What Is Life Insurance With Living Benefits?

Life insurance traditionally provides a death benefit to beneficiaries upon the policyholder’s passing, helping loved ones manage financial obligations, replace lost income, and maintain their standard of living. Modern life insurance policies now include “living benefits,” which allow policyholders to access a portion of their policy’s value while they are still alive.

Living benefits provide financial support to the policyholder during their lifetime, particularly when facing significant health challenges. These benefits offer a layer of protection, enabling individuals to address financial needs that arise from severe illnesses or chronic conditions. Unlike the traditional death benefit, living benefits allow for an early payout, providing liquidity when it is most needed. This transforms life insurance into a more comprehensive financial planning tool, offering assistance directly to the policyholder.

Understanding Living Benefits

Living benefits are provisions, often added as riders, that allow policyholders to access a portion of their life insurance policy’s death benefit while they are still alive. These riders enhance the policy’s utility by providing financial liquidity during times of significant need, such as a severe illness or injury. They differ from traditional life insurance, which typically only provides a payout to beneficiaries after the insured’s death. The core function of living benefits is to help cover expenses like medical bills, long-term care costs, or to replace lost income due to an inability to work.

When a policyholder accesses living benefits, the amount received is deducted from the policy’s total death benefit. This means the eventual payout to beneficiaries will be reduced by the amount advanced to the policyholder during their lifetime. This mechanism ensures that the policy remains a single pool of funds, from which portions can be accelerated under specific conditions. This highlights the trade-off between receiving funds early and preserving the full death benefit for heirs.

Categories of Living Benefits

Living benefits are commonly categorized based on the specific health conditions or circumstances that trigger their activation.

Terminal Illness Benefit

This benefit, also known as an accelerated death benefit rider, allows a policyholder to receive an advance on their death benefit if they are diagnosed with an illness that is expected to result in death within a specified period, often 12 or 24 months. The funds provided can help cover end-of-life care, medical expenses, or other financial needs.

Chronic Illness Benefit

This benefit activates if a policyholder is unable to perform a certain number of Activities of Daily Living (ADLs) or requires substantial supervision due to cognitive impairment. ADLs generally include essential self-care tasks such as bathing, continence, dressing, eating, toileting, and transferring. Policyholders usually need to be unable to perform at least two of these activities, or have severe cognitive impairment, to qualify. This benefit is designed to assist with long-term care costs.

Critical Illness Benefit

Critical illness benefits provide a lump-sum payment upon diagnosis of a specific severe illness listed in the policy. These conditions frequently include major health events such as a heart attack, stroke, or life-threatening cancer. The specific illnesses covered can vary between insurance providers. The payout from a critical illness rider can help manage high medical costs, replace lost income, or provide financial flexibility during recovery.

Long-Term Care (LTC) Rider

A Long-Term Care (LTC) rider can function similarly to a chronic illness benefit, specifically providing funds for long-term care services. Some policies integrate LTC benefits directly, while others offer it as a distinct rider. These riders are designed to cover expenses related to custodial care, skilled nursing care, or home health care, often triggered by the same ADL impairment criteria as chronic illness benefits. Policyholders should review their policy contract carefully for specific definitions.

How Living Benefits Are Accessed

Accessing living benefits involves a defined process. The policyholder or their representative must notify the insurer of a qualifying event. This notification signals the need for an accelerated payout due to a severe health condition.

Extensive documentation is required to substantiate the claim. This usually includes medical records, physician certifications detailing the diagnosis and prognosis, and other forms that prove the policyholder meets the eligibility criteria. For instance, a terminal illness claim might require a doctor’s certification of a life expectancy of 12 to 24 months or less. For chronic illness, a licensed health care professional must certify the inability to perform a specified number of ADLs or the presence of severe cognitive impairment.

Upon receipt of the documentation, the insurer will conduct a medical review to verify the claim and confirm that the conditions for the living benefit are met. Once approved, the benefits are distributed to the policyholder through various mechanisms, such as a lump sum payment or monthly installments, depending on the policy and the nature of the benefit.

Any amount received as a living benefit directly reduces the death benefit that will ultimately be paid to the policy’s beneficiaries. For example, if a policy has a $500,000 death benefit and $100,000 is accelerated through a living benefit, the remaining death benefit for beneficiaries would be $400,000. This reduction impacts the financial legacy intended for heirs.

Policy Provisions and Considerations

Life insurance policies with living benefits come with specific provisions and considerations. Eligibility requires the policy to be in force and active at the time of the qualifying event. Some policies may also impose waiting periods, meaning a certain amount of time must pass after policy issuance or diagnosis before benefits can be accessed. For instance, a waiting period of 30 to 90 days after diagnosis is common before a claim can be filed.

Benefit limits and caps are also standard features, restricting the maximum amount that can be accelerated through living benefits. These limits are often expressed as a percentage of the death benefit, such as 50% to 95%, or a fixed dollar amount, which can range from $250,000 to $2 million depending on the insurer and policy. The actual amount received may be less than the requested amount, as insurers may apply a discount factor based on factors like life expectancy and lost interest due to early payment.

The cost of including living benefits varies; some are built into the policy at no additional premium, while others are offered as optional riders that may incur an extra charge. If an additional premium is required, the cost can depend on factors like the policyholder’s age, health, and the type and amount of coverage. It is essential to review the policy documents to determine how these features are priced.

Regarding tax implications, benefits received from living benefit riders are generally excluded from gross income for federal tax purposes if the insured is certified as terminally or chronically ill. This tax treatment is governed by Internal Revenue Code Section 101.

However, exceptions can apply, particularly if benefits for chronic illness exceed certain annual limits or if the policy is owned by a taxpayer with an insurable interest that is not the insured. Policyholders should consult with a tax professional to understand their specific situation, as tax rules can be complex.