The policy had been in force for thirty-one years. Gerald’s wife, Marie, had bought it when their youngest was in elementary school, a $250,000 whole life policy that she paid into every quarter without missing a payment. When Marie was diagnosed with vascular dementia at 79, the family focused on her care needs and never thought about the insurance policy. It sat in a filing cabinet in the den, accumulating cash value that nobody checked.
It was their daughter Elaine who asked the question. She was sitting with an elder law attorney, trying to figure out how to pay for a small residential care home in San Diego that the family had visited and loved. The monthly cost was $6,200. Marie’s Social Security covered $2,100. The gap was real, and the savings would last about two years. The attorney asked a simple question: does your mother have a life insurance policy?
That question changed the family’s financial picture entirely.
The policy most families forget about
Life insurance is designed to pay out when someone dies. That is its purpose, and most families think of it that way. What many families do not realize is that a life insurance policy can have significant financial value while the insured person is still alive, and that value can be converted into cash to pay for care.
This is not a loophole or a creative workaround. Insurance companies and federal tax law have established specific mechanisms for accessing life insurance value during a policyholder’s lifetime. The options vary depending on the type of policy, the health of the insured, and the face value, but for families struggling to fund residential care, a life insurance policy sitting in a drawer may represent tens or hundreds of thousands of dollars in untapped resources.
There are four main ways to access the value of a life insurance policy before death: accelerated death benefits, life settlements, policy loans, and cash surrender. Each works differently and has different costs, tax consequences, and implications for the death benefit that would otherwise go to beneficiaries.
Accelerated death benefits
An accelerated death benefit, sometimes called a living benefit, is a provision built into many life insurance policies that allows the insured to receive a portion of the death benefit early if they are diagnosed with a terminal or chronic illness. Many policies issued in the last twenty years include this provision automatically, and some older policies have it as a rider that was added at purchase.
For families paying for care, the chronic illness trigger is the relevant one. Under most policies and under the federal tax definition, a person is chronically ill if they are unable to perform at least two of six activities of daily living (bathing, dressing, eating, toileting, transferring, continence) without substantial assistance, or if they require substantial supervision due to a severe cognitive impairment. This definition overlaps significantly with the criteria for needing residential care, which means many people moving into a board and care home or adult family home will qualify.
The typical payout is 50 to 80 percent of the policy’s face value, paid in a lump sum or in monthly installments. The insurance company deducts the accelerated benefit from the death benefit, so what remains for the beneficiaries is reduced by whatever amount was paid out early. Some policies also charge an administrative fee or discount the payout to account for the early payment.
The tax treatment is favorable. Under Internal Revenue Code Section 101(g), accelerated death benefits paid to a chronically ill person are generally tax-free, provided the funds are used to pay for qualified long-term care services. There are annual caps on the tax-free amount that are adjusted for inflation, but for most families paying for residential care, the entire accelerated benefit falls within the tax-free limit.
To access an accelerated death benefit, the policyholder (or their power of attorney) contacts the insurance company and requests the living benefit claim form. The insurer will require medical documentation confirming the chronic or terminal illness diagnosis. Processing typically takes two to six weeks.
The advantage of an accelerated death benefit over the other options is simplicity. The policyholder keeps the policy, keeps whatever death benefit remains, and does not involve any third parties. The disadvantage is that it reduces the inheritance that would go to beneficiaries, and not every policy includes this provision.
Life settlements
A life settlement is the sale of a life insurance policy to a third-party buyer. The buyer pays the policyholder a lump sum, takes over the premium payments, and collects the full death benefit when the insured dies. The policyholder gives up the policy entirely, including any remaining death benefit.
Life settlements are regulated at the state level. Most states require the buyer (called a life settlement provider) to be licensed, and many states require a waiting period (typically two to five years from the policy’s issue date) before a settlement is allowed. The transaction usually involves a broker who shops the policy to multiple buyers to get the best offer.
The typical payout is 20 to 50 percent of the policy’s face value, though the exact amount depends on several factors: the insured’s age and health (older and sicker means a higher payout, because the buyer expects to collect sooner), the face value of the policy, the type of policy, the annual premium cost, and current interest rates. Policies with face values under $100,000 are generally not worth pursuing through a life settlement because the transaction costs eat into the proceeds.
