When buying life insurance, the coverage kicks in as soon as you make your first payment.
Most policies pay out the full death benefit amount regardless of whether you pass three days after buying a policy or 30 years later. Life insurance plans with a graded death benefit, however, work differently. They do not pay out the full death benefit amount right away.
Guaranteed issue life insurance policies usually have graded death benefits. These plans involve minimal underwriting and, as such, are a good option for people who do not qualify for standard policies.
But before you sign up, take time to understand how graded benefit life insurance works so that you know exactly what you are getting into. Let's dive into the details.
How Does Graded Benefit Life Insurance Work?
Graded death benefit life insurance is a type of insurance coverage that pays a limited death benefit for a set period, usually two to three years after buying the policy.
The death benefit gradually increases as the time passes until it reaches the full amount specified in the contract. These policies do not require a medical exam, as they are designed for individuals with pre-existing conditions and seniors. Premium rates are based on only two factors: age and gender.
Typically, a life insurance policy with a graded benefit indicates either of the following:
- There’s a 2-year waiting period. If you pass while the policy is in the waiting period, the insured will only issue the premiums paid so far plus interest to the designated beneficiary.
- There’s a tired payout structure. For example, if your death occurs within a year of taking the policy, your beneficiary will receive only a part of the death benefit (like 25%). If you die in year two, the payout will be larger, say 50%. The full benefit amount will be paid only from year three onwards.
Accidental deaths, however, qualify for the full death benefit from Day 1 of your policy’s commencement date. After you survive the waiting period, your beneficiary receives the full amount, regardless of the cause of death.
Compared to traditional life insurance policies, graded death benefit plans have higher premiums and lower death benefits. However, the upside is that someone with a serious illness can get coverage that would otherwise be out of reach.
Who Needs Graded Benefit Life Insurance?
Guaranteed issue life insurance plans typically feature graded death benefits. Unlike standard life insurance, guaranteed issue life insurance involves neither a medical exam nor health questions. This means people with pre-existing conditions can easily get approval, as long as they meet certain age requirements. Most insurers won’t issue to you after age 80 and before age 40.
You may want to consider a policy with a graded benefit if you do not qualify for a standard life insurance plan on account of poor health. A guaranteed life insurance policy allows you to leave a small financial legacy or cover end