21 Jun Can I access life insurance benefits tax-free?

Q. My term life insurance policy has an early benefits option usable if you have a fatal disease that your doctor confirms will make you deceased within 18 months. After death, life insurance payments to my spouse are tax-free. Are these early paid benefits also tax-free if received by my spouse and me before my death?
— Planning ahead

A. We’re sorry to hear about your health, but we’re glad you’re looking closely at your finances.

Let’s start with a look back at when many insurance carriers began to offer this free option, known as an Accelerated Benefit Rider, or ABR. This allows a portion of the death benefit to be paid before death in certain terminal illness situations.

There would typically be a schedule in the policy that illustrated a percentage of the total death benefit eligible for the accelerated payment, said Ed Gaelick, a Chartered Life Underwriter and Chartered Financial Consultant with PSI Consultants in Glen Rock.

Generally the younger you are, the smaller the percentage you could get, and the older you are, the more you could get, Gerlick said.

“There would have to be a terminal illness, certified by at least one independent physician, which can reasonably be expected to result in death within 12 months,” he said.

Payments under this rider, ABR, are in essence a death benefit and intended to qualify for favorable tax treatment under IRC 101(g), meaning benefits would be income tax free, Gaelick said.

“However, this can get complicated and it is always best to consult with a competent tax advisor to determine if there would be any tax consequence before requesting any accelerated benefits,” he said.

Gaelick said some insurance companies also offer an Enhanced Accelerated Benefit Rider, or EABR, where the criteria to accelerate benefits could be for critical care and not have to be terminal.

“Since this would be considered a lean on the benefits, the favorable tax treatment may or may not apply,” he said. :That would depend on the current IRS maximum allowed amounts and the amount of benefit received.”

To further complicate things, Gaelick said, some insurance companies now offer a long-term care insurance rider that in essence is an EABR. This allows for the accelerated death benefits should an insured become long-term care benefit eligible with cognitive impairment or the inability to perform activities of daily living.

“Since this does not have to be terminal, the benefits paid would also be considered a lien and could potentially create some taxable income,” he said. “Again, the IRS maximums and amount of benefits paid would determine the income tax consequence, if any.”

So your answer: The benefits may be tax-free, or maybe not. You should take your policy to your tax advisor so the advisor can examine the specifics of your policy before you decide to take any benefits.

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This story was originally published on June 21, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.