How Does Life Insurance Work If You Don’t Die?

Life insurance is widely recognized for its primary role in providing financial security to beneficiaries after the insured’s passing. Its fundamental purpose ensures loved ones receive a death benefit. Beyond this traditional function, certain life insurance policies offer distinct benefits and accumulate value during the policyholder’s lifetime. These living benefits and cash value components allow individuals to access policy resources, addressing various financial needs or health challenges that may arise while they are still alive. This expands its utility beyond just a death benefit.

Accessing Policy Value While Living

Many permanent life insurance policies include a savings component known as cash value, which accumulates over time and is distinct from the death benefit. This cash value grows on a tax-deferred basis and can become a significant financial asset. The accumulation is typically based on a portion of the premium payments, policy fees, and an interest rate or investment performance, depending on the policy type.

Policyholders can access the accumulated cash value through policy loans. The policy remains in force, and the loan is generally not taxable as income. Interest accrues on the outstanding loan balance, and typical interest rates for these loans often range from 5% to 8% annually, though these can vary by insurer and economic conditions. If a policy loan is not repaid, the outstanding balance, including accrued interest, will reduce the death benefit paid to beneficiaries upon the insured’s death. Consistent interest accrual can deplete the cash value over time if not managed, potentially leading to the policy lapsing if the cash value falls below zero.

Another method of accessing policy value is through withdrawals from the cash value. Unlike loans, withdrawals directly reduce both the policy’s cash value and its death benefit. Withdrawals are generally treated as a return of premium paid, meaning they are usually tax-free up to the amount of premiums paid into the policy. However, any amount withdrawn that exceeds the total premiums paid is considered taxable income, subject to ordinary income tax rates. For example, if a policyholder paid $50,000 in premiums and withdraws $60,000, the $10,000 gain would be taxable.

Policy surrender is a third option, where the policyholder terminates the life insurance contract entirely in exchange for its cash surrender value. The cash surrender value is the accumulated cash value minus any surrender charges or outstanding loans. Surrender charges, fees for early termination, are often highest in the initial years of a policy and decrease over time. When a policy is surrendered, any gain—the cash surrender value received in excess of the total premiums paid—is considered taxable income.

Utilizing Living Benefits and Riders

Many life insurance policies offer “living benefits,” also known as accelerated death benefits, allowing policyholders to access a portion of their death benefit while still alive. These benefits are typically triggered by specific health conditions or life events.

One common type is the critical illness rider, which provides a lump sum payment if the insured is diagnosed with a specified severe illness. Conditions often covered include:
Heart attack
Stroke
Cancer
Kidney failure
Major organ transplant
Paralysis

Chronic illness riders are designed to provide funds if the insured is unable to perform a certain number of Activities of Daily Living (ADLs) or requires substantial supervision due to cognitive impairment. ADLs commonly include:
Bathing
Dressing
Eating
Continence
Toileting
Transferring (moving in and out of a bed or chair)

Terminal illness riders allow access to a portion of the death benefit if the insured is diagnosed with a limited life expectancy, often 12 or 24 months. This benefit can provide financial flexibility for end-of-life care, medical treatments, or to fulfill personal wishes.

Long-term care riders are another form of living benefit that provides monthly payments to help cover the costs of long-term care services. These services may include nursing home care, assisted living, or home health care, often triggered by the inability to perform a specified number of ADLs. The specific terms, conditions, and availability of these living benefit riders can vary significantly between insurance carriers and policy types.

Policy Types Supporting Living Benefits

Accessing cash value and utilizing living benefits is predominantly associated with permanent life insurance policies. These policies provide coverage for the insured’s entire life, as long as premiums are paid, and typically include a savings component that accumulates cash value over time. Specific features and flexibility vary considerably among different permanent life insurance products.

Whole life insurance is a type of permanent policy characterized by guaranteed cash value growth, fixed premiums, and a guaranteed death benefit. The cash value component grows at a predetermined rate. Many whole life policies also incorporate living benefit riders, such as terminal illness or chronic illness riders, allowing access to funds under specific health circumstances.

Universal life insurance offers more flexibility than whole life, allowing policyholders to adjust premium payments and death benefit amounts. Its cash value growth is tied to an interest rate, which can fluctuate, although some policies offer a guaranteed minimum interest rate. Universal life policies commonly include various living benefit riders, providing options for critical, chronic, or terminal illness scenarios.

Variable universal life insurance is a universal life policy where the cash value is invested in various sub-accounts, similar to mutual funds. This offers the potential for higher cash value growth but also carries investment risk, as the value can fluctuate with market performance. These policies typically include provisions for living benefits, but the actual value available will depend on the investment performance of the chosen sub-accounts.

In contrast, term life insurance policies generally do not build cash value and are designed to provide coverage for a specific period, such as 10, 20, or 30 years. While term policies typically do not offer cash value access, some may include limited living benefit riders, most commonly a terminal illness rider, allowing for early access to a portion of the death benefit if a life-limiting illness is diagnosed. The availability of specific cash value features or living benefit riders depends on the policy, the issuing insurer, and state regulations.