For a family with a $250,000 policy on a parent in their late 70s or 80s with significant health conditions, a life settlement might yield $75,000 to $125,000. That is real money for care. At $6,000 per month for a small care home, $100,000 covers roughly sixteen months of care.
The tax treatment is more complicated than accelerated death benefits. The portion of the settlement that exceeds the total premiums paid into the policy is generally taxable as ordinary income, and a portion may be taxed as capital gains. The rules changed under the Tax Cuts and Jobs Act of 2017, and the specifics depend on the policy’s cost basis. A tax professional should review any life settlement before the transaction closes.
The Medicaid implications are significant. The lump sum from a life settlement is counted as income in the month received and as a countable asset thereafter. If the parent may need Medicaid in the future, the timing and use of settlement proceeds needs careful planning. An elder law attorney can help structure the transaction to minimize Medicaid disruption.
Red flags in life settlements
The life settlement industry has matured significantly since the early 2000s, but predatory practices still exist. Watch for these warning signs:
Brokers who pressure quick decisions. A legitimate life settlement takes weeks to complete. If someone is pushing for a fast signature, walk away.
Undisclosed fees. The broker’s commission typically comes from the buyer, not the seller, but some arrangements include hidden fees that reduce the seller’s payout. Ask for a complete disclosure of all fees before signing anything.
Lowball offers without competitive bidding. A good broker shops the policy to multiple licensed providers. If only one offer is presented, the seller may be leaving money on the table.
Unlicensed providers. Check with your state’s insurance department to confirm that the life settlement provider and broker are licensed in your state. The National Association of Insurance Commissioners maintains a list of state regulators.
Viatical settlements
A viatical settlement is similar to a life settlement but is specifically for people who are terminally ill, typically with a life expectancy of two years or less. The mechanics are the same: the policyholder sells the policy to a third party for a lump sum and gives up the death benefit.
Viatical settlements generally pay a higher percentage of the face value than life settlements, often 50 to 80 percent, because the buyer expects to collect the death benefit sooner. The other significant difference is tax treatment: proceeds from a viatical settlement for a terminally ill person are generally tax-free under federal law. Some states also exempt viatical settlement proceeds from state income tax.
Viatical settlements were originally developed during the AIDS crisis of the 1980s and 1990s, when terminally ill individuals needed cash for medical treatment. Today, they serve the same function for anyone with a terminal diagnosis who needs funds for care or other expenses.
If the parent is terminally ill and entering a care home for end-of-life care, a viatical settlement may provide more cash and a better tax outcome than an accelerated death benefit. The trade-off is that the family gives up the death benefit entirely, and the transaction takes longer to complete than an accelerated benefit claim.
Policy loans
If the parent has a whole life or universal life insurance policy with accumulated cash value, they can borrow against that cash value without selling or surrendering the policy. This is called a policy loan.
Policy loans have several features that make them unusual compared to other types of borrowing. There is no credit check and no income verification, because the insurance company is lending against its own asset (the cash value). The interest rates are set by the policy contract, typically between 5 and 8 percent. There is no required repayment schedule. The loan and accrued interest are deducted from the death benefit when the insured dies, or from the cash surrender value if the policy is surrendered.
Because there is no required repayment, a policy loan can function as a way to access cash value without formally surrendering the policy. The death benefit is reduced by the outstanding loan and interest, but the policy remains in force as long as the premiums are paid and the loan does not exceed the cash surrender value.
The tax treatment is straightforward: a policy loan is not a taxable event. The IRS treats it as a loan, not as income. However, if the policy lapses or is surrendered with an outstanding loan, the loan amount may become taxable to the extent it exceeds the policy’s cost basis.
Policy loans work best for families that want to preserve some death benefit while accessing cash for care. The parent takes a loan against a portion of the cash value, uses the funds to pay for the care home, and the remaining death benefit (minus the outstanding loan and interest) still passes to the beneficiaries.
The limitation is that policy loans are only available on policies with cash value, which means whole life and universal life. Term life policies have no cash value and cannot be borrowed against (though they may have other value through a life settlement if the face amount is large enough and the insured meets certain health and age criteria).
Cash surrender
The simplest option is also the least strategic: surrendering the policy for its cash surrender value. The policyholder contacts the insurance company, cancels the policy, and receives the cash surrender value minus any outstanding loans and surrender charges.
Cash surrender is fast and uncomplicated. The money typically arrives within two to four weeks. But for policies with significant face value, surrendering is often the worst financial choice. The cash surrender value of a whole life policy is almost always less than what the policy would bring through a life settlement, and significantly less than the death benefit that would eventually be paid.
