Life Insurance: Can You Access Benefits Before Death?

Life insurance is commonly thought of as a means of financial protection for loved ones after the policyholder's death. However, certain life insurance policies, particularly permanent life insurance, offer benefits that can be utilised while the policyholder is still alive. Permanent life insurance policies, including whole life and universal life insurance, often accumulate a cash value that can be accessed during the policyholder's lifetime. This cash value can be used for various purposes, such as paying premiums, taking out loans, or covering long-term care expenses. While accessing this cash value can provide short-term financial benefits, it is important to consider the potential reduction in the death benefit for beneficiaries and the possibility of fees and taxes associated with early withdrawals.

Accessing the cash value of a permanent life insurance policy

Permanent life insurance policies often contain a cash value component that can be accessed during the policyholder's life. Permanent life insurance consists of two types: whole life and universal life. Whole life insurance policies provide a death benefit and cash value for individuals. The death benefit is received by beneficiaries after the policyholder's death, and the cash value can be accessed in several ways throughout the policy's duration.

• Use the cash to pay premiums: Once you have accumulated enough cash value, you can use it to cover your monthly insurance payments. This process, known as "paying up", is allowed by many insurance companies. By doing this, you could save thousands of dollars in premiums each year without affecting your death benefit.
• Borrow against the cash: You can borrow cash from your whole life insurance policy through a policy loan, often at a lower interest rate than what banks offer. Technically, you are not required to pay back this loan, but any money you owe, including interest, will be deducted from your policy's death benefit.
• Increase the death benefit: You can use your accumulated cash value as leverage with your insurance company to request a larger benefit. This option is suitable for those who want to ensure their family's financial security.
• Withdraw the cash: Most whole life insurance policies allow for partial or full cash value withdrawals. However, withdrawals will directly affect the amount of your death benefit, and there may be tax implications if you withdraw more than you've paid into the policy.
• Surrender your policy: If you surrender your whole life policy, you will receive the cash value, but you will lose all benefits, including the death benefit. You will also incur surrender fees and have to pay income taxes on the cash value received.

It's important to carefully consider your options before accessing the cash value of your permanent life insurance policy, as it will impact the amount available to you, your death benefit, and your account's growth. Additionally, not all policies allow for early access, so it's essential to review the terms of your plan. Consulting a financial advisor can help you understand the potential consequences of accessing your cash value.

Using life insurance to pay for long-term care

Life insurance can be used to pay for long-term care in several ways. Here are some options to consider:

Combination (Life/Long-Term Care) Products:

Some insurance companies now offer combination products that merge life insurance with long-term care insurance. This ensures that policy benefits will be paid out in one form or another. The amount of the long-term care benefit is often expressed as a percentage of the life insurance benefit. These products are still evolving, so the features may change over time.

Accelerated Death Benefits (ADBs):

Some life insurance policies include a feature called Accelerated Death Benefits (ADBs), which allows policyholders to receive a tax-free advance on their life insurance death benefit while they are still alive. ADBs may be included in the policy at little or no extra cost, or you may need to pay an additional premium. There are different types of ADBs, and depending on your policy, you may be able to receive a cash advance if you are terminally ill, have a life-threatening diagnosis, need long-term care services, or are permanently confined to a nursing home and unable to perform basic activities of daily living (ADLs). The amount you receive will vary, but typically, the accelerated benefit payment is capped at 50% of the death benefit. It's important to consider that using ADBs may affect your eligibility for Medicaid and could leave little or no death benefit for your survivors.

Viatical Settlements:

Viatical settlements allow you to sell your life insurance policy to a third party and use the money to pay for long-term care. This option is only available if you are terminally ill, and the money received is usually tax-free. However, there are some important considerations, such as the requirement to meet specific health criteria, the possibility of not having a death benefit for your heirs, and the approval rate of less than 50% for applicants.

Sell a Policy for a Life Settlement:

With a life settlement, you can sell your life insurance policy to a third party for its market value and use the proceeds to fund long-term care. Any type of life insurance can be used, but most companies require a minimum death benefit of $50,000. The shorter your life expectancy, the larger the percentage of the death benefit you are likely to receive. It is important to note that selling your policy will likely result in little or no death benefit for your heirs, and the proceeds may be taxed.

Set up a Living Benefit Program:

A living benefit program provides a lump-sum payment to those who meet specific medical criteria. It allows you to receive up to 50% of your life insurance policy's death benefit while still reserving some benefits for your family. To qualify, you typically need a life insurance policy with a death benefit of at least $100,000, and it is important to remember that a living benefit is essentially a loan against the policy, which must be repaid to avoid deductions from the death benefit.

Surrender the Life Insurance Policy for Cash Value:

When you surrender a life insurance policy, you give up ownership and the death benefit. If the policy has accumulated cash, the insurance company will pay you the full amount of the cash value, which may be taxable, depending on whether the cash value exceeds the cumulative premium amount paid. Surrendering a policy early may result in penalties, and if you plan to use Medicaid, the cash portion of your policy may count against you for eligibility.

