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How to Use Life Insurance While Alive: Beyond the Death Benefit

Life insurance is often perceived as a safety net exclusively for beneficiaries after your passing. However, the modern life insurance landscape offers various ways to leverage your policy while you’re still alive, providing valuable financial tools and options you might not have considered. The key lies in understanding the features and riders available within different life insurance policies. Accessing the cash value of permanent policies, utilizing living benefits like accelerated death benefits, and even strategically borrowing against your policy are just a few ways to tap into its potential during your lifetime.

Understanding the Living Benefits of Life Insurance

Many people are unaware of the benefits they can reap from life insurance beyond the traditional death benefit. Let’s delve into the specific ways you can use your life insurance while you’re still around.

Accessing Cash Value: A Financial Resource

Whole Life Insurance: This type of policy accumulates cash value over time on a tax-deferred basis. This cash value grows predictably and is guaranteed by the insurance company. You can borrow against this cash value or even make withdrawals. However, withdrawals may reduce the death benefit and can have tax implications.
Universal Life Insurance: Similar to whole life, universal life also builds cash value. However, it offers more flexibility in premium payments and death benefit amounts. The cash value growth is tied to the performance of the underlying investments.
Variable Life Insurance: This policy allows you to allocate your cash value among various investment sub-accounts, offering potentially higher returns but also greater risk. You can access the cash value through loans or withdrawals, just like with other permanent policies.

Borrowing against your policy is a common strategy. The interest rates are often lower than traditional loans, and you’re not required to go through a credit check. However, remember that if you don’t repay the loan, the death benefit will be reduced. Making withdrawals can provide immediate access to funds, but it permanently reduces the policy’s value and can have tax consequences.

Living Benefits: Accelerated Death Benefits

Many life insurance policies now include accelerated death benefit riders. These riders allow you to access a portion of your death benefit while you’re alive if you meet certain criteria, such as:

Terminal Illness: If you’re diagnosed with a terminal illness and have a limited life expectancy (typically 12-24 months).
Critical Illness: If you suffer a major health event like a heart attack, stroke, or cancer.
Chronic Illness: If you’re unable to perform certain activities of daily living (ADLs), such as bathing, dressing, or eating.
Long-Term Care: If you require long-term care services, either at home or in a nursing facility.

Accessing these benefits can help cover medical expenses, long-term care costs, and other financial burdens associated with these difficult situations. It provides a crucial financial cushion when you need it most.

Policy Loans: Leveraging Your Policy for Opportunities

As mentioned earlier, policy loans offer a unique advantage. You’re essentially borrowing from yourself, using your policy’s cash value as collateral. The terms are often flexible, and you don’t need to undergo a credit check. This can be a valuable option for funding a business venture, paying for education, or covering unexpected expenses.

However, it’s crucial to understand the implications. Unpaid loan interest can accumulate and reduce the death benefit. If the loan balance plus interest exceeds the cash value, the policy could lapse, resulting in a taxable event.

Surrendering the Policy: A Last Resort

Surrendering your life insurance policy means canceling it and receiving the cash surrender value. This should be considered a last resort as you’ll lose the death benefit protection. The cash surrender value is typically less than the total premiums paid, especially in the early years of the policy, due to surrender charges and other fees.

Tax Implications of Using Life Insurance While Alive

Understanding the tax implications is crucial when utilizing your life insurance policy during your lifetime.

Policy Loans: Generally, policy loans are not considered taxable income as long as the policy remains in force.
Withdrawals: Withdrawals up to the amount of premiums paid are typically tax-free. However, withdrawals exceeding the premium basis may be subject to income tax.
Accelerated Death Benefits: In most cases, accelerated death benefits are tax-free, especially when used for long-term care or terminal illness expenses. However, it’s essential to consult with a tax advisor for personalized advice.
Surrender: When you surrender a policy, any cash value received above the amount of premiums paid is considered taxable income.

Choosing the Right Policy for Living Benefits

Not all life insurance policies are created equal when it comes to living benefits. If you’re interested in leveraging your policy during your lifetime, consider these factors:

Permanent vs. Term Life Insurance: Permanent life insurance (whole, universal, variable) is necessary to accumulate cash value. Term life insurance typically does not offer cash value or living benefits.
Rider Options: Review the available riders, particularly accelerated death benefit riders, and choose a policy that aligns with your specific needs and concerns.
Policy Fees and Charges: Compare the fees and charges associated with different policies, as these can impact the cash value growth.
Financial Strength of the Insurer: Opt for a financially stable insurance company with a strong credit rating to ensure your policy’s long-term security.

Frequently Asked Questions (FAQs)

Here are 12 frequently asked questions related to using life insurance while alive:

What is the difference between a policy loan and a withdrawal from my life insurance policy?
A policy loan is a loan from the insurance company, using your cash value as collateral. You’re required to repay the loan, although the terms are often flexible. A withdrawal is a direct reduction of your cash value, and you’re not required to repay it. However, it permanently reduces the death benefit.
Will taking a loan against my life insurance policy affect my credit score?
No, policy loans do not affect your credit score. The insurance company is not reporting the loan to credit bureaus since it’s secured by the policy’s cash value.
Are accelerated death benefits taxable?

In most cases, accelerated death benefits are not taxable, especially when used for qualified long-term care expenses or terminal illness. However, it’s always best to consult with a tax professional for personalized advice based on your specific situation.
Can I access my life insurance cash value at any age?
Yes, you can typically access your cash value at any age. However, accessing it too early in the policy’s life may result in lower cash value due to surrender charges or policy fees.
What happens if I can’t repay a policy loan?
If you can’t repay a policy loan, the outstanding loan balance and any accrued interest will be deducted from the death benefit paid to your beneficiaries. If the loan balance plus interest exceeds the cash value, the policy could lapse, resulting in a taxable event.
Do all life insurance policies offer living benefits?
No, not all life insurance policies offer living benefits. Living benefits are typically available on permanent life insurance policies (whole, universal, variable) and often come in the form of riders. Term life insurance generally does not offer these benefits.
How do I file a claim for accelerated death benefits?
To file a claim for accelerated death benefits, you’ll typically need to provide medical documentation from your doctor confirming your diagnosis and meeting the requirements outlined in the policy. Contact your insurance company for specific claim procedures.
What are the potential downsides of surrendering my life insurance policy?
Surrendering your life insurance policy means losing the death benefit protection. The cash surrender value may be less than the total premiums paid, especially in the early years of the policy, due to surrender charges and other fees. Any cash value received above the amount of premiums paid is considered taxable income.
How does inflation affect the cash value of my life insurance policy?
Inflation erodes the purchasing power of money. While the cash value of your life insurance policy may grow, the real value (adjusted for inflation) may not increase at the same rate. Consider this when making long-term financial plans.
Can I use the cash value of my life insurance to pay for long-term care?
Yes, you can use the cash value of your life insurance to pay for long-term care expenses. You can access the cash value through policy loans or withdrawals. Alternatively, some policies offer accelerated death benefit riders specifically for long-term care.
If I have multiple life insurance policies, can I access the living benefits from all of them?
Yes, if you have multiple life insurance policies that offer living benefits, you can potentially access them from each policy, provided you meet the eligibility requirements for each policy.
Should I consult a financial advisor before accessing my life insurance cash value or utilizing living benefits?
Absolutely. Consulting a financial advisor is highly recommended before making any decisions regarding your life insurance policy. They can help you understand the potential tax implications, assess your financial needs, and determine the best course of action based on your individual circumstances. They can also help you coordinate your life insurance strategy with your overall financial plan.