Consider cash surrender as a baseline. If the cash surrender value is $40,000 but a life settlement would yield $80,000, surrendering leaves $40,000 on the table. The right comparison is to get quotes for both options before deciding.
For term life policies, there is no cash surrender value. The only options are to convert the policy (if a conversion option exists), sell it through a life settlement, or let it lapse.
How to evaluate the options
The right choice depends on the specific policy, the parent’s health, and the family’s broader financial picture. Here is a framework for thinking through it.
Start with the policy details. Pull out the policy documents or call the insurance company. You need to know: the type of policy (term, whole life, universal life), the face value, the current cash surrender value, the annual premium, any outstanding loans, and whether the policy includes an accelerated death benefit provision.
Assess the parent’s health. A terminal diagnosis (life expectancy of two years or less) opens the door to viatical settlements and accelerated death benefits with the most favorable tax treatment. A chronic illness that meets the two-ADL or cognitive impairment threshold qualifies for accelerated death benefits under most policies. A parent who is aging but not terminally or chronically ill may still qualify for a life settlement based on age and general health.
Consider the family’s Medicaid timeline. If the parent will need Medicaid within the next five years, any lump sum received from a life insurance transaction will affect the Medicaid look-back analysis. The timing of the transaction, the way the proceeds are spent, and the structuring of any remaining assets all matter. Do not access life insurance proceeds without talking to an elder law attorney if Medicaid is a possibility.
Compare the options side by side. For a whole life policy with both cash value and a significant face value on a chronically ill insured, the family might have four simultaneous options: accelerated death benefit ($125,000 to $200,000, tax-free), life settlement ($50,000 to $125,000, partially taxable), policy loan ($40,000 to $80,000, not taxable), or cash surrender ($40,000 to $80,000, partially taxable). The numbers will vary, but getting quotes for each option takes a few weeks and costs nothing.
Factor in the death benefit. Every option except a policy loan with continued premium payments reduces or eliminates the death benefit. For some families, preserving the death benefit for a surviving spouse or for final expenses is an important priority. For others, the immediate need for care funding outweighs the future death benefit. This is a family conversation, not a purely financial calculation.
When this approach makes sense
Using life insurance to fund care is most appropriate when:
- The parent has a policy with significant face value ($100,000 or more) or substantial cash value
- Other funding sources (Social Security, family contributions, VA benefits, long-term care insurance) do not fully cover the cost of care
- The parent qualifies for an accelerated death benefit due to chronic or terminal illness
- The family has considered the impact on beneficiaries and agrees that funding care is the priority
- The Medicaid implications have been reviewed by a professional
It is less appropriate when:
- The policy face value is small (under $50,000), where transaction costs may consume too much of the proceeds
- The parent is healthy and unlikely to qualify for accelerated benefits or a favorable life settlement
- The family plans to apply for Medicaid soon and has not consulted an attorney about the asset implications
- The death benefit is critical for a surviving spouse’s financial security
Related financial options
Life insurance conversion is one piece of a larger funding puzzle. Most families paying for residential care use a combination of sources. Our seven ways to pay guide covers the full landscape, including VA Aid and Attendance, Medicaid HCBS waivers, and long-term care insurance. For families thinking about what happens when savings run thin, our guide on what happens when the money runs out covers the Medicaid transition process.
If the parent also owns a home, a reverse mortgage is another asset-based option worth comparing, though it has its own set of limitations.
The next step
If your parent has a life insurance policy and the family is trying to figure out how to pay for care, the most useful action this week is to locate the policy documents. Call the insurance company and ask for a current statement that includes the policy type, face value, cash surrender value, outstanding loans, and whether the policy includes an accelerated death benefit rider.
With that information in hand, you can make informed comparisons. If the face value is over $100,000 and the parent qualifies medically, get a life settlement quote from a licensed broker. If the policy has cash value, ask the insurer about the policy loan terms. If the parent meets the chronic illness definition, file for the accelerated death benefit.
And before any transaction closes, sit down with an elder law attorney who can review the tax and Medicaid implications for your family’s specific situation. The consultation typically costs a few hundred dollars and can save the family tens of thousands in avoidable tax or Medicaid consequences. Our guide on choosing between an elder law attorney and a Medicaid planner can help you find the right professional.