Life insurance is usually associated with providing financial security to loved ones in the event of the policyholder's death. While the death benefit remains a crucial component of life insurance, many policies offer an additional layer of protection known as living benefits.
Living benefits are optional features that can be added to a life insurance policy, providing policyholders access to a portion of their death benefit and the policy’s cash value while they are still alive. Specific qualifying events, such as a severe illness, disability, or terminal illness diagnosis, can trigger these benefits.
Types of living benefits
- Cash value: Cash value in a permanent life insurance policy, like whole life or universal life, is a living benefit that policyholders can tap into during their lifetime. It serves as a savings component, accumulating a portion based on premium payments over time. It can be accessed through loans or withdrawals for various financial needs, such as supplementing retirement income. Cash value in a life insurance policy grows tax-deferred, and any income taken can generally be received income tax-free if appropriately structured. Keep in mind that cash value is a benefit only available in permanent life policies; it cannot be added to term policies.
- Policy dividends: With whole life policies, dividends are a living benefit where policyholders may receive a portion of the insurance carrier’s profits. These dividends can be obtained as cash payouts, used to reduce premiums, purchase additional coverage, or left to accumulate, providing policyholders with financial flexibility and the potential for enhanced policy value. It is important to note that dividends are never guaranteed and are at the carrier's discretion.
- Accelerated death benefit: An accelerated death benefit is a provision within a life insurance policy that allows the policyholder to receive a portion of the death benefit in advance if they are diagnosed with a terminal or critical illness to cover medical expenses. If exercised, it does reduce the net death benefit available for beneficiaries. This benefit can be added to any life insurance product, but availability may vary based on the carrier.
- Long-term care (LTC): While this can be purchased as a stand-alone policy, permanent life insurance offers a separate rider for long-term care, which provides funds for assisted living or nursing home care, alleviating the financial burden on policyholders and their families. Remember, this rider cannot be applied to term policies.
- Disability care: Similar to LTC coverage, disability benefits can be purchased as its own policy but are often available as a rider. Disability coverage provides policyholders financial support if they become disabled and cannot work. These benefits can replace a portion of the policyholder's income, helping to cover living expenses and maintain financial stability during the disability period. Unlike LTC riders, disability riders can be added to any life insurance product.
Riders vs. standalone coverage
As mentioned above, both LTC and disability coverage can be purchased as a standalone policy or added to a policy as a rider. Whether a rider or a standalone policy is better depends on the individual’s needs, preferences, and financial situation. Both options have advantages and disadvantages; here’s a quick look:
Pros of adding a rider:
- Convenience: Adding a rider is a convenient way to combine two types of coverage into a single policy. The policyholder only needs to manage one policy and make one premium payment.
- Cost-effective: Riders are often more cost-effective than standalone policies because they leverage the existing life insurance policy's underwriting and administrative processes.
- Simplicity: Managing a single policy with a rider can be simpler and easier to understand than having multiple separate policies.
- No additional underwriting: With a policy rider, there is typically no need for further underwriting or medical exams. If an individual is denied coverage for a standalone policy, they will likely still be able to obtain the decided coverage through a rider.
Cons of adding a rider:
- Coverage limits: Riders may have limitations on the amount of coverage provided for long-term care or disability, which might not be sufficient for the policyholder’s needs.
The drawbacks of living benefits
While living benefits in life insurance policies offer valuable financial flexibility, there are potential drawbacks to consider:
- Reduced death benefit: Accessing living benefits may decrease the overall death benefit payable to beneficiaries upon the policyholder's death.
- Increased policy costs: Adding living benefits to a life insurance policy typically comes with an additional cost in administrative fees and higher premiums.
- Risk of policy lapse: If the policyholder exhausts the living benefits, they may be left without adequate coverage for their original insurance needs. It's essential to balance using living benefits and maintaining the core protection the policy initially intended to provide.
- Loan interest: If a policyholder takes a loan against the policy, interest can add up if the loan is not repaid at some point. If it is not repaid, the policyholder can at least pay the ongoing loan interest to keep this effect to a minimum.
Underwriting and living benefits
No matter the policy an individual is looking for, the underwriting process will remain basically the same. When determining an individual's eligibility and premium rates, carriers will look at factors like age, health, and financial stability. It's important to note that the availability of living benefits can vary widely among insurance companies and policy types. Some policies include living benefits as a standard feature, while others offer them as optional riders. The policy's terms and conditions, including any waiting periods or limitations, should be carefully reviewed.
While living benefits offer valuable advantages, it's crucial for policyholders to carefully weigh the potential drawbacks and consult with financial professionals to ensure that accessing these benefits aligns with their long-term financial goals and priorities.
Through our extensive industry expertise and access to a wide array of products, Modern Life equips advisors with the knowledge and resources they need to tailor insurance solutions that encompass critical living benefits like accelerated death benefits, disability benefits, and cash value accumulation.
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