How Do You Use Your Life Insurance While Alive?

Think life insurance is only good for your beneficiaries after you’re gone? Think again! While the death benefit is undoubtedly the primary function, some life insurance policies offer surprising avenues for utilization during your lifetime. The key lies in understanding the features and riders available, transforming your policy into a potential financial tool while you’re still around to enjoy the benefits. In short, you can use your life insurance while alive by accessing the cash value accumulated in permanent policies, utilizing accelerated death benefit riders, or even selling your policy through a life settlement.

Understanding the Landscape: Not All Policies Are Created Equal

Before diving into the specifics, it’s crucial to recognize that term life insurance generally does not offer living benefits. It’s designed solely to provide a death benefit within a specific timeframe. Permanent life insurance, such as whole life, universal life, and variable life, are the policies that typically provide options for accessing funds during your lifetime. These policies build cash value over time, offering potential for loans, withdrawals, and other living benefits.

Cash Value: Your Personal Emergency Fund?

The cash value component of permanent life insurance is arguably the most well-known living benefit. This value grows on a tax-deferred basis over the life of the policy. How can you access it?

• Policy Loans: You can borrow against your policy’s cash value. The insurance company uses the cash value as collateral, and you’ll need to repay the loan with interest. A significant advantage is that you typically don’t need to undergo a credit check, and the loan terms are often flexible. However, unpaid loans and accrued interest reduce the death benefit paid to your beneficiaries. Moreover, if the policy lapses due to unpaid loans and interest, the outstanding loan amount may be considered taxable income.
• Withdrawals: You can withdraw funds directly from your cash value. However, withdrawals exceeding the policy’s cost basis (the total premiums you’ve paid) are generally taxable as ordinary income. Also, withdrawals will reduce both the cash value and the death benefit.

Accelerated Death Benefit Riders: Accessing Funds in Times of Need

Accelerated death benefit riders are provisions attached to a life insurance policy that allow you to access a portion of the death benefit while alive if you meet certain qualifying conditions. These conditions typically include:

• Terminal Illness: If diagnosed with a terminal illness with a limited life expectancy (usually 12-24 months), you can access a portion of the death benefit to cover medical expenses, palliative care, or other end-of-life costs.
• Critical Illness: Some riders cover conditions like heart attack, stroke, cancer, or organ transplant, providing funds to help manage the associated expenses.
• Chronic Illness: This allows access to funds if you’re unable to perform certain activities of daily living (ADLs) like bathing, dressing, or eating, or if you require substantial supervision due to cognitive impairment.
• Long-Term Care: Similar to chronic illness riders, these provide benefits to help cover the costs of long-term care services, whether at home, in assisted living, or in a nursing home.

These riders can be invaluable in alleviating financial stress during challenging times. It’s important to carefully review the specific terms and conditions of the rider to understand the qualifying events and the amount of the death benefit you can access. Note that accessing funds through an accelerated death benefit rider will reduce the death benefit ultimately paid to your beneficiaries.

Life Settlements: Selling Your Policy for Cash

A life settlement involves selling your life insurance policy to a third-party for a lump sum of cash. The buyer then becomes the beneficiary and assumes responsibility for paying the premiums. Life settlements are typically an option for older adults (generally 65 or older) with a life insurance policy they no longer need or can afford.

The amount you receive from a life settlement is generally more than the policy’s cash surrender value but less than the death benefit. Several factors influence the settlement offer, including your age, health, the policy’s death benefit, and premium costs. This can be a viable option if you need immediate access to a significant sum of money and don’t have other options.

Viatical Settlements: A Specific Type of Life Settlement

Viatical settlements are similar to life settlements but specifically involve individuals with a terminal illness. They provide a way to access funds to cover medical expenses, improve quality of life, or provide for loved ones during a difficult time. The process and factors influencing the settlement amount are similar to life settlements.

