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Tapping your own life insurance policy

Tapping your own life insurance

A serious illness can take a major toll on your life, including your wallet. But there may be a way to deal with the growing stack of medical bills and other financial pressures: Tap your own life insurance.

Many life insurance policies offer a perk, the accelerated death benefit, that lets terminally ill policyholders get part of their life insurance money early.

However, many policyholders don't know about the benefit or, if they do, don't use it, says Matthew Hill, executive vice president of Client Focused Advisors, a member of the John Hancock Financial Network.

In his 13 years in the industry, Hill says he's never known of a client who has applied for accelerated death benefits.

"It's kind of a rare thing," he says.

See also: Why you should review your life insurance beneficiaries

What is an accelerated death benefit?

Most people buy life insurance to replace their salary so that, if they die, their loved ones can pay the mortgage, keep the lights on and buy groceries.

But an accelerated death benefit, also known as a living benefit, offers you the ability to tap your own life insurance to help support yourself and your family financially during a catastrophic illness.

See also: Women don't have enough life insurance

This option may either be included as part of a life insurance policy or attached as a rider, an addition to the policy, according to life insurance expert Matthew Teel, an agency director of Barnum Financial Group, a MetLife company.

However, unlike some riders, the accelerated death benefit usually doesn't increase your premium, Teel says.

If you're not sure whether your policy includes an accelerated death benefit, check with your agent or insurer -- or, if you have a group policy through work, with your benefits administrator, the American Council of Life Insurers recommends.

Some insurance companies will even let you add the accelerated death benefit rider to an existing policy, Teel says.

When can you get life insurance money early?

Just getting sick doesn't mean you'll qualify to tap your own benefits. Insurance company requirements for the accelerated death benefit tend to be strict, Hill says. "You pretty much have to know you're going to die."

Here are situations in which you might be able to get life insurance money early:

  • You have a terminal illness, such as advanced cancer, and your life expectancy is short, usually between six months and two years, depending on the policy, according to Aetna. For most policies, it's less than a year, Hill says.
  • You have another very serious condition, such as amyotrophic lateral sclerosis (ALS), or you're on artificial life support, according to Aetna.
  • You suffer from organ failure but are not eligible for a transplant, according to Aetna.

The amount you can get early depends on the policy, but it's usually 50 percent to 80 percent of the policy's total value, according to Aetna.

In most cases, you have to apply for early benefits, then the insurance company will conduct an independent medical review, going over your medical records to make sure you qualify.

"It looks good and it sounds good, but there are lots of little caveats," Hill says.

The pros and cons of tapping your life insurance

Using an accelerated death benefit in your life insurance policy can be a good way to ease the financial stresses of a major illness.

One big plus is that there's no restriction on how you can use the money, according to Aetna. For example, you could use the cash to fund experimental treatment not covered by your health insurance, to pay off your mortgage or even do something you've always wanted to do. You could even prefund your child's college education, Teel says.

For example, one of Teel's colleagues was diagnosed with terminal cancer and used the accelerated death benefit to pay off bills and take a dream vacation with his family. "He really cherished that," Teel says.

However, using an accelerated death benefit may have downsides. Here are four issues to consider before applying for these benefits.

  1. A living benefit can count as income, so it might affect your eligibility for government programs such as Medicaid, according to the American Council of Life Insurers. If you are using or planning to use any government program, contact an office of that program directly to see if the additional income could change your status, the council recommends.
  2. If you're terminally ill, meaning you have a condition that's likely to cause death within two years, you should not have to pay federal income tax on accelerated death benefit money, according to the IRS. However, you should consult a tax pro before applying, just in case, Hill says.
  3. It costs you to use the benefit. Most companies charge a small administrative fee around $100 to $250, as well as subtracting the amount they would have earned in interest had they held onto the money until your death. So, for example, you might receive $95,000 instead of the $100,000 your family would have gotten a year later, Teel says.
  4. One of the biggest drawbacks to getting a big chunk of your life insurance money while you're alive is that it negates the reason you likely purchased the policy. If and when you die of your illness, your family will receive the value of your policy minus the amount you already got, Hill says.

"You have to weigh your options and the benefits of using the money or not using the money down the road," Hill says.

See also: Millennials fear buying life insurance 

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