What Are Living Benefits in Life Insurance?
B.A. Risk Management
Life Insurance Agent
A death benefit is what your life insurance policy will pay when you pass away.
But did you know you can tap into some of the "living benefits" of a life insurance policy as well?
What is a living benefit of life insurance?
Simply stated, living benefits allow you to enjoy some of the policy benefits of life insurance while you’re still alive.
For example, with the right kind of policy, the owner can build cash value that accumulates throughout the policy life. You can borrow against this cash value to pay for an unforeseen (i.e., medical emergency) or a planned expense (i.e., college expenses), thus making it a living benefit.
The difference between a living benefit and a living benefits rider
There is a difference between a living benefit for life insurance and living benefits rider. The living benefits rider is an option you can add to some policies that let the owner receive an advanced payment of some of the death benefit in the event they are stricken by a terminal, chronic or critical illness. Sometimes, this is referred to as an accelerated death benefit rider.
For terminal illness, you need a diagnosis that gives you 6 to 24 months or less to live, depending on the provisions of the rider.
You are considered chronically ill if you can’t perform a majority of the six activities of daily living that include eating, bathing, getting dressed, toileting, transferring, and continence.
A critical illness means that you have been diagnosed with cancer, a stroke, ESRD, a heart attack, organ transplant, or a similar and severe life-threatening condition.
The loss of income or added expenses, such as those not covered by your health insurance, could deplete your family’s assets or put you in a financial hole before you pass away. Your heirs would then need to settle your debts with proceeds from your estate.
Living benefit riders typically pay anywhere from 25-100% of policy value. Some policies will put a cap on the dollar amount as well, so it's best to discuss this with an agent when you're shopping for a policy.
The pros and cons of living benefits
Permanent life insurance policies do not subtract from the death benefit in some cases, which is different than an accelerated benefits rider. Depending on the policy, they can be in addition to whatever the death benefit is that is paid when you pass.
Building cash value makes this possible. Tax advantages make living benefits even more attractive.
Guaranteed growth. With a permanent whole life insurance policy, your cash value grows by a guaranteed amount every year, and never declines in value. It provides you with a tax-deferred, conservative, and consistent asset to help you reach your financial goals.
Policy loan collateral. That accumulation and the death benefit can be used for collateral against a policy loan. You can borrow against the equity in your policy for any reason and at any time. You can use the loan to buy a new home, invest in a business, pay for your children’s college, protect against a financial emergency or to create a reliable stream of supplemental income when you retire. You are not required to disclose the reason when you borrow against the policy.
However, if you die and there is still an outstanding loan balance, then that balance will be paid off by the death benefit. Your beneficiaries will receive the remaining amount.
Dividend payments. Mutual insurance companies often pay dividends on policies annually. You can use these dividend payments to pay off a policy loan, to buy additional insurance, or you can choose cash. When you purchase additional insurance, this is known as a paid-up addition that increases both the death benefit and the cash value of your policy.
Retirement flexibility. Living benefits also provide you with flexibility in retirement. If you don’t need the death benefit any longer (perhaps because your kids are grown and on their own), you can use your life insurance cash value to supplement your retirement income without penalties or limitations that might apply to your IRA or 401(k) accounts.
You can receive dividends in cash, take a policy loan, or surrender paid-up policy additions you made in previous years. You can also cancel the policy and have the cash surrender values paid out to you as a lifetime annuity.
Tax benefits. One important thing to note is you could be taxed on the equity you take out of your policy if it is more than the premiums you have paid during the life of the policy. You should check with your tax advisor to make sure you don't make this mistake.
Regarding tax benefits overall, permanent life policies include tax-deferred growth on cash value that accumulates, tax-free access to your cash value, and tax-free income distribution of death benefits.
Paying for college. Another significant benefit, if you have children headed to college, is that life insurance cash value is not considered as an asset when applying for college financial aid. Not only can you use the cash value to pay for tuition and other college-related expenses, but you could also benefit from more financial aid compared to other families who have a similar sized 529 Plan.
Long-term care protection. A living benefit can also provide protection if you suffer from a significant long-term health issue. You can use the cash value to pay for your care if needed. Some states allow hybrid policies to be sold that include a long-term care benefit that is combined with a regular death benefit. Some policies will also let you add a rider to your policy to cover this specific instance.
A waiver of premium. One of the living benefits you may enjoy is if you become totally disabled, a provision in your policy (typically at an extra cost) will pay your premium for you so that your policy does not lapse. Certain limitations may vary by state or by age.