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How does an Accelerated Death Benefit Work?

by Jeff Rose on December 29, 2012 · 1 comment

accelerated death benefitFor anyone with a terminal illness, an accelerated death benefit can be savior.

An accelerated death benefit is an insurance benefit that pays out while the insured is still alive.

Usually, only people who are suffering from terminal illnesses are eligible for accelerated death benefits.

This is also called a living benefit.

What is a Living Benefit?

A living benefit can be added to an insurance policy before or after purchase. With this benefit, patients who have a terminal illness can access part of their benefits before their death. Initially, when this benefit was first created, it was offered only to people with HIV/AIDS.

Overtime, it was offered to people who suffered from kidney failure, cancer, and other terminal illnesses. Medical expenses for a terminal illness can be very expensive, and there are also living expenses that the terminally ill have to pay as well. A living benefit can aid with all of these expenses and can be of a great help to those who have terminal illnesses.

Many insurance companies offer a living benefit as a rider in some of their life insurance policies. It is commonly included in permanent life insurance policies. There are many different packages and payment options for living death benefit. You can receive the death benefit if you already have a terminal disease or if you contract one in the future.

Not everyone wants to think of the possibility of contracting a terminal disease, but for some, a living benefit may be something they wish to add to their policy. You will receive a percentage of the death benefits depending on the insurance company. This company usually ranges from 25-95%. After death, the remainder of the benefit is paid out to your beneficiaries. If you should recover from your illness, then you will not have to repay the benefits you received.

How do You Qualify for an Accelerated Death Benefit?

You qualify for a living benefit if you have contracted a terminal illness and are expected to die in two years, if you have been diagnosed with an illness that will reduce your life span, or you have an illness that requires an organ transplant, you are in long-term care in a hospice. As well as if you need assistance with every day, activities like bathing or using the toilet.

The cost of a living benefit will vary depending on the company. If the coverage is already included, then the cost will be included in the policy. If not, then you will have to pay a fee or a percentage of the death benefit.

How are you taxed on Accelerated Death Benefits?

These benefits are not taxable. These benefits are usually tax exempt for individuals who are expected to die within two years. This type of benefit isn’t meant to substitute long term coverage. It is used to supplement any costs that aren’t covered by your insurance company. If you believe you may be eligible for a death benefit, then talk with your insurance agent. Also, keep in mind that receiving a living benefit can affect your eligibility for Medicaid and SSI.

Accelerated Death Benefit Example

Here’s an example of how an accidental benefit rider might play out.

  1. Client induces a qualifying chronic, critical, or terminal illness.
  2. Client files a claim to accelerate all or a portion of the death benefit.
  3. Our claims department and underwriters review the medical records and prognosis ratings and make a discounted offer, based on the change in life expectancy. The higher the change in life expectancy, the higher the percentage the client will be offered.
  4. If the client accepts the offer, they receive the determined amount as a lump sum within two weeks. If the entire death benefit is accelerated, the remaining face is $0 and the policy terminates. If a portion of the death benefit remains, the client’s premium will reflect the new face amount. Below is an example:
Fred is 40 years old, preferred non-tobacco with a $1 million policy. He suffered a major heart attack and decides he wants to accelerate $500,000 of his face. The insurance company reviews the claim and makes a lump sum offer of $265,000. Fred accepts the offer and is mailed a $265,000 check in the next two weeks. His death benefit has now been decreased by the amount of face he accelerated ($500,000), so his remaining death benefit is $500,000. He will now pay premiums based on a $500,000 face amount, not the initial $1 million face.

Regarding the taxes: first and foremost, be aware of the fact that I or the insurance company can act in the capacity of a tax advisor or CPA. We always advise our clients to seek their own tax council. That being said, we have designed our ABRs to be within compliance with current IRS regulations. With regards to the terminal illness rider, the IRS has defined it to be an acceleration of the death benefits, and therefore it is not taxable.

What About Chronic Illness?

For chronic illness, they have proposed but not adopted the rider in the same light. The IRS has not provided any opinion on critical illness payments. With all of that in mind, I am not aware of any accelerated benefit that has been taxed by the IRS. This is, of course, under the assumption that the policy has not be turned into a modified endowment contract (MEC). Once a policy is MEC’d, it is always a MEC, and all benefits are taxable. But again, always involve a tax advisor or CPA when dealing with the IRS. They know the dark side of the force better than any of us.

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