How Can I Use My Life Insurance While Alive?

Life insurance primarily provides a death benefit to beneficiaries upon the policyholder’s passing. However, certain policy structures and external mechanisms allow access to funds while the insured is still alive. Understanding these options offers financial flexibility, enabling individuals to leverage their policy for various needs during their lifetime. These living benefits can be a valuable financial resource, complementing the traditional role of life insurance.

Accessing Policy Cash Value

Certain permanent life insurance policies, such as whole life, universal life, variable universal life, and indexed universal life, accumulate a cash value. This component grows over time as premiums are paid, often on a tax-deferred basis, similar to a savings account. Policyholders can access this accumulated cash value while they are still living, distinct from the policy’s death benefit.

One common method to access cash value is through a policy loan, using the policy’s cash value as collateral. These loans typically do not require a credit check or formal approval, with funds often available within days. Policy loans offer flexible repayment terms, though interest accrues on the borrowed amount. If the loan and accrued interest are not repaid, the outstanding balance is deducted from the death benefit. If the loan balance plus interest exceeds the policy’s cash value, the policy could lapse, resulting in a loss of coverage.

Alternatively, policyholders can make direct withdrawals from their cash value. Unlike a loan, a withdrawal permanently reduces the policy’s cash value and its death benefit. Withdrawals are generally tax-free up to the amount of premiums paid into the policy. Any amount withdrawn exceeding total premiums paid may be subject to income tax. This tax treatment is relevant if the policy is a Modified Endowment Contract (MEC), where withdrawals or loans are taxed on a “last-in, first-out” basis, meaning gains are taxed first.

Another option is to surrender the life insurance policy for its cash surrender value. This terminates the policy, meaning all coverage ceases and no death benefit will be paid. The cash surrender value is the accumulated cash value minus any surrender charges, which can be substantial in early years. If the cash surrender value received exceeds total premiums paid, the excess is considered a taxable gain subject to ordinary income tax. Consulting a tax professional is advisable to understand specific implications before surrendering a policy.

Utilizing Accelerated Death Benefits

Beyond accessing cash value, some life insurance policies include accelerated death benefits, also known as living benefits or riders. These provisions allow policyholders to receive a portion of their death benefit while still alive, under specific qualifying circumstances. These benefits provide financial relief, often without requiring an additional premium. However, some insurers may charge a fee or reduce the payout for early distribution.

Qualifying events for accelerated death benefits include a diagnosis of a terminal illness. Other triggers can include chronic illness, defined as the inability to perform certain activities of daily living or requiring supervision due to cognitive impairment. Critical illnesses, such as a heart attack, stroke, cancer, or organ failure, can also activate these benefits, depending on the specific rider. The criteria for each illness are detailed within the policy’s terms.

When an accelerated death benefit is utilized, the policyholder receives an advance on the death benefit, which reduces the amount paid to beneficiaries. The accessible amount can vary, with insurers typically allowing policyholders to withdraw anywhere from 25% to 100% of the death benefit. Funds can be used for any purpose, such as covering medical expenses or long-term care costs. These benefits are generally considered tax-free under federal law if the policyholder meets specific criteria for terminal or chronic illness. It is prudent to consult with a tax advisor, as eligibility for public assistance programs like Medicaid may be affected, and policyholders should review their policy documents or contact their insurer to understand the process for initiating a claim.

Considering Viatical and Life Settlements

For policyholders who no longer need or can afford their life insurance, or require immediate liquidity, viatical and life settlements offer an alternative to surrendering the policy. These arrangements involve selling the policy to a third-party investor for a lump sum of cash. The payout received is more than the policy’s cash surrender value but less than the full death benefit.

A viatical settlement is for individuals who are terminally or chronically ill. The policyholder sells their policy to a viatical settlement provider. The provider pays a cash sum, assumes future premium payments, and becomes the new beneficiary, receiving the full death benefit upon the insured’s death. Proceeds from a viatical settlement are generally not subject to federal income tax, given the policyholder’s health status.

Conversely, a life settlement applies to policyholders who are generally older or not terminally/chronically ill but wish to sell their policy. Reasons include no longer needing coverage, unaffordable premiums, or needing funds for retirement or other expenses. The process is similar to a viatical settlement: the policyholder sells the policy to a life settlement provider for a cash payment, and the provider takes over premium payments and receives the death benefit. Unlike viatical settlements, proceeds from a life settlement may be subject to income tax on gains above premiums paid.

The process for both viatical and life settlements involves working with a licensed provider or broker. The policy’s face value, the insured’s health, and life expectancy are factors in determining the offer. Once the sale is complete, the original policyholder relinquishes all rights to the policy, and the new owner assumes full control, including the right to receive the death benefit. This means the original beneficiaries will not receive any payout from that specific policy.