What Is Living Benefit Life Insurance?

Fundamentals of Living Benefits

Living benefits allow life insurance policyholders to access a portion of their death benefit while still alive. Often called “accelerated death benefits,” these funds provide early access to money that would otherwise be paid to beneficiaries. Available through optional riders, they offer financial relief during challenging health circumstances.

The core purpose of living benefits is to help policyholders manage significant expenses arising from specific qualifying events. These events typically involve severe health conditions that create substantial financial burdens, such as extensive medical treatments, specialized care, or loss of income. By providing early access to funds, living benefits can alleviate financial stress.

To activate living benefits, a policyholder must experience a “triggering event” defined by the insurance contract. Common events include a diagnosis of a terminal illness, a chronic illness requiring assistance with daily activities, or a critical illness like a heart attack or stroke. These conditions often lead to high out-of-pocket costs not fully covered by health insurance. The funds received can be used for any purpose, providing flexibility to address immediate financial needs.

The amount accessible typically ranges from 25% to 100% of the policy’s death benefit. This is usually capped at a maximum dollar amount, which varies significantly by insurer and policy, often ranging from $250,000 to $1,000,000 or more.

Types of Accelerated Benefit Riders

Life insurance policies can include several types of accelerated benefit riders, each addressing distinct health challenges.

Terminal Illness Rider

This rider allows a policyholder to receive a portion of their death benefit if diagnosed with a terminal illness. To qualify, a medical professional typically certifies a life expectancy of 12 or 24 months or less, depending on the rider’s terms. The payout can cover end-of-life expenses, medical treatments, or other financial needs.

Chronic Illness Rider

This rider provides access to funds if the policyholder cannot perform a certain number of Activities of Daily Living (ADLs) or suffers from severe cognitive impairment. ADLs commonly include bathing, dressing, continence, eating, toileting, and transferring. Inability to perform at least two ADLs, or a diagnosis of severe cognitive impairment like Alzheimer’s disease, typically triggers the benefit. This rider helps cover long-term care costs, such as home health care or assisted living.

Critical Illness Rider

This rider offers a lump-sum payout upon diagnosis of a specified critical illness. Covered illnesses vary by insurer but often include heart attack, stroke, cancer, kidney failure, major organ transplant, or paralysis. The diagnosis must meet specific medical criteria. Funds from a critical illness payout are typically unrestricted and can cover medical deductibles, co-pays, lost income, or household expenses.

Long-Term Care (LTC) Rider

An LTC Rider can be integrated into a life insurance policy to address long-term care costs. Unlike a standalone long-term care policy, this rider draws from the life insurance death benefit, reducing it by the amount of care costs paid out. Qualification criteria are similar to the chronic illness rider, often based on the inability to perform ADLs or cognitive impairment. This rider helps pay for services like nursing home care, assisted living, or home health care.

Impact on Policy Value and Premiums

Activating a living benefit directly affects a life insurance policy’s financial structure. When a policyholder receives an accelerated death benefit payout, that amount is subtracted from the policy’s total death benefit. This reduces the remaining death benefit payable to beneficiaries. For example, if a policy has a $500,000 death benefit and a $100,000 living benefit is accessed, the remaining death benefit would be $400,000.

Insurers may also charge administrative fees or interest on the accelerated amount, typically deducted from the payout or remaining death benefit. Some policies treat the accelerated benefit as a lien against the death benefit, accruing interest until the policyholder’s death. This further reduces the final payout to beneficiaries.

For policies with a cash value component, such as whole life or universal life insurance, taking an accelerated benefit may proportionally reduce the cash value. This occurs because the cash value is linked to the death benefit and the policy’s reserves. A diminished cash value can affect future options like policy loans or cash withdrawals.

Premium obligations generally continue even after a living benefit is accessed. However, some policies or riders might include provisions for premium reduction or waiver if a significant portion of the death benefit has been accelerated. Policyholders should review their specific policy documents to understand these effects.

Tax Treatment of Living Benefits

The tax treatment of living benefits is a significant consideration. Under the Health Insurance Portability and Accountability Act (HIPAA), accelerated death benefits for terminally ill individuals are generally excluded from gross income for federal income tax purposes. This means the payout is typically tax-free, allowing the policyholder to use the funds without incurring an immediate tax liability. To qualify as terminally ill under IRS guidelines, a physician must certify the individual is not expected to live more than 24 months.

Accelerated death benefits for chronically ill individuals can also be tax-free, provided certain conditions are met. The policyholder must be certified by a licensed health care practitioner as unable to perform at least two Activities of Daily Living (ADLs) for a period of at least 90 days, or requiring substantial supervision due to severe cognitive impairment. The funds must also be used for qualified long-term care services, and the payout cannot exceed certain per diem limits for long-term care benefits, which are adjusted annually by the IRS. For example, in 2024, the per diem limit for tax-free long-term care benefits is $430 per day.

If accelerated benefits for a chronic illness exceed the IRS per diem limit and are not used for qualified long-term care services, the excess amount may be considered taxable income. Additionally, if the recipient does not meet IRS definitions of terminally or chronically ill, the accelerated death benefit payout may be fully or partially taxable. For instance, benefits from a critical illness rider, if the illness is not terminal or chronic under IRS definitions, could be subject to taxation.

Due to the complexities involved, individuals considering accessing living benefits or those who have already received a payout should consult with a qualified tax professional. A tax professional can provide personalized advice based on the specific circumstances of the illness, the amount received, and how the funds are used. This guidance helps ensure compliance with current tax laws and avoids unexpected tax obligations.