Life insurance with living benefits offers access to a portion of the death benefit while you are still alive provided you meet the criteria defined in the policy. The purpose of living benefits on life insurance is to provide money for you and your family during a significant health-related situation. The three distinct living benefits addressed below cover terminal illness, critical illness, and chronic illness.
What Types of Life Insurance Have Living Benefits?
Living benefits are not exclusive to any specific type of life insurance. You can find them on all three major life insurance types. This means you can find living benefits on term life insurance, whole life insurance, and universal life insurance.
The availability of living benefits on a specific type of life insurance can vary from company to company. This means a company may have living benefits available on one type of life insurance but not all types of life insurance it issues.
The exact living benefits can also vary from product type within companies. So while some companies may issue whole life policies with robust living benefits, it might also issue term life insurance with less generous living benefits.
How They Work
Living benefits are effectively a rider added to the insurance policy. In general, these riders have no upfront costs. This means that you do not pay an additional premium to have them available. Instead, you normally pay an administrative fee when activating these benefits–usually a few hundred dollars to activate the feature.
Activating the benefit requires that the insured have a specific health situation that qualifies him/her for the living benefit. These conditions usually breakdown into three main categories:
- Terminal Illness – meaning life expectancy falls within a relatively short number of months, e.g. 12 months or less
- Chronic Illness – usually defined as a permanent loss of the ability to perform a specific number of Activities of Daily Living (ADL) or mental incapacitation
- Critical Illness/Injury – Usually a list of various illnesses or injuries (less often injuries) that have serious health and often financial ramifications (e.g. heart attack, metastasized cancer, and stroke).
If the insured meets the criteria set forth in the life insurance contract to trigger a living benefit, he/she files a claim with the insurance company to receive an advancement of his/her death benefit while still alive.
The insurer will typically require certification from a licensed medical professional that the insured does, in fact, meet the medical circumstances that qualify as terminal, chronic, or critical illness.
Difference Between Living Benefits and Cash Value Benefits
While some people certainly consider the cash value accumulation feature of whole life or universal life insurance a “living benefit” this feature isn't what most insurance companies and marketers are referring to when they use the term.
It is certainly the case that one can use the cash value in a whole life or universal life policy, and this is certainly happening while the insured/policy owner is alive. But the industry tends to look at cash value as a separate feature and reserves the living benefits term to the advancement of a portion of the death benefit when the insured qualifies under certain conditions.
The Tax Consequences
Triggering the living benefit on a life insurance policy causes the life insurance company to advance some of the death benefit to the policy owner. While the taxability of a life insurance death benefit is well-established law, the rules governing advanced death benefits to living insureds are far less straightforward.
In fact, there really isn't a clear law specifically saying what happens when someone uses a life insurance living benefit. Additionally, the IRS has yet to offer any opinion on how these advancements are or are not taxed.
Life insurers went through great lengths to add various technical aspects to living benefits to meet what they interpreted as the spirit of the law that keeps the payment of living benefits tax-free. Presently, the prevailing assumption is living benefits payments are tax-free to the policy owner/insured.
The Pros and Cons
While the upside of having a life insurance policy with living benefits seem great, there are a few potential pitfalls you should understand.
First one the pro side, living benefits offer much-needed capital when someone faces serious health problems that often lead to financial ruin. This capital can make the difference in keeping one's finances intact during the ordeal.
Living benefits can also open doors for experimental procedures that health insurance normally will not cover.
Living benefits can help meet the costs associated with long term care needs, also potentially keeping someone in his/her home longer.
Lastly, life insurance living benefits could help achieve someone's ultimate life goal by providing the funds necessary to embark on the task when facing a terminal illness.
But there are some warnings about living benefits you should understand.
First, not all living benefits work the same way. You should take time to understand exactly what sort of coverage you have and what you don't have. This can at times be tricky, as specific information is sometimes vague.
The living benefits you want may not be available at a specific life insurance company with which you'd like to do business. A less expensive policy might not have the living benefits you seek. Or a company from which you already own a policy may not offer a new policy with living benefits.
Lastly, you should carefully consider what the effect using the living benefit will have on the death benefit you will leave to your beneficiary(ies). Advancing a portion of the death benefit to the insured means there is less death benefit left over for his/her loved ones after death. Many living benefits function as leans against the policy's death benefit.
There is an interest factor that will further reduce the remaining death benefit payable to beneficiaries–this is one of the ways insurers seek to keep the payment of living benefits tax-free. You should carefully understand how accessing the living benefit affects your policy both immediately and in the future.