I think most people understand that life insurance has a death benefit that’s payable at your death, but did you know there are also living benefits? You can use life insurance while you are still alive in some cases.
Typically there are two different kinds of life insurance: Term Life Insurance and Whole Life Insurance (aka Indexed Universal Life Insurance)
Term Insurance
Term insurance is where you pay a premium for a certain term and you have a death benefit for a certain term. At the end of your term, the premium stops and the death benefit stops. Common examples of this are a 15-year term or a 20-year term.
Whole Life Insurance
Back in the old days, it was called whole life insurance. Nowadays it’s called indexed universal life insurance.
We use the example of old console TVs. My kids don’t understand how huge these TVs used to be since flat-screen TVs have come out. They kind of do the same thing, but the flat screens are much better. The same thing is true in the last 20 years with life insurance.
The insurance industry has come out with life insurance that can last forever, just like whole life insurance, so no matter when you die the death benefit is payable but it has a lot more features. Some of those features are called living benefits. These are features that you can use while living.
Benefit #1: Terminal Illness Rider
The first benefit is called a terminal illness rider. If you were terminally ill and got a doctor to fill out the form saying so, you can access a large portion of your death benefit while living.
There are several reasons why someone may want to do this. Maybe there are some bucket list items of family travel or something like that that you need this money to be able to afford. That’s the terminal illness rider.
Benefit #2: Critical Illness Rider
Next, let’s talk about the critical illness rider. Let’s say you’ve had a stroke, a heart attack, or some critical illness as defined in the policy. The life insurance company will advance you a certain portion of the death benefit immediately.
I had a friend of mine who had two policies that had this rider on them. He is self-employed and had a stroke.
He was in the hospital for several weeks and did not get back to work for a while. His income had completely stopped because he had stopped working. In his case, the life insurance company advanced him $20,000 within a week.
The way this rider works is the insurance company subtracted $50,000 from the death benefit to advance him $20,000 in cash.
On the surface, that sounds like a terrible deal; why would anybody do that? His income had completely stopped and he was in need of money. He had a $500,000 policy, so lowering the death benefit by $50,000 was not a huge deal for him.
The benefit came in that he needed the $20,000 in cash. He actually had two separate policies so he was able to file two claims and got $20,000 deposited into his account twice. This was a huge benefit in his life.
This is an optional rider so you don’t have to do it if you don’t want to do it. If this happens to you and you have this rider, you figure out if this is helpful or not. It really fixed a need in his life.
Benefit #3: Chronic Illness Rider
The third thing is called a chronic illness rider. This is also known as long-term care provisions.
If you can meet two of the six daily functions, then you qualify for this benefit. These six daily life functions are:
- Bathing
- Dressing
- Eating
- Transferring
- Toileting
- Continence
You have to get a doctor to fill out some paperwork proving that you qualify and the life insurance company will start advancing the death benefit to you so that you can pay for long-term care expenses.
With life insurance, they advance money at the beginning and you have that money for the entire year to spend as you want. At the end of that year, if you still qualify, then they will advance you another year’s worth of money upfront and you can then pay for things as you need them.
This is called Indemnity. This is a better way of doing it rather than Reimbursement. This is a big difference compared to some long-term care policies where you have to front the money and turn in receipts, and then at the end of the year, if you did everything right, you will be reimbursed.
Another great thing about this is that this benefit is included in the life insurance. So all the years that you’re paying for the life insurance and not using this benefit, technically you’re not paying for this benefit.
When you do want to elect to take some money early, there is a discount factor. For instance, you may qualify for them to advance $50,000. The amount of money that you actually get is based on your age at the time that you make the claim.
For instance, they may lower the death benefit by $50,000 and you receive $42,000. You can now spend this money however you want for your long-term care needs.
The reason the $42,000 is less than the $50,000 is that you’re taking the money early. There is a discount factor factored in based on your age because the insurance company is giving you money earlier than they had to. They are missing out on earnings they could have had on that money.
I view this as you finally paying for this benefit. You have not been paying for the long-term care benefit the whole time you’ve had the policy, and now that you need it, this is when, in essence, you are charged for it. The main problem I have with a standard long-term care policy is the fact that you can pay for it year after year and then die never having used it.
Life insurance works in the exact opposite manner. You are not paying for the LTC year after year, and you only pay for it if you choose to go on claim and get money early. If you have other money to pay for long-term care needs, then you don’t have to go on claim and the death benefit will remain intact for your beneficiaries. If you want to spend the life insurance money instead of your other money, you can go on a claim. Just know that they will subtract from the death benefit more than what you are actually getting.
Another great feature if you go on claim is that the payment generally stops. You no longer have to make your monthly premium during the year that you’re on claim.
Now, each and every year you have to prove that you still can’t do two of the six daily functions. Depending on how much your death benefit is and how much you are taking out each year, that will determine how many years you can receive this benefit.
I think this is an important update to how life insurance used to be. These features are vital with proper planning.
Planning for Long-Term Care Needs
One of the scenarios in your plan that can mess up your retirement is if you have a long-term care need and you haven’t planned for it. Using life insurance appropriately cannot only provide the death benefit to help in your planning, but it can also cover some of the long-term care needs that you may have.
In the past, retirement accounts have been a great way to pass money to beneficiaries. The IRS put out a recent opinion on how they will treat retirement accounts in the future and they have lost some of their benefits. IRAs are no longer allowed to be “stretched.” In the past, you could leave an IRA to your children or other Non-Spouse beneficiaries and they could leave the money there for 30 or 40 years, letting it take advantage of the tax benefits of the retirement account.
The IRS says you can no longer do that. When you leave an IRA to a non-spouse beneficiary, they have to remove it from the account by the end of the 10th year after the death, thereby losing the tax advantages of an IRA and a Roth IRA.
That one change has now made life insurance a much more attractive option to leave money to your beneficiaries. The death benefit of life insurance is generally tax-free. If you leave your beneficiary large Traditional IRAs, with the new IRS rules, they are going to be more heavily taxed than in the past.
Why do I say more heavily taxed?
Because you can no longer take out small distributions, they force you to take larger distributions by forcing you to fully get the money out of the IRAs and Roth IRAs by the 10-year mark. Larger distributions will move you up the tax bracket and cause more taxes at potentially higher tax bracket rates.
If your plan does not have life insurance included in it or you’d like more information on these types of planning techniques, please reach out to Christy Capital.
