How can I cash out of a life insurance policy to pay for medical or long-term care?

A fellow caregiver asked...

How can I cash out of a life insurance policy to pay for medical or long-term care?

Expert Answer

A life insurance policy is intended to provide money to a survivor or survivors of the deceased policyholder. But for many people with a life insurance policy, it can instead be turned into a source of cash to help pay the insured person's own expenses. This might be done by collecting "accelerated benefits" from the insurance company itself or by making a "life settlement" with an outside company that specializes in such transactions.

  • Accelerated benefits. Depending on the terms of the policy itself, life insurance might be cashed in with the insurance company that issued it. If a policyholder qualifies for these accelerated benefits (sometimes called "living benefits"), they're usually between 60 and 80 percent of the policy's face value. With some policies, however, collecting accelerated benefits depends on the policyholder having a terminal illness -- usually defined as having less than two years to live -- as certified by the policyholder's physician.
  • Life settlement. Someone whose life insurance policy does not provide for accelerated benefits, or who does not qualify for the accelerated benefits the policy offers, might nonetheless be able to get cash for the policy by negotiating a life settlement with an outside company. A policyholder (usually only if age 65 or over) can get a cash payment of between 40 and 75 percent of the policy's face value. The exact amount depends on the amount of the policy premiums and on the age and health of the policyholder -- the longer the policyholder is likely to live, the lower the settlement amount. Once the settlement is made, the settlement company pays the policy premiums. Then the company, rather than the original beneficiaries named in the policy, collects the benefits when the policyholder dies.

There may be tax consequences to cashing in a life insurance policy. The cash someone receives might be treated as capital gains under state or federal tax laws; anyone considering cashing in a policy should find out from a tax accountant what the tax implications are in his or her particular case. If there would be a large tax bite, a settlement might not be worth it.

Also, cashing in a life insurance policy can affect Medicaid eligibility. If someone has very low income and few enough assets to qualify for Medicaid coverage, the cash received in the settlement might put that person over the asset eligibility limit. With regard to Medicaid eligibility for nursing home coverage, the settlement money would be counted as belonging to the policyholder even if he or she gives it away to family or friends.