Life insurance, from the planning side

What the policy actually pays

The number on the front of the policy is the death benefit, and it is a ceiling rather than a floor. Two things routinely make the payment smaller than the owner expected, and both are invisible until the claim.

Cash value is not added to it

Owners of a permanent policy watch a cash value accumulate for decades and reasonably assume the family will receive the death benefit plus that balance. Generally they will not. The insurer pays the stated death benefit, and no more, however much cash value stood in the policy the moment before. Some whole life policies do pay both — that is an exception written into a particular contract, not the rule.^{Source 3}

A policy loan is subtracted from it

Money borrowed against the policy, plus the interest that has been running on it since, comes off the death benefit. A loan taken fifteen years ago to cover something urgent, never repaid because nothing ever demanded repayment, is quietly reducing what the family will receive.^{Source 3}

If you have a permanent policy, the question worth asking the insurer in writing is simply: what would be paid today, after any outstanding loan and interest? That number, not the face amount, is what your plan actually rests on.

The money you can draw while you are alive

This is the least-known provision in the whole subject and the one that changes the most for the people it reaches. Someone certified by a physician as terminally or chronically ill can generally take money out of their own death benefit while still living — the insurer calls it an accelerated death benefit or a living benefit — and the tax code treats that money as if it had been paid on death, which means it is not taxed.

The threshold for a terminal illness is set by statute: a physician certifies an illness or condition that can reasonably be expected to cause death within 24 months of the certification. A chronic illness qualifies too, on the separate long-term care definition.^{Source 2}

The reason this matters is what families do instead. In the months after a terminal diagnosis, people spend down savings, take on debt, borrow from relatives and sell things they wanted to keep — while an asset that is already theirs, and already free of tax, sits in a drawer. Nobody at the insurer calls to mention it.^{Source 4}

Drawing on the benefit reduces what the beneficiaries receive later, and it can affect means-tested benefits. It is money moved forward, not money created. Ask the insurer in writing how much is available and how much is retained for the beneficiaries before deciding.

If the policy has no such provision, the same tax treatment reaches a sale of the policy to a licensed viatical settlement provider — the proceeds are also treated as paid by reason of death. That is a real market with real pricing questions, and it is a decision to take with an adviser rather than from a page.^{Source 2}

Rights already in the policy that expire unused

A policy is a contract, and contracts contain options. These are the ones that cost nothing to exercise, are commonly present, and are almost never claimed because the owner does not know they are there.

• Waiver of premium — if you develop a covered illness or disability, you stop paying premiums and the cover stays in force. Check whether there is a waiting period after diagnosis.
• Guaranteed insurability — you can increase the death benefit at set points in the future with no medical exam, priced on your age and the increase rather than on your health.
• A long-term care rider — part of the death benefit can be used for long-term care costs, usually once you cannot perform certain activities of daily living.
• The term conversion privilege — many term policies can be traded for a permanent policy during a conversion window even if your health has since become poor. The premiums will be higher; the point is that you cannot be refused.^{Source 4}

The conversion privilege is the one that expires quietly. It is exercisable regardless of health, but only inside the window the contract sets — and by the time someone wishes they had used it, the window is usually the thing that closed.

What your family will owe on it

Generally nothing. A death benefit is not income to the person who receives it, whether it is paid as one sum or in installments. This is federal statute and it is the same everywhere.^{Source 1}

Two qualifications are worth knowing rather than discovering. Interest the insurer adds after the death — because the money sat for a while, or because it is being paid in installments — is ordinary income; the exclusion covers the death benefit, not what it earns afterwards. And where a policy was bought from its original owner rather than inherited, the exclusion is capped at what the buyer paid plus the premiums they paid later.^{Source 1}

Not being income tax is not the same as being outside the estate. A policy the deceased person owned can still count toward the size of the estate for estate tax, which reaches almost nobody — the after-a-death tax page covers where that line falls.

Who is allowed to own a policy on your life

Only someone with an insurable interest in you. A stranger cannot buy a policy on your life. Immediate family generally qualify, and in some circumstances an employer or a business partner does.^{Source 5}

The requirement is tested when the policy is taken out, not when it pays. A policy a family member bought years ago stays valid even if the relationship has since ended — which is worth knowing in both directions, because it is also how an ex-spouse can still hold a policy on you.^{Source 5}

What this page will not tell you

How much cover you need, and whether term or permanent is right for you, are financial questions that depend on your income, your dependants, your debts and your tolerance for cost. Sahvelo does not answer them, does not rank products, and takes nothing from anyone who sells them.

What Sahvelo will say is that the answer should come from someone who is not paid more for one answer than the other, and that your state's insurance department publishes which agents and companies are licensed where you live.