Traditional life insurance policies allow insureds to financially provide for their beneficiaries if something happens to them and also accomplish various other estate planning functions, such as making charitable gifts or reducing estate taxes.
However, one thing always had to happen before the death benefit could be paid out: the insured had to die. The insured could never access the death benefit on the policy, even if they could use the cash value. That was before insurance companies created some innovative life insurance riders to add to policies.
But times have changed, and the life insurance industry as a whole came to realize that if it wanted to stay relevant to today’s prospective policy owners, then it would have to learn some new tricks. The biggest “trick” that it has learned is how to allow insureds to access some or all of the death benefit in their life insurance policies if certain conditions are met. Accelerated benefit riders represent a major step forward for insurers as a whole.
What is an accelerated benefit rider?
How does an accelerated death benefit work? In a nutshell, accelerated death benefit riders (ADBs) pay out a portion of the death benefit in an insurance policy as a living benefit before the insured passes away. This accelerated benefit payment can happen when the insured needs cash to cover certain types of expenses. They should not be confused with life or viatical settlements, where the insured sells his or her policy to a life settlement company in exchange for a lump sum cash payment upfront.
Some accelerated benefit riders are built directly into the insurance policy, meaning that they were included in the original life insurance contract. Meanwhile, others can be added on separately.
Some separate riders are free while others come with an additional cost. The particulars vary from one life insurance product to another and also by life insurance carrier. Some ADBs will only pay out a portion of the death benefit while other policies allow the insured to receive the entire death benefit if necessary. Anyone who purchases a life insurance policy with these riders has the eligibility to use them if the need arises. ABRs are typically found in cash value life insurance policies – universal life insurance policies, indexed life, and variable life insurance policies.
Types of accelerated death benefits
There are five main types of accelerated death benefits available in life insurance policies today. They are all triggered by various types of medical conditions (and in some cases, the same health condition can trigger different types of benefit options in different policies). The five types of ADB riders are broken down as follows:
Long-term care
Life insurance with a long-term care rider can help to pay for any type of personal care or medical expenses that are not covered by health insurance. This includes managed care, home health care, adult day care, assisted living facilities, and nursing home care. The insured may have to take a medical exam to qualify for this type of additional coverage, and then meet certain additional health-related criteria before benefits are paid.
Some long-term care riders will pay the insured the entire accelerated benefit in one lump sum, depending upon the benefit provision. Others will only reimburse the insured for expenses that are paid as they accrue. LTC riders can cover any form of long-term care services that a standalone long-term care insurance policy will.
Disability
This rider can reimburse the insured for the loss of earned income that they face as a result of becoming disabled. The definition of disability can vary from one type of life insurance policy to another, and some riders pay differing levels of benefits depending upon whether the disability is total or permanent versus partial or temporary.
Critical illness
This type of rider usually makes a single lump-sum payment to the insured. If the insured is diagnosed with a critical illness, such as cancer, heart attack, lupus, or fibrosis of the liver, then he or she will likely need a substantial amount of money upfront in order to cover medical bills. Major organ transplants also qualify for critical illness benefits.
Chronic illness
This type of rider will pay out when the insured becomes unable to function in the same manner as a healthy person can. This can result from such conditions as Alzheimer’s or another form of severe cognitive impairment.
The benefits that this type of rider pays out are often very similar to those of the long-term care rider in that the person who is chronically ill may end up needing one or more of the types of care that are typically covered under an LTC rider. Some riders also require the insured to have a terminal illness before benefits can be paid.
Terminal illness
If an insured is diagnosed as being terminally ill with a very short life expectancy, then many policies will use a terminal illness rider to pay out a portion of the death benefit upfront. In most cases, the money used from these riders is directed towards making the insured as comfortable as possible for the remainder of their lives.
Accelerated death benefit triggers
As mentioned previously, all four of the types of accelerated benefit riders are triggered when the insured is diagnosed with a certain type of condition or becomes unable to function normally. For long-term care and chronic illness riders, the benefits are usually triggered when the insured becomes physically unable to perform at least two out of the six activities of daily living (ADLs) without assistance from another person.
The six activities of daily living include…
- eating
- bathing
- toileting
- continence
- personal grooming
- transferring (such as from a wheelchair to a bed)
When a doctor certifies that the insured can no longer perform at least two out of these six activities, then benefits will be paid (on a monthly basis in most cases, unless the insured is also diagnosed with a critical illness). So qualifying for these benefits is not always easy.
Disability riders will usually pay out when the insured becomes physically or mentally incapable of performing his or her normal job duties as certified by a doctor or specialist. These riders may pay out a lump sum or a monthly benefit, depending on the rider and the carrier.
Different insurance providers have different rules on what conditions can trigger which benefits, but all of them can improve the insured’s life span in many cases. This is true even in New York, where the rules for life insurance companies differ widely from the rest of the country in many cases.
