Waiver of Premium, Policy Debt, and an Accelerated Death Benefit

Elimination period. The rider requires 6 consecutive months of total disability. Counting from the March onset, that period ends in September, so the waiver begins with the September premium and continues as long as she remains totally disabled.

Retroactive feature. Because the rider is retroactive to the onset of disability:

• The April and May premiums that came due after the disability began are waived - the policy does not lapse for nonpayment, because the waiver keeps it in force retroactively.
• The June through November premiums she actually paid are refunded or credited.

Caveats to check in the contract: if the grace period had already run and the policy had lapsed before the disability was established, the rider generally would not resurrect it. Also confirm the rider's own definition (own-occupation vs. any-occupation) and any terminal age for waiver, typically 65; she is 52, so age is not a problem. Her total cessation of work satisfies either definition.

The loan is not waived. The waiver covers premiums only. The $20,200 balance keeps accruing 6% interest and capitalizing at each anniversary, increasing policy debt and therefore reducing the net death benefit. Policy debt can eventually erode cash value, but the waived premium itself will not cause a lapse while the waiver is in force.

Amount. The carrier pays face amount minus policy debt:

$500,000 − $21,600 = $478,400

The waived premiums do not reduce the face amount - the policy is fully in force. Interest that capitalized up to the date of death is included in the loan balance that is subtracted.

Taxation. The proceeds are paid to a named beneficiary as a lump sum and are excluded from the beneficiary's gross income under IRC §101(a); the beneficiary owes no income tax on the gain.

Estate inclusion. Because Diane owned the policy and held all incidents of ownership, the full $500,000 (not the net amount) is included in her gross estate for federal estate tax purposes - relevant only if her estate exceeds the exclusion amount. If she had transferred ownership to an irrevocable life insurance trust more than three years before death, the proceeds would be outside the estate.

Timing detail. Interest the insurer pays the beneficiary from the date of death to the date of payment is taxable to the beneficiary as interest income.

Mechanics. An accelerated death benefit for terminal illness (prognosis of 12 months or less) typically pays a stated percentage of the face amount, here 50% = $250,000. Two structures exist:

• Discount method: the insurer pays less than $250,000, discounting for early payment. She receives less cash, and the remaining death benefit stays close to $250,000.
• Lien method: she receives the full $250,000, and that amount becomes a lien against the policy, so the remaining death benefit is reduced dollar-for-dollar.

What happens at death. Either way, the face amount available at death shrinks to about $250,000, and the outstanding loan of $21,600 (still accruing interest - acceleration does not freeze loan interest) is deducted. Under a lien structure the beneficiary would receive roughly $250,000 − $21,600 = $228,400, less any accrued interest.

Taxation. Accelerated death benefits paid to a terminally ill insured are generally excluded from gross income under IRC §101(g), the same as a death benefit. By contrast, chronic-illness acceleration is tax-favored only up to a per-diem limit - a distinction worth confirming before she elects.

Practical point. Check the rider's maximum acceleration (often capped at $250,000 or $500,000) and whether the acceleration is irrevocable; some riders bar further changes once elected.