Cautions and Considerations

While accessing life insurance benefits during your lifetime can be advantageous, it’s crucial to proceed with caution and consider the potential downsides:

• Reduced Death Benefit: Any loans, withdrawals, or accelerated death benefit payments will reduce the death benefit paid to your beneficiaries.
• Tax Implications: Withdrawals exceeding the policy’s cost basis and unpaid policy loans can be taxable.
• Policy Lapse: Unpaid policy loans can lead to policy lapse, resulting in the loss of coverage and potential tax liabilities.
• Fees and Charges: Some policies may have fees associated with withdrawals or loans.
• Impact on Financial Goals: Accessing funds from your life insurance policy may impact your long-term financial goals, such as retirement planning.

It’s always advisable to consult with a qualified financial advisor and tax professional before making any decisions about accessing your life insurance benefits.

Frequently Asked Questions (FAQs)

1. What is the difference between cash value and death benefit?

Cash value is the accumulated savings component within a permanent life insurance policy that grows over time on a tax-deferred basis. The death benefit is the lump sum of money paid to your beneficiaries upon your death. You can access the cash value while alive through loans or withdrawals, while the death benefit is paid only after your passing.

2. Can I borrow against my term life insurance policy?

Generally, no. Term life insurance policies typically do not have a cash value component and therefore do not offer the option of borrowing against them. Only permanent life insurance policies accumulate cash value.

3. How do I find out if my policy has an accelerated death benefit rider?

Review your policy documents carefully. The terms and conditions of any riders attached to your policy will be detailed in the rider agreement. You can also contact your insurance agent or the insurance company directly to inquire about any riders attached to your policy.

4. Are life settlement proceeds taxable?

Life settlement proceeds are generally taxed in three parts: The amount up to the policy’s cost basis (total premiums paid) is typically tax-free. The amount exceeding the cost basis but less than the policy’s cash value is taxed as ordinary income. Any amount exceeding the cash value is taxed as capital gains.

5. How does borrowing from my life insurance policy affect my credit score?

Borrowing from your life insurance policy typically does not affect your credit score. The loan is secured by your policy’s cash value, so there’s no credit check involved, and your borrowing activity isn’t reported to credit bureaus. However, allowing the policy to lapse due to unpaid loans could indirectly affect your credit if you’re unable to pay off associated debts.

6. What are the alternatives to using life insurance for living expenses?

Consider options like: tapping into emergency savings, exploring personal loans or lines of credit, selling assets you no longer need, or seeking assistance from government or charitable programs. Consulting with a financial advisor can help you explore the best options based on your individual circumstances.

7. Can I reinstate a lapsed life insurance policy after taking a withdrawal?

It depends on the policy terms and the reason for the lapse. Most policies have a reinstatement period (typically a few years) during which you can reinstate the policy by repaying any outstanding loans, unpaid premiums, and potentially proving insurability. However, reinstatement is not always guaranteed.

8. Does the insurance company need to approve how I use the funds from an accelerated death benefit?

Generally, no. The insurance company typically does not dictate how you use the funds from an accelerated death benefit. You have the freedom to use the money for medical expenses, long-term care, living expenses, or any other purpose you deem necessary.

9. Are viatical settlements available for all terminal illnesses?

While viatical settlements are designed for individuals with terminal illnesses, the specific illnesses covered and the eligibility criteria can vary depending on the viatical settlement company. It’s essential to discuss your situation with a reputable provider to determine if you qualify.

10. How can I ensure my beneficiaries are protected if I take a policy loan?

Communicate your plans with your beneficiaries so they understand the reduced death benefit. Consider purchasing additional life insurance to offset the reduction caused by the loan. Most importantly, prioritize repaying the loan as quickly as possible to restore the full death benefit.

11. What are the risks of surrendering my life insurance policy for cash?

Surrendering your life insurance policy means terminating the coverage and receiving the policy’s cash surrender value. Risks include: losing the death benefit protection, potentially incurring surrender charges, and the possibility of taxes on the amount exceeding your cost basis.

12. Should I consult a professional before accessing my life insurance benefits?

Absolutely. Consulting with a financial advisor and a tax professional is highly recommended before making any decisions about accessing your life insurance benefits. They can help you understand the potential financial and tax implications, evaluate your options, and develop a plan that aligns with your overall financial goals. They can assess your individual situation, explain the complexities of policy loans, withdrawals, accelerated death benefits, and life settlements, and ensure you make informed decisions that are in your best interest.