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Godsends for clients: 3 life insurance policy living benefits

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Throughout the years, the vast majority of life insurance policies have been purchased for their death benefit coverage. But today, more carriers are offering the ability for insureds to access a portion of the face amount — in some cases, up to 90 percent or more — while still alive, provided that they meet certain qualifications. This can be accomplished through living benefits.

Living benefits are also referred to as accelerated death benefits. Having these benefits will essentially “accelerate” a portion of the death benefit on the policy so that the funds can be used prior to the insured’s passing. These benefits can be added as a rider to a life insurance policy at the time that it is purchased, or alternatively, it can be added at a later time.  

Accessing living benefit funds

Living benefit funds can be received either as one single lump sum, or they can be taken by the insured in regular installments. While the insured must qualify based on a health or medical condition to receive the cash, the money doesn’t have to be spent on medical bills.

So, if the individual wants to pay off their insurance deductible or the cost of their medical procedures, they can do so. But if they would rather use the funds to take a vacation, they can do that, too.  

The amount of the cash that is accessed will be applied against the policy’s death benefit. It is thus important to consider how much survivors will need at the insured’s death and whether decreasing the amount of the death benefit will create a potential hardship for beneficiaries.

The money received by the insured is typically not subject to federal income tax, provided that the distribution meets certain criteria. This criteria includes the insured being classified as terminally ill when filing an income tax return.

Also, living benefits from life insurance policies aren’t subject to state income tax in most U.S. states. (There may still be some instances where taxes are due, though, so it is always best to check with a tax advisor in this situation).

Policy holders need to keep in mind that even though the death benefit will be reduced when they receive living benefit funds, they will still be responsible for paying the policy’s premium, as this will keep the remainder of the policy in force.

Types of living benefits available

Several types of living benefits are available, each typically requiring different qualification criteria from the insured to pay out. Such benefits can include:

  • Critical illness: The critical illness benefit will pay a lump sum benefit if the insured is diagnosed with a critical condition such as a stroke, heart attack, or cancer. Other conditions may also qualify, such as kidney failure, Lou Gehrig’s disease (ALS), or blindness due to diabetes.

  • Chronic illness: The chronic illness benefit pays out a monthly benefit if the insured is diagnosed as being chronically ill and they are unable to perform two activities of daily living. These activities may include bathing, eating, dressing, transferring, continence, or toileting. Typically, the policy must be in force for a certain length of time before this benefit will pay out.

  • Terminal illness: The terminal illness benefit will pay the insured a percentage of the death benefit if he or she is diagnosed with a terminal illness that results in the individual having a life expectancy of 12 months or less (in some states this is 24 months or less). Funds may be used in any way that the insured sees fit.

Advantages and considerations

There are a number of reasons why offering life insurance policies with living benefits could be attractive to consumers. First, many Americans today live with little savings. Even those who do have a sizeable nest egg will likely have those dollars earmarked for things other than paying for critical illness or long-term care.

Next is the issue of long-term care itself. Today’s long-term care insurance policies have become extremely costly. The few carriers left in that marketplace have seen some fairly substantial rate increases over the past couple of years.

So, even though living benefits shouldn’t be considered a replacement for long-term care insurance, they can provide a good source of cash for someone who doesn’t have this coverage, which can in turn help to protect their other financial resources.

For those who are able to access living benefits for a critical illness situation, these funds can be a godsend. Bankruptcies resulting from unpaid medical bills can affect millions of people every year — even those who have health insurance or Medicare.

Policies that carry 4- or 5-figure annual out-of-pocket deductibles can easily be reached when someone is struck with an unexpected ailment like a stroke, heart attack, or cancer. So the funds from a life insurance policy could be a good solution.

That being said, it is also important to ensure that removing a certain percentage of the death benefit will not create a financial burden on survivors after the insured passes away. For example, it is important to be sure that the original intent for the life insurance is still being covered.