How Living Benefits Riders Let You Use Your Life Insurance Death Benefit Early

This is the fourth in a series of columns discussing life insurance, to help federal employees and retirees understand their need for life insurance and the choices they have among the different types of life insurance policies available to meet their needs. This column discusses life insurance accelerated living benefits, or simply “living benefits.”

A life insurance policy is designed primarily to give a life insurance policyowner’s beneficiary financial support after the policyowner dies. But today’s life insurance policies offered by insurance companies offer a way — called accelerated living benefits, or “living benefits” — for the policyowner to tap into the death benefit before the policyowner dies. This may happen when the policyowner has a chronic or terminal medical condition. Living benefits can provide needed financial support to the policyowner during financially challenging times. However, it is important for policyowners to understand how living benefits work, when the policyowner can use them, and how living benefits affect the death benefit payout.

Living benefits were originally limited to accelerated death benefits for life insurance policyowners with a terminal illness and less than 12 months to live. Living benefits have since expanded to policyowners with certain medical conditions or long-term care needs that allow these policyowners to access their death benefits early. Note that when living benefits in a life insurance policy are accessed, the money the insured accesses will reduce the policy’s death benefit to beneficiaries.

Types of Living Benefits Riders

There are four types of living benefits riders offered by some life insurance companies. The definitions, amount available, and cost for choosing any of these riders vary by life insurance company and are presented below:

• Terminal Illness Rider: A terminal illness rider is the original type of living benefit. It lets the insured (and policyowner) access a portion of their death benefit if a physician certifies that the insured has a terminal illness with a limited life expectancy, typically 12 to 24 months. Most life insurance companies offer this rider. The insured may be able to access 50 to 100 percent of the death benefit, depending on the life insurance company. The insured may use the living benefits for any purpose, with no tax consequences.
• Chronic Illness Riders: With a chronic illness rider, the insured can access a portion of their policy’s death benefit if a licensed healthcare practitioner certifies that the insured is chronically ill. Chronically ill is defined as: (1) being unable to perform two out of six activities of daily living — bathing, dressing, eating, toileting, continence, or transferring; or (2) requiring substantial supervision due to severe cognitive impairment. Some insurance companies require the chronically ill condition to be permanent, while other companies require the insured to need assistance for at least 90 days. The insured may be able to access 50 to 100 percent of their death benefit; the amount varies by life insurance company. The insured can receive this money in a lump-sum payment or through a monthly amount, depending on the insurance company.
• Long-Term Care (LTC) Rider: Some insurance companies offer long-term care riders that cover the cost of care in a nursing home, assisted living facility, or the insured’s home. LTC riders usually have an extra cost. They are triggered if the insured is unable to complete two out of six activities of daily living or is suffering from a severe cognitive impairment that requires substantial supervision.
• Critical Illness Rider: A critical illness rider allows the insured to access a portion of their life insurance death benefit early if they are diagnosed with certain medical conditions. The most common medical conditions are heart attack, stroke, and cancer. Some insurance companies expand the critical illness category to ALS (Lou Gehrig’s disease), end-stage renal disease, major organ transplant, heart-valve replacement, cystic fibrosis, blindness (in some states), and other qualifying diseases. This rider typically pays out a smaller amount than the other living benefits; the typical payout is no more than 25 percent of the death benefit.

How Accelerated Death Benefit Riders Work

Accelerated death benefit riders are either automatically included in the insurance company’s life insurance policy, or the insured may be given the option to add the rider(s) when purchasing the policy.

The following are steps a life insurance policyowner should take to add a living benefits rider to their policy and to activate the rider once the insured has an eligible medical condition:

1. Upon buying the life insurance policy, if the insured finds that a particular rider has not been added to the policy, the insured should add the living benefits rider to the policy. Note that some riders are included automatically, while others can be added later.
2. Upon receiving an official diagnosis of an eligible critical illness, terminal illness, or chronic condition that requires assistance with two activities of daily living or a cognitive impairment, the insured should find out how much they are eligible to receive and how that will affect the insured’s death benefit. The amount depends on which living benefits rider the insured has.
3. The insured should submit a claim to the insurance company with the required documentation.
4. If approved by the insurance company, the insured will receive the living benefits payout, which will reduce the death benefit.

It is important that before an insured elects any living benefit rider, they find out how taking the resulting payout will affect their death benefit. In fact, all 50 states and the District of Columbia require the insurance company to provide a claim disclosure form that shows the death benefit value in the policy before and after a living benefits claim.

In some situations, it may be more beneficial for the insured to withdraw or borrow from the cash value of a permanent (cash value) life insurance policy. It is recommended that policyowners request an in-force life insurance illustration showing what would happen to the policy’s death benefit and cash value if the insured took a policy loan compared to using the living benefit.

Paying for Living Benefits Riders

Usually, the insured does not pay extra premiums for the most common accelerated benefit riders. However, the insured does pay for accelerated death benefit riders by accessing the death benefit early. In particular, the death benefit is reduced dollar-for-dollar based on the amount used, plus one or more of the following charges: (1) an additional death benefit reduction based on the insured’s life expectancy; (2) administrative and processing fees, typically ranging from $100 to $300; and (3) interest charges based on the insured’s life expectancy and prevailing interest rates.

The cost for a rider is often incurred upon its use. However, the insured may have to pay upfront for some riders. For example, a long-term care rider can be added when the insurance policy is purchased; in that case, the insured will pay an extra premium at the time of purchase.

Advantages and Disadvantages of Life Insurance Living Benefits

While life insurance living benefits can provide money that helps the insured during a serious medical condition, accessing them reduces the death benefit for beneficiaries. The following are some advantages and disadvantages of life insurance living benefits that the insured should consider before deciding to access the death benefit from their life insurance policy.

Advantages

1. More money than policy loans or withdrawals. The insured is able to access more money through living benefits compared to accessing the insurance policy’s cash value.
2. No upfront fees. The insured usually does not have to pay extra upfront fees — except for a long-term care rider — to include living benefits on their policy; the insured pays for the benefit only upon use.
3. A source for paying some LTC expenses. An LTC living benefits rider can provide an extra source of money to help pay for long-term care.
4. Tax benefits. In most cases, the payout from accelerated living benefits is income-tax-free. Note that special Internal Revenue Service (IRS) rules may apply to chronic care living benefits riders if the insured receives more than a certain daily payout amount.

Disadvantages

1. Decreased death benefit. A living benefits payout is subtracted from the death benefit, so the insured’s beneficiaries will receive less money at the insured’s death.
2. No payback. Unlike borrowing against a life insurance policy’s cash value, the insured cannot put the money from a living benefits rider back and restore the full death benefit.
3. Complicated fee calculations. The insured does not pay a fee for riders unless they use them. However, life insurance companies use complicated actuarial calculations to determine the charge when the insured accesses the money, often based on how long the insured has owned the policy and the insured’s life expectancy.

For more information on life insurance living benefits, federal employees and retirees are advised to consult with a licensed and knowledgeable insurance professional.