loans, withdrawals, accelerated death benefits, or settlements—accessing funds during the policyholder’s lifetime will reduce or entirely eliminate the death benefit amount otherwise payable to the designated beneficiaries.