How to use life insurance while alive?
Quick Answer / Executive Summary
You can access value from a life insurance policy while alive in two main ways: borrowing against or withdrawing from a permanent policy's accumulated cash value, or using an accelerated death benefit rider (increasingly common on both term and permanent policies) that pays out a portion of the death benefit early if you're diagnosed with a qualifying terminal or chronic illness. Term life insurance without such a rider generally offers no way to access money while you're alive.
Key Takeaways at a Glance
- Permanent life insurance (whole or universal) builds cash value you can borrow against or withdraw from while alive, though unpaid loans reduce the eventual death benefit.
- Many modern policies, term and permanent alike, include an accelerated death benefit rider that pays out a portion (commonly 25-50% is a common range, though it varies by insurer and diagnosis) of the death benefit early for a qualifying terminal or chronic illness diagnosis.
- A policy loan against cash value is generally not taxed as income as long as the policy remains in force, but an unpaid loan balance is subtracted from the death benefit paid to beneficiaries.
- A viatical settlement — selling your policy to a third party for a lump sum below the full death benefit — is another, less common way to access value while alive, typically used by people with a shorter life expectancy.
Borrowing Against or Withdrawing Cash Value
A permanent life insurance policy's cash value can generally be borrowed against (with interest charged by the insurer) or partially withdrawn. A policy loan doesn't require credit approval since the cash value itself secures it, but any unpaid loan balance, plus accrued interest, reduces the death benefit your beneficiaries eventually receive — and if the loan balance ever exceeds the cash value, the policy can lapse.
Accelerated Death Benefit Riders
Many insurers now include, or offer as an add-on, an accelerated death benefit (sometimes called a living benefit) rider that allows you to receive a portion of your death benefit early if you're diagnosed with a qualifying terminal illness, and increasingly for chronic or critical illness diagnoses as well. The exact qualifying conditions and payout percentage vary significantly by insurer and by the specific rider, so reviewing your policy's actual rider language matters more than a general assumption about what's covered.
Viatical Settlements: A Less Common Option
A viatical settlement involves selling your life insurance policy to a third-party company for a lump-sum cash payment that's less than the full death benefit but more than the policy's cash surrender value, typically used by policyholders with a shortened life expectancy who need funds immediately. This is a more specialized transaction with its own regulatory framework and tax considerations, worth discussing with a financial advisor before pursuing.
Real-Life Case Incident & Precedent
Precedent: Accelerated death benefit payments for a qualifying terminal illness are generally excluded from federal taxable income under Internal Revenue Code Section 101(g), a specific statutory exception that treats these payments similarly to a standard death benefit for tax purposes, though state tax treatment and the exact qualifying conditions can vary by policy and situation.
Case Study: Using an Accelerated Death Benefit After a Terminal Diagnosis
Scenario: A policyholder with a term life policy that included an accelerated death benefit rider received a terminal illness diagnosis and needed funds for medical care and to make arrangements for his family.
Resolution & Judicial Outcome: He accessed 50% of his policy's death benefit early through the accelerated death benefit rider, receiving it as a lump sum to cover medical expenses; the remaining 50% death benefit will be paid to his named beneficiaries upon his death, reduced accordingly by the amount already accelerated.
Related Case Study Simulation:
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What You Should Do: Step-by-Step Action Plan
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Step 1: Check whether your policy already includes an accelerated death benefit rider, and if not, ask your insurer whether one can be added.
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Step 2: If considering a policy loan, ask your insurer for the current interest rate and how an outstanding balance would affect your death benefit.
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Step 3: Before pursuing a viatical settlement, get valuations from multiple providers and consult a financial advisor, since offers can vary significantly.
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Step 4: Confirm the tax treatment of any living-benefit payout with a tax professional, since specifics can depend on the type of illness and payout structure.
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Step 5: Keep beneficiaries informed if you access living benefits, since it will reduce the eventual death benefit they receive.
Critical Mistakes to Avoid
- Assuming term life insurance always offers no living benefits — many modern term policies now include an accelerated death benefit rider.
- Taking a large policy loan without understanding how it reduces your eventual death benefit if unpaid.
- Accepting the first viatical settlement offer without comparing quotes from multiple providers.
- Not informing beneficiaries about a living-benefit payout, leading to confusion later about a reduced death benefit.