What Are the Living Benefits of Life Insurance?

Life insurance traditionally serves as a financial safety net for beneficiaries after the policyholder’s passing. However, many modern life insurance policies offer “living benefits,” allowing policyholders to access funds or benefits while still alive. These features provide financial assistance during unforeseen circumstances or for planned needs, offering flexibility and support.

Accelerated Death Benefits: Accessing Funds Due to Illness

Accelerated Death Benefits (ADBs) allow policyholders to access a portion of their life insurance policy’s death benefit while still living, typically under specific health conditions. These conditions generally fall into categories such as terminal illness, critical illness, or chronic illness. For a terminal illness, a policyholder is usually required to have a prognosis of 12 to 24 months or less to live. Critical illness provisions cover specific severe health events like a heart attack, stroke, or cancer diagnosis.

Chronic illness benefits are commonly triggered when a policyholder is unable to perform a specified number of Activities of Daily Living (ADLs), typically two out of six, such as bathing, dressing, eating, continence, toileting, or transferring. Severe cognitive impairment, like that caused by Alzheimer’s disease, can also qualify a policyholder for chronic illness benefits. Once a qualifying condition is met, a percentage of the death benefit, often ranging from 25% to 95%, can be advanced to the policyholder.

Accessing these accelerated benefits reduces the eventual death benefit paid to beneficiaries. Generally, accelerated death benefits are not considered taxable income if the insured is certified as terminally ill or chronically ill and the funds are used for qualified long-term care expenses. Exceptions can arise if benefits exceed IRS per diem limits for chronic illness or if interest is accrued on installment payouts.

Policy Cash Value: A Source of Living Funds

Certain permanent life insurance policies, such as whole life and universal life, build cash value over time. A portion of each premium payment is allocated to this cash value, where it grows on a tax-deferred basis. This accumulation occurs because a part of the premium covers the cost of insurance, while the remainder is invested and earns interest.

Policyholders can access this accumulated cash value through several mechanisms. One common method is taking a policy loan, where the policyholder borrows against the cash value. These loans typically have competitive interest rates, often ranging from 5% to 8%, and do not require a credit check or strict repayment schedule.

Any outstanding loan balance, including accrued interest, will reduce the death benefit if not repaid before the policyholder’s death. Policy loans are generally tax-free as long as the policy remains in force, but if the policy lapses with an outstanding loan, the loan amount exceeding the premiums paid may become taxable.

Another way to access cash value is through withdrawals. Policyholders can withdraw funds directly from the cash value, which reduces both the cash value and the death benefit. Withdrawals are typically tax-free up to the amount of premiums paid into the policy. Any amount withdrawn that exceeds this is usually considered taxable income.

Finally, a policyholder can surrender the policy for its cash surrender value, which terminates the insurance coverage. The amount received upon surrender that exceeds the total premiums paid is considered a taxable gain.

Benefits for Long-Term Care Needs

Life insurance policies can also offer financial assistance for long-term care expenses, which involve services such as nursing home care, assisted living, or in-home health care. This support is often provided through specific long-term care riders or as part of hybrid life/long-term care policies. Benefits are typically triggered when a policyholder is certified as unable to perform at least two Activities of Daily Living (ADLs) or has a severe cognitive impairment.

These benefits can be paid out in various ways, including monthly benefits or as reimbursements for actual care expenses. The funds provided for long-term care needs reduce the policy’s death benefit. Long-term care benefits are specifically designed to cover qualifying care expenses and are generally income tax-free. Chronic illness riders, while also allowing early access, may provide a lump sum for any purpose, with potential tax implications if exceeding IRS limits.