What Are Living Benefit Options in Life Insurance?

Understanding Living Benefits in Life Insurance

Life insurance traditionally provides financial protection, offering a death benefit to designated beneficiaries upon the passing of the insured individual. This primary function helps ensure financial stability for loved ones during a difficult time. Contemporary life insurance policies now incorporate “living benefits,” which enable policyholders to access a portion of their policy’s value while they are still alive, under specific qualifying circumstances. These provisions also extend financial utility beyond just a death benefit.

Understanding Living Benefits

Living benefits are optional features or riders that allow policyholders to receive an advance on their policy’s death benefit. This access is typically granted when the insured individual faces specific, challenging health events. Their primary purpose is to help alleviate financial burdens that may arise from medical care, potential loss of income, or other associated costs during a serious illness. These funds are an acceleration of the death benefit, not additional to the policy’s value.

By accessing a portion of the death benefit early, policyholders can address immediate financial needs. These might include covering medical expenses, adapting their home for accessibility, or managing daily living costs.

Categories of Living Benefits

Living benefits are categorized based on the specific health conditions or events that trigger their activation, each designed to address distinct financial challenges. Understanding these distinctions helps clarify how each benefit functions.

Accelerated Death Benefits

Accelerated death benefits (ADBs) provide financial relief for severe health circumstances. This benefit is available when a policyholder is diagnosed with a terminal illness, typically defined as having a limited life expectancy of 12 or 24 months, depending on the insurer and state regulations. Funds from an ADB can be used at the policyholder’s discretion, such as covering hospice care, experimental treatments, or settling financial affairs. The payout usually ranges from 25% to 100% of the death benefit, often capped at a specific dollar amount like $250,000 or $500,000.

Chronic Illness Riders

Chronic illness riders provide access to a portion of the death benefit if the insured develops a chronic illness. A chronic illness is defined by the inability to perform a certain number of Activities of Daily Living (ADLs), typically two out of six, without substantial assistance. These ADLs include:
Bathing
Dressing
Eating
Continence
Toileting
Transferring

Some policies may also define chronic illness as requiring substantial supervision due to severe cognitive impairment, such as Alzheimer’s disease. The funds can be used for in-home care services, assisted living facilities, or home modifications. Payouts often involve monthly installments or a lump sum, based on a percentage of the death benefit, frequently up to 2% per month or a maximum annual percentage like 24%.

Critical Illness Riders

Critical illness riders offer a lump-sum payment upon the diagnosis of a specific, severe medical condition listed in the policy. Common conditions include:
Heart attack
Stroke
Life-threatening cancer
Major organ transplant
Kidney failure
Paralysis

This benefit helps policyholders manage the immediate financial impact of such a diagnosis, including medical deductibles, co-payments, rehabilitation costs, or income replacement during recovery. Unlike chronic illness benefits, which focus on long-term care, critical illness benefits address the acute financial shock of a major health event. The payout is often a fixed percentage of the death benefit, such as 25%, 50%, or 100%, up to a specified maximum.

Long-Term Care Riders

Long-term care (LTC) riders cover costs associated with long-term care services, including nursing home care, assisted living, adult day care, or professional home health care. These riders function similarly to standalone long-term care insurance policies but are integrated into a life insurance contract. Activation occurs when the insured cannot perform a certain number of ADLs (usually two out of six) or suffers from severe cognitive impairment, similar to chronic illness riders. The benefit is typically paid as a monthly allowance for a specified duration, such as two to five years, or until the benefit amount is exhausted. Funds are earmarked for long-term care services, often requiring submission of invoices or proof of expenses.

Activating Living Benefits

Activating a living benefit requires the policyholder or their authorized representative to follow a process set forth by the insurance company. The initial step involves notifying the insurer of the intent to file a claim, which prompts the insurer to provide claim forms and instructions.

Policyholders must then provide documentation to substantiate their claim. This commonly includes statements from licensed physicians certifying the qualifying medical condition, such as a terminal illness diagnosis, chronic illness requiring ADL assistance, or a critical illness diagnosis. Medical records, diagnostic reports, and sometimes an independent medical examination may be required to verify the condition meets policy criteria. Some benefits, particularly chronic illness and long-term care riders, may include an “elimination period” or “waiting period” (e.g., 30, 60, or 90 days) that must pass after the qualifying event before benefits begin. After documentation is submitted, the insurer reviews the claim to ensure it aligns with policy terms. Once approved, the benefit payment process commences according to the rider’s specifications, whether as a lump sum or scheduled installments.

Impact on Policy Value

Utilizing a living benefit impacts the financial aspects of a life insurance policy. The amount received is an advance on the policy’s death benefit, meaning the remaining death benefit payable to beneficiaries will be reduced by the amount taken. For example, if a policy has a $500,000 death benefit and a policyholder receives a $100,000 living benefit payout, the remaining death benefit for beneficiaries would be $400,000.

Some living benefit payouts may incur administrative fees or an interest charge on the advanced amount, further reducing the net amount available to beneficiaries. The taxation of living benefits can vary. Accelerated death benefits paid to terminally ill individuals are generally excludable from gross income under Internal Revenue Code Section 101, meaning they are not typically subject to federal income tax. However, benefits received for chronic illness may be taxable if they exceed certain per diem limits set by the IRS or if the funds are not used for qualified long-term care expenses. Policy cash values, if applicable, may also be reduced or eliminated, and premium payments may still be required, though some policies may offer premium waivers after a living benefit is activated.