Underwriting requirements for accelerated death benefit riders
Some accelerated benefit riders have underwriting requirements that are every bit as strict as those found in standalone insurance policies. Policyholders may have to submit to a comprehensive medical examination and do blood work along with other tests. Other ABRs use a form of simplified underwriting that merely requires the prospective insured to answer a series of health-related questions either via telephone or online.
If you are considering buying a life insurance policy that has ADBs, be sure to find out what the underwriting requirements are before signing on the dotted line. This way you’ll know beforehand whether that will become an issue going forward.
The impact of ABRs on the death benefit of a life insurance policy
Accelerated death benefits will reduce the amount of the remaining death benefit payment in a policy according to the formula used by the life insurance company.
For example, if a life insurance policy has an accelerated benefit rider for disability and a death benefit of $200,000, then the policy may allow the insured to access up to $80,000 if he or she becomes disabled and unable to work. Or the policy may allow the insured to take the entire death benefit while he or she is living if necessary.
Insureds who intend to use an accelerated benefit rider should be sure to notify the beneficiaries on their life insurance policy and other loved ones that they will not be receiving the full amount of their life insurance benefits (or they may be getting nothing at all, depending on how things go).
Some life policies will still pay out at least a small portion of the face amount if the entire death benefit is used while the insured still lives. For example, if the insured in the previous example does use up the entire death benefit of $200,000, then the policy may still pay the beneficiaries a death benefit of 10% of the original death benefit, or $20,000.
Taxation of accelerated death benefits
The income tax rules pertaining to the benefits paid by accelerated benefit riders are very simple. All benefits that are received by the insured from one or more of these riders are unconditionally tax-free. This is because the death benefit itself is always tax-free to the beneficiaries. Therefore the IRS has classified ADB rider payments as tax-free as well, since they are, as their name states, simply some or all of the death benefit that is paid out sooner than normal.
ADBs vs alternatives to cashing out a life insurance policy
Accelerated death benefit riders are by far the best way to get cash out of a permanent life insurance policy. Otherwise, the insured can only get the cash value out of a policy, which in most cases will be substantially less than what an ADB can pay out.
A straight cash withdrawal from a policy will typically incur surrender charges and other fees that must be deducted from the amount the insured receives. Surrendering a policy in order to get the remaining cash surrender value also means forfeiting the protection offered by the ADB. Borrowing from the policy is probably a more efficient method of accessing the cash value, but you can only borrow up to the amount of cash value, which will always be far less than the death benefit.
So the only way to really get hold of a substantial portion of the policy’s death benefit without actually dying is by using an ADB. Of course, the insured has to medically qualify to receive the benefit amount from an ADB, but in many cases, the insureds are free to spend their benefits however they please.
The life settlement alternative
If you need cash now for medical or other bills, and your cash value or term life insurance policy doesn’t have any accelerated death benefit riders included, then the next best thing may be to sell your life insurance policy to a third party in a life settlement transaction. If you are at least 60 to 65 years old and own a cash value policy with a face value of at least $50,000, then you can probably sell your policy to a life settlement company. This way you can quickly get two to three times the amount of cash value in your policy in your hands and spend it on anything you choose.
There are no medical underwriting requirements for this. In fact, if you are in poor health, you will get a higher payout than you would if you were fully healthy, because your life expectancy will be shorter. And this is a far superior alternative than trying to qualify for Medicaid or Social Security disability payments.
ADBs in annuities
Many annuities today also come with accelerated benefit riders that will double or triple the payout from the contract if the annuitant needs any form of managed care or goes into a nursing home.
Get a free valuation of your life insurance policy
Accelerated death benefit riders have ultimately increased the value of their underlying life insurance policies by affording the insured several different types of protection in one vehicle. This trend is only likely to grow as time goes on, and a day may come when we see all cash value policies including at least one of these riders as a standard practice. Consult your financial or tax advisor for more information on accelerated benefit riders and how they can benefit you. You can find other articles for educational purposes on Q Capital’s Blog.
Want to see how much you could sell your life insurance policy for? Get started with a quote from our free life settlement calculator. You can also call Q Capital at 866-679-9410, contact us here, make an appointment, or email us info@qcapital.com to discuss your situation. Our team is available and ready to explain to you all that you would want to know about life settlements.
Remember: Never abandon a life insurance policy without looking at the life settlement option first!
Author: Steven Shapiro
Steven Shapiro is the founder of the Company and also the President and CEO of Q Capital Strategies, LLC and Life Settlement Solutions LLC. Steven has been active in the life settlement industry for the last 18 years. In addition to his life settlement experience, Steven has expertise in strategic consulting, investment banking advisory services, and private equity investing. Steven holds a B.A. degree in economics from the University of Pennsylvania and an M.B.A. in finance and entrepreneurial management from The Wharton School of the University of Pennsylvania. Steven is also the immediate past Chair of LISA (having previously served as Chair), the Life Insurance Settlement Association, the oldest and largest trade organization in the life settlement industry.
