What Are Accelerated Death Benefits and How Do They Work?

You have many options when you buy life insurance. Your goal should be to get the coverage your family needs to survive financially when you die. 

As you build your assets, you may no longer need life insurance. That’s why most people are likely best off getting a simple term life insurance policy. 

But other types of permanent life insurance policies also fit specific needs.

Permanent life insurance policies have many variations. These variations could provide helpful life insurance benefits for unique circumstances.

Now:

No matter what type of life insurance contracts you get, there are items called riders you may be able to add. A rider is essentially an option you add on to the policy. 

Sometimes riders don’t have an additional cost. Other riders may result in an extra fee on your policy. 

One example of a rider is an accelerated death benefit rider. These riders are so common that you generally aren’t charged for them. 

Here’s what they are and how they work.

What Is an Accelerated Death Benefit Rider and What Does It Do?

A standard life insurance policy pays the death benefit to your beneficiaries after you pass away.

If your policy has an accelerated death benefit rider, you may be able to access a part of your death benefit while you’re still alive. 

The rider allows those that are terminally ill to receive a part of their death benefit in advance.

The big draw:

You can then use the money to help pay for treatment, a long-term care facility or other needs before your death.

Other names for an accelerated death benefit rider could include terminal illness benefit or living benefit rider.

How Do They Work in Practice?

The accelerated death benefit rider’s rules may vary from insurance company to insurance company.

Here’s how they work the majority of the time. 

The most common way to access part of your death benefit early is being terminally ill. For the rider to work, your illness must be diagnosed by a doctor. 

Doctors must say your life expectancy is two years or less in most cases. Some policies may require your life expectancy to be shorter to pay out, though. The time requirement may be 12 months or six months.

Sometimes, other major illnesses may trigger the ability to activate this type of rider. Other times, these illnesses are covered under a critical illness rider. 

Examples of other major illnesses could include the following, depending on your policy:

• Cancer
• Heart attack
• Major organ transplant
• Stroke

Look:

These are often expensive illnesses. Accessing the funds from your life insurance payout could help you pay your medical bills.

After you qualify, you then have to dig into how much your payout could be. The amount you take out from your policy will be removed from your death benefit. There may also be fees to use the accelerated death benefit rider.

If you want to know specifics about how your policy works, read it carefully.

Look for the accelerated death benefit rider or critical illness rider. Then, read that section of your life insurance contract to learn more. 

That said:

The policy can be complex and in legalese.

If you’re having problems understanding it, consider consulting your life insurance company, agent or a fiduciary financial advisor.

An example

Here’s an example of how using an accelerated death benefit rider may work.

You get diagnosed with a type of cancer that has no treatment. The doctor finds your remaining life expectancy is 12 months. Due to this diagnosis, your policy allows you to use your accelerated death benefit rider.

You currently have a $1,000,000 life insurance policy. After looking at the contract, you find you can take out up to $400,000 due to the accelerated death benefit rider.

If you take out $400,000 as an accelerated death benefit, only $600,000 will remain in the policy. That means when you die, your beneficiaries will only receive $600,000 upon your death.

To make matters more complicated, you may not get a payout of an accelerated death benefit for the full amount. There may be administrative fees taken out which could lower your death benefit below the $400,000 you’re expecting.

Make sure you understand how much you’ll receive and how much will remain as a death benefit payout before you use the rider benefit.

What Does the Accelerated Death Benefit Payout Cover?

Life insurance proceeds, including accelerated death benefits, don’t usually require you to use them in a certain way. 

The intent behind these riders is to give you access to money. You may need it to pay bills for treatment or to spend quality time with family.

For instance, a severe illness could require some people to enter nursing homes, which can be very expensive.

Alternatively, you could use it to pay off debt, such as a mortgage. This way, your spouse won’t have to deal with it after you pass away.

That said:

You could use it in any way you want as long as your policy doesn’t specify otherwise.

Will I Owe Taxes on an Accelerated Death Benefit?

In most cases, you won’t owe taxes on accelerated death benefit amounts received. 

The IRS states: 

“Certain amounts paid as accelerated death benefits under a life insurance contract or viatical settlement before the insured's death are excluded from income if the insured is terminally or chronically ill.”

Since you have to be terminally or chronically ill to receive an accelerated death benefit, you’re often in the clear.

Unfortunately, taxes are complicated. Like with most tax rules, there are always exceptions.

Normally, the accelerated death benefits are made in a lump sum payment. However, they can be paid in installments in some instances. If your payment is received in installments that earn interest, you may have to pay taxes on the interest.

You may also face taxes when you die. If there is any money remaining when you pass away, you may owe estate taxes depending on your estate’s size. 

Now:

This won’t be a problem for most people.

There is a large exemption amount. It could be an issue for wealthier individuals, though. 

In 2020, you have to file an estate tax return if your estate and prior taxable gifts exceed $11,580,000.

As with most payments, it will be reported to the IRS. You will receive a Form 1099-LTC detailing the accelerated death benefit payment. 

Consult your tax professional before taking an accelerated death benefit payout. They can examine your unique financial situation. Based on the examination, they can see if there are any tax impacts of taking the benefit.

Benefits of Having or Using an Accelerated Death Benefit Rider

Having an accelerated death benefit rider as part of your policy is a smart move as long as it doesn’t come with an added cost.

You aren’t forced to take advantage of it if you don’t want to. It merely provides the option if you do need to use it.

Using the rider to take money out of your policy can help relieve the stress of the situation when you’re diagnosed with a terminal illness. 

Many families don’t have the financial means to pay for necessary care. Using the rider could provide money to do so.

Otherwise, your family may spend the little time you have left stressing over money, medical bills and debt. 

Drawbacks

The money received from an accelerated death benefit rider could have unintended consequences.

While the money isn’t typically taxable, it could impact other benefits.

Impact on Medicaid coverage

Getting the cash before your death could mean you no longer qualify for Medicaid coverage.

In this case, the money could be exhausted paying for care that would have otherwise been covered by Medicaid.

Reduced death benefit payout

Using an accelerated death benefit rider also reduces your death benefit payout. 

Most people buy life insurance to cover financial needs after they pass away.

By reducing the payout, your family may not have the money they need to live a comfortable life after your death.

Consult a Professional

An accelerated death benefit rider can allow you to get a payout for some of your life insurance death benefit before you die.

You usually have to be terminally or chronically ill with a life expectancy of two years or less to qualify. 

Deciding if or how to take an accelerated death benefit payout is a big deal. 

When you’re facing a terminal or chronic illness that shortens your life expectancy, you’re overwhelmed. It takes enough to manage your medical condition without considering your finances.

Additionally, accelerated death benefit riders, their tax impacts and other consequences could have a considerable effect on you and your beneficiaries’ financial futures. 

For these reasons:

It makes sense to consult a tax professional, life insurance agent or fiduciary financial advisor before making any decisions. They can look at your situation and recommend the best course of action based on their expertise.