Many new senior living residents use equity from the sale of a home to cover most or all of their move into senior living. But some people no longer own a home or sold their house earlier when downsizing to an apartment, and now must consider other ways to fund the move. This choice is especially important for those moving into a continuing care retirement community (CCRC or “life plan community”), which often requires a sizable entry fee in exchange for priority access to a continuum of care and other potential benefits.
One funding option some older adults consider is tapping the cash value of a permanent life insurance policy. Many people purchased policies years ago that have accumulated significant cash value. If life insurance coverage is no longer needed, using that accumulated cash to cover a senior living move may be an option worth evaluating.
The life insurance policy options
Please note: using cash value from a life insurance policy is a decision you should discuss with a financial professional and a tax advisor. This content is informational and not personal financial advice.
To understand how withdrawals or loans against a policy work, it helps to know why cash-value policies exist and how they accumulate funds.
There are two main categories of life insurance: term life insurance and permanent (cash-value) life insurance.
Term life insurance is generally the least expensive option. It covers a specific period—commonly 10, 20, or 30 years—and does not accumulate cash value. If you still need coverage when the term ends, you must buy a new policy, typically at a higher premium because of increased age or health changes. Term insurance is usually best for temporary protection needs.
Permanent (cash-value) life insurance is designed to last the insured’s lifetime as long as premiums are paid. It provides lifetime coverage and, if properly funded, typically avoids large premium increases later. Because permanent policies build a cash-value reserve, early premiums are higher than term policies to fund that reserve.
A closer look at how permanent cash-value policies work
Permanent life insurance works by having policyholders pay premiums that exceed the pure cost of insurance in early years. The excess is credited to a cash-value account that grows on a tax-advantaged basis.
As the insured ages and the pure cost of insurance rises, accumulated cash value helps cover the increasing cost so that the premium amount can remain level. If the cash value grows sufficiently—helped by compound growth—it can continue to provide support even while being used to subsidize rising insurance costs.
Whether a policy performs this way depends on the policy type and how well it was funded early on. Flexible-premium policies let you adjust premium amounts within limits, but if the policy is underfunded, cash value may never grow enough and could be depleted, which can result in a lapse of coverage.
Common types of permanent policies include:
- Whole life
- Universal life (UL)
- Variable universal life (VUL)
- Equity-indexed universal life
- Hybrid policies that include a long-term care insurance component
With variable universal life policies (VULs), the cash reserves are invested in sub-accounts that behave like mutual funds, so cash value will fluctuate with investment performance.
What to know before using life insurance to pay for senior living
Assuming a properly funded policy with available cash value, here are key considerations before tapping a permanent life insurance policy to pay for senior living:
Is there a surrender charge?
Most permanent policies impose a surrender charge if you cash out during an early period, which in some cases can last 20 years or more. Confirm whether a surrender penalty applies before cashing out.
Does the cash value exceed total premiums paid?
If cash value exceeds total premiums paid, withdrawals are generally treated on a first-in, first-out (FIFO) basis under current tax rules. Withdrawals are treated first as a return of cost basis, and once cost basis is exhausted, subsequent distributions are taxed as ordinary income. Tax due depends on your tax bracket. Unlike many retirement accounts, life insurance withdrawals are not subject to the age 59½ early withdrawal penalty—unless another rule applies (see modified endowment policies below).
Is the policy a modified endowment contract (MEC)?
Policies can be classified as modified endowment contracts if too much premium is paid early in an attempt to maximize tax-advantaged growth. If a policy is a MEC, withdrawals follow last-in, first-out (LIFO) treatment, meaning gains are taxed first, and distributions may be subject to the 59½ early withdrawal penalty.
Is the withdrawal full or partial?
A full withdrawal of cash value terminates the policy, which may be acceptable if coverage is no longer desired. Partial withdrawals typically reduce the death benefit on a dollar-for-dollar basis, although some policies allow small withdrawals without an immediate reduction. Alternatively, you can take a policy loan: loans generally do not change the death benefit while outstanding (unless unpaid at death), and loans are not taxable when taken. However, unpaid loan balances accrue interest and can cause the policy to lapse, potentially creating a taxable event.
Make an educated decision on paying for senior living with life insurance
There are several options for accessing cash from a life insurance policy you no longer need, but it’s important to understand potential tax consequences and how any decision might affect your estate plans. Life insurance often remains a highly efficient way to leave an inheritance because:
- Proceeds generally avoid probate when a beneficiary is named.
- Death benefits are typically received income-tax free by beneficiaries.
- Life insurance can provide a large death benefit relative to total premiums paid, offering significant value to heirs.
Another option is a life settlement, where a life settlement provider or broker purchases an existing policy. These buyers usually pay the policyholder more than the policy’s cash surrender value but less than the death benefit, then become the policy’s beneficiary. While legitimate life settlement firms exist, this area has both reputable providers and scams, so exercise caution and seek professional guidance.
In short: whether you cash out a policy to fund senior living, sell it via a life settlement, or keep it for heirs, doing due diligence is essential. Review your policy details and consult with an experienced attorney, financial adviser, and tax professional to understand how each option will affect your finances, taxes, and estate.