Life Insurance Living Benefits: Use Your Policy While Still Alive

This article, Life Insurance Living Benefits: Use Your Policy While Still Alive, provides an overview of the various living benefits associated with modern life insurance policies.

Most of the life insurance policies purchased in the marketplace are intended for financial protection in the form of the policy’s death benefit. These policies provide income protection for growing families, mortgage protection for homeowners, continued charitable donations from benefactors, ensure business continuation for small businesses, and provide financial security in several other facets. The emphasis on a policy’s death benefit is traditionally considered how life insurance works.

In fact, life insurance is the only financial vehicle that pays a predetermined tax-free amount at an individual’s death, regardless of the total premiums previously contributed.

However, not all benefits associated with life insurance policies are tied to a death benefit. Many policies offer a variety of living benefits that can be utilized during a primary insured’s lifetime. Life insurance living benefits may include a range of policy features from accelerated benefits to a policy’s cash value and other valuable options.

There are a number of life insurance policies offering living benefits available in today’s marketplace. The policy features and options discussed provide information related to common living benefits and the financial options they provide. Living benefits highlighted include accelerated benefits, cash value accumulation, policy dividends, policy loans and withdrawals, nonforfeiture values, collateral assignment, policy exchanges, and viatical and life settlements.

Accelerated benefits associated with life insurance policies have become increasingly popular in recent years. Essentially, accelerated benefits are any policy feature that allows access to a portion of the death benefit prior to the primary insured’s passing.

Not all life insurance policies offer accelerated benefits, so care should be taken to research the options available with specific policies. Popular life insurance accelerated benefits include chronic illness, critical illness, and terminal illness benefit features.

A life insurance policy’s cash accumulation value is likely the most well-known of living benefits, traditionally associated with permanent or cash value life insurance. Cash value life insurance policies may include whole life, universal life, indexed universal life, variable life, variable universal life, and others.

These types of policies accumulate cash value as premiums are paid, and interest is credited, while expenses such as the cost of insurance and administrative charges are periodically deducted. Additionally, based on current tax guidelines, life insurance cash values accumulate on a tax-deferred basis. This status allows a policy owner’s cash accumulation value to potentially grow faster than fully taxable financial products.

Given time to accumulate, a life insurance policy’s cash accumulation value can grow into a substantial asset for the policy owner. Subject to surrender charges and other policy restrictions, life insurance policy cash accumulation values can be accessed or utilized in several ways.

Cash value options for policy owners include: 

Policy dividends are payments made to owners of participating life insurance policies that serve as a potentially reoccurring living benefit. Traditionally associated with whole life policies issued by mutual insurance companies, policy dividends are the result of favorable financial outcomes on the part of the insurer. In such instances, the insurance company may elect to pay dividends to policy owners.

Policy dividends are traditionally determined and paid annually but are not guaranteed. In most instances, policy dividends are not taxable since they are considered a return of premiums paid. However, dividends can be taxable when payments exceed total premiums paid. Also, when dividends are left to accumulate interest, the interest earned is considered taxable income.

Policy dividend options available include:

As previously discussed related to cash accumulation value, policy loans, and withdrawals are available to policy owners with sufficient cash value.

According to the International Risk Management Institute, “all states have enacted nonforfeiture laws that require that whole life insurance policies specify the nonforfeiture values in a schedule in the policy.”

Collateral assignment of a life insurance policy involves temporarily assigning rights associated with a policy to a third party for the purpose of securing a loan. Depending upon the type of loan request, a lender may consider the life insurance policy’s cash value adequate security.

A collateral assignment does NOT require naming the proposed creditor as beneficiary of the policy. 

In the event of an untimely death the outstanding debt to the creditor would be repaid, and the remaining policy proceeds would be paid to the named beneficiaries. Also, once the debt has been paid in full, the collateral assignment would be removed, returning all policy rights to the policy owner.

It is recommended that policy owners considering a collateral assignment consult a qualified insurance and/or legal professional to ensure that they understand assigned rights under the proposed agreement.

A 1035 exchange refers to exchanging one life insurance policy for another similar contract. This living benefit gets its name from the Internal Revenue Code (IRC) Section 1035, which addresses the taxation of such exchanges. Essentially, the Internal Revenue Code states that, within specific guidelines, certain insurance products can be exchanged for other similar insurance products with no taxable gain or loss being realized.

Qualifying 1035 exchanges allowed for life insurance policies include exchanging a life insurance policy for another life insurance policy, an annuity contract, a qualified long-term care policy, or an endowment contract.

As a side note, annuity contracts may only be exchanged for another annuity or for a long-term care policy, NOT a life insurance policy. 

These tax-free exchanges allow policy owners to realign policies as their coverage needs change.

Viatical and life settlements refer to selling an in-force life insurance policy to a third party on the secondary market. These arrangements allow policy owners to sell policies at a time when they need immediate cash and serve as an investment for the companies purchasing the policies.

The difference between the two types of settlements is that a viatical settlement involves the sale of a policy insuring the life of someone who is terminally or chronically ill, whereas a life settlement involves the sale of a policy insuring an older individual who is not necessarily in poor health.

It is recommended that policy owners considering a viatical or life settlement consult a qualified insurance and/or legal professional to ensure that they understand the proposed transaction.

As discussed, living benefits provide opportunities for policy owners and/or insured individuals to benefit financially from a policy during their lifetime. Essentially, using their life insurance while still alive. Life insurance policy living benefits can prove extremely valuable features of a policy originally intended for death benefit protection. The following case studies provide examples of living benefits in action.

Disclaimer: Information in this article is intended to be educational in nature and should not be considered tax and/or legal advice. It is recommended that individuals considering the use of life insurance living benefits contact a qualified tax and/or legal professional related to their specific situation.