How to Use Your Life Insurance While You Are Alive

Life insurance traditionally provides financial protection for beneficiaries after a policyholder’s death. However, many permanent life insurance policies, such as whole life and universal life, also offer “living benefits” that can be accessed during the policyholder’s lifetime. These benefits provide financial flexibility for various life situations, including unforeseen expenses, long-term care needs, or supplemental income. Term life insurance policies typically do not offer these specific living benefits.

Accessing Policy Cash Value

Permanent life insurance policies accumulate a savings component known as cash value, which grows over time on a tax-deferred basis. This cash value can be accessed by the policyholder through several methods, providing a financial resource distinct from the death benefit. The amount available depends on the policy’s terms and the accumulated cash value.

One common way to access cash value is through a policy loan. This involves borrowing money directly from the insurer, with the policy’s cash value serving as collateral. To initiate a loan request, gather your policy number, the specific loan amount desired, and bank account details. Contact the insurer to obtain the necessary loan request form, complete it, and submit it for processing.

Policy loans accrue interest, though repayment is generally optional and flexible. An outstanding loan balance, including any accrued interest, will reduce the death benefit paid to beneficiaries if not repaid before the policyholder’s death. Policy loans are generally not considered taxable income unless the policy lapses or is surrendered with an outstanding loan balance that exceeds the premiums paid.

Another method to access cash value is through withdrawals. This involves directly removing funds from the policy’s accumulated cash value. Before requesting a withdrawal, identify your policy number and the exact amount you wish to withdraw. Contact the insurer to obtain the specific withdrawal request form. Once completed and submitted, the insurer processes the request, and funds are disbursed.

Withdrawals reduce both 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 Any amount withdrawn in excess of the premiums paid may be subject to ordinary income tax.

Policy surrender is a third option, involving cashing out the entire accumulated cash value and terminating the life insurance coverage. To surrender a policy, you need your policy number and possibly a voided check for direct deposit. Contact the insurer to request the formal surrender form. After completing and submitting the form, the insurer processes the surrender, cancels the policy, and pays out the cash value.

Surrendering a policy ends all insurance coverage, meaning no death benefit will be paid to beneficiaries. The cash value received upon surrender is taxable as ordinary income to the extent it exceeds the total premiums paid into the policy.

Utilizing Living Benefit Riders

Living benefit riders, also known as accelerated death benefit riders, allow access to a portion of the death benefit before the policyholder’s death under specific health-related circumstances. Unlike cash value access, these riders are triggered by health events, providing financial support during severe challenges.

A Terminal Illness Rider provides funds if the policyholder is diagnosed with a terminal illness. To claim, obtain a physician’s medical certification and submit it with the insurer’s claim form. If approved, the insurer disburses a portion of the death benefit.

Payouts from a terminal illness rider reduce the policy’s death benefit. Under the Health Insurance Portability and Accountability Act (HIPAA), these accelerated death benefits are generally tax-free.

A Chronic Illness Rider allows access to a portion of the death benefit if the policyholder becomes chronically ill, meaning they are permanently unable to perform a certain number of Activities of Daily Living (ADLs) or have severe cognitive impairment. The six standard ADLs include:
Bathing
Continence
Dressing
Eating
Toileting
Transferring

To claim, a licensed healthcare practitioner must certify the chronic illness and inability to perform ADLs or cognitive impairment. Submit this certification with the insurer’s claim forms.

The approved payout reduces the policy’s death benefit. Under HIPAA, proceeds from a chronic illness rider are generally tax-free if used for qualified long-term care expenses and within annual limits. Excess amounts or funds not used for qualified care may be taxable.

A Critical Illness Rider provides a lump sum payment upon diagnosis of specific critical illnesses, such as heart attack, stroke, or cancer. Eligibility criteria are defined in the policy and require a confirmed diagnosis. Gather all relevant medical documentation and submit it with the insurer’s claim form for processing.

The payout from a critical illness rider reduces the policy’s death benefit. Tax implications can vary depending on the illness and how funds are used; consult a tax professional.

Exploring Viatical Settlements

A viatical settlement is a financial transaction where a policyholder, typically with a terminal or chronic illness, sells their life insurance policy to a third-party company for a lump sum. The viatical settlement provider becomes the new owner and beneficiary, assumes future premium payments, and collects the full death benefit upon the insured’s death.

Viatical settlements are considered when policyholders face significant medical expenses, no longer need coverage, or find premiums unaffordable. This option provides immediate liquidity, often greater than the cash surrender value but less than the full death benefit. Before pursuing a settlement, gather policy details, current cash value, death benefit amount, and medical records confirming your illness.

Contact a licensed viatical settlement broker or provider to obtain offers. Review offers and select one that aligns with your needs. Once an offer is accepted, complete paperwork to transfer policy ownership and beneficiary rights to the provider. Funds are typically placed in an escrow account and released once ownership transfer is verified.

The policyholder relinquishes all rights to the policy, and original beneficiaries receive no death benefit. For terminally ill individuals, viatical settlement proceeds are generally tax-free under federal law. For chronically ill individuals, proceeds may also be tax-free if used for qualified long-term care expenses, subject to limits. However, if conditions are not met, the settlement may be partially or fully taxable.