Take a Loan from Cash Accumulation:

You can take out a loan against the cash value of your life insurance policy. This option allows you to access most of the cash value, which you then pay back with interest. However, if your healthcare needs exceed the amount in the policy, you may need to surrender the policy to access all the funds. Taking a loan against the policy will reduce the death benefit for your beneficiaries.

Use Cash Value to Fund a New Long-Term Care Policy:

If you have time to plan, you can use a 1035 exchange to transfer the cash value of an existing insurance policy to a new policy without incurring tax exposure. This allows you to use the cash value to fund premiums on a hybrid policy, which includes life insurance, long-term care benefits, and living benefits for costs related to serious illnesses.

It is important to remember that using life insurance to pay for long-term care can be complicated, and it is always best to consult a financial expert before making any changes to your policies. Additionally, each option has its own set of considerations, such as eligibility requirements, tax implications, and the potential impact on death benefits for survivors.

Borrowing from your life insurance policy

If you have a whole life insurance or universal life insurance policy, you can borrow against the cash value of your policy. The cash value of these policies grows over time, and you can borrow against it once it reaches a certain threshold. It is important to note that it may take several years for your policy to accumulate enough value to borrow against. The minimum cash value required for a policy loan varies by insurer, and you can typically borrow up to 90% of the policy's cash value.

Unlike a bank loan or credit card, policy loans do not affect your credit score, and there is no approval process or credit check. The loan is also not recognised by the IRS as income, so it remains tax-free as long as the policy stays active. However, it is expected that a policy loan will be paid back with interest, and there is no mandatory monthly payment. The interest rates on policy loans are typically much lower than on bank loans or credit cards, ranging from 5% to 8%.

When you borrow from your life insurance policy, you are essentially borrowing from yourself. The insurance company lends you the money, and the cash value of your policy is used as collateral. This means that the policy's cash value can continue to accumulate, but it is important to check with your insurance company how interest and any dividends will be determined and paid when you have an active loan.

While borrowing from your life insurance policy can be a convenient option, it is important to consider the potential risks. If you do not pay back the loan, the amount you owe, including interest, will be deducted from the death benefit, reducing the amount your beneficiaries will receive. Additionally, if the loan and interest exceed the policy's cash value, your policy could lapse, and you may owe taxes on the amount borrowed. Therefore, it is important to make regular interest and premium payments to avoid these risks.

Surrendering your life insurance policy

When to Surrender Your Life Insurance Policy

The timing of when to surrender your life insurance policy depends on your personal preference and financial situation. However, it is beneficial to wait until after the surrender period, which can vary from a couple of years to over 15 years, as you may face surrender fees if you cancel during this time. Surrender fees tend to decrease over the life of the policy, so waiting until they are minimal or non-existent will result in a higher payout.

How to Surrender Your Policy

Most insurance companies have a straightforward process for surrendering your policy. Typically, you will need to contact your insurance company or agent, and you may have to sign paperwork to confirm. Once the process is in motion, the insurance company will handle the details of calculating your final payout. This amount is generally your cash value balance minus any surrender fees or outstanding loans on your policy.

Tax Implications

It is important to note that you may have to pay taxes on the amount you receive that is above the cost basis, or the amount you paid in premiums. Consulting with a tax expert is recommended to properly report the payout.

Alternatives to Surrendering Your Policy

If you want to access your cash value while maintaining your coverage, there are a few alternatives to surrendering your policy. These include borrowing against your cash value, withdrawing from your cash value, or using your cash value to pay your premiums.

Using life insurance to pay premiums

Life insurance is a contract between a policyholder and an insurance company that pays out a death benefit when the insured person passes away. There are several kinds of life insurance, including term and permanent plans. Permanent life insurance consists of two types: whole life and universal life.

Whole life insurance policies guarantee that your loved ones will be able to continue meeting their financial needs after your death. The cash value aspect of your policy can also be used as a policy loan, for withdrawal, to increase the death benefit, and more while you are alive.

If you have accumulated enough cash value, some of it can be used to cover your monthly insurance payments. This process, called "paying up", is honoured by a large array of Canadian life insurance companies. By paying up, you could save thousands of dollars in premiums each year. For most policies, this will not affect your death benefit.

Borrowing against the cash value of your whole life insurance policy is done through a policy loan. Technically, you are not obligated to pay back this loan; however, any money you owe, including interest, will be deducted from your policy's death benefit upon your passing.

It's important to note that not all life insurance policies allow you to use your benefits before you die. Term life insurance, for example, does not have a cash element for policyholders to access. If you're planning on using your life insurance as a backup cash resource, you'll want to avoid term policies.

Frequently asked questions