How Can I Use Life Insurance While Alive?

Life insurance, traditionally a financial safety net for beneficiaries after a policyholder’s passing, offers benefits accessible while the insured is still alive. These “living benefits” transform a policy into a versatile financial tool. Understanding how to use these features provides financial flexibility for various needs, from unexpected expenses to long-term care, without waiting for the death benefit. Policyholders can leverage accumulated value or specific provisions to address immediate or future financial challenges.

Accessing Funds Through Policy Loans

Permanent life insurance policies, such as whole life or universal life, accumulate cash value over time, which policyholders can borrow against. A policy loan involves borrowing money directly from the insurance company, using the policy’s cash value as collateral. Unlike traditional bank loans, these loans typically do not require a credit check or extensive application process because the loan is secured by the policy’s value.

Interest accrues on the outstanding loan balance, and the policyholder determines the repayment schedule. Repayment is generally optional; however, any outstanding loan balance, including accrued interest, will reduce the death benefit paid to beneficiaries. If the loan amount plus accrued interest ever exceeds the policy’s cash value, the policy could lapse, potentially triggering a taxable event on any gains.

The policy usually remains in force even with an outstanding loan, continuing to provide coverage. While the loan is not considered taxable income when taken, if the policy lapses with an outstanding loan, the amount of the loan, to the extent it exceeds the premiums paid, may become taxable. This access offers a flexible way to obtain funds without permanently reducing the policy’s cash value or death benefit, if managed responsibly.

Accessing Funds Through Withdrawals and Surrenders

Beyond policy loans, policyholders can access a policy’s cash value through withdrawals or by surrendering the policy. A withdrawal involves taking a portion of the cash value, which directly reduces the policy’s cash value and, consequently, the death benefit. Withdrawals are generally permitted in universal life policies.

The tax implications of withdrawals depend on the amount taken relative to premiums paid. Amounts withdrawn up to the “cost basis”—the total premiums paid—are typically tax-free. Any amount withdrawn exceeding this cost basis, representing the policy’s earnings, is usually subject to ordinary income tax. If the policy is classified as a Modified Endowment Contract (MEC), withdrawals are taxed on a “last-in, first-out” basis, meaning earnings are taxed first, and a 10% penalty may apply if the policyholder is under age 59½.

Surrendering a policy means terminating the entire life insurance contract to receive its cash surrender value. This action immediately cancels the policy, ending all coverage and eliminating the death benefit. The cash surrender value is the accumulated cash value minus any applicable surrender charges, which can be substantial, especially in early policy years.

When a policy is surrendered, any amount received that exceeds the total premiums paid is considered a taxable gain and is subject to ordinary income tax. For example, if a policyholder paid $50,000 in premiums and the cash surrender value is $65,000, the $15,000 gain would be taxable income. This option provides immediate access to the policy’s value but at the cost of losing all life insurance coverage.

Utilizing Accelerated Death Benefits and Living Benefit Riders

Accelerated Death Benefits (ADBs) and Living Benefit Riders allow policyholders to access a portion of their life insurance death benefit while still alive, under specific health-related circumstances. These provisions provide financial relief during severe illness. They are often included as riders, sometimes for an additional premium, or may be built into the policy.

One common trigger for ADBs is a terminal illness diagnosis, where a physician certifies a life expectancy of a specified period, typically 6 to 24 months. Accessing this benefit provides a lump sum or periodic payments, usable for medical expenses, end-of-life care, or other financial needs. The amount received reduces the death benefit paid to beneficiaries.

Chronic illness riders are another living benefit, activated when the insured is unable to perform a certain number of Activities of Daily Living (ADLs), generally two out of six, or experiences severe cognitive impairment. The six ADLs typically include bathing, continence, dressing, eating, toileting, and transferring. These benefits help cover costs associated with long-term care, such as in-home care or nursing facility 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 list of covered conditions varies by insurer and policy. These benefits are usually paid as a lump sum, which can help offset lost income, medical bills, or other financial burdens from the illness. The amount received directly reduces the policy’s future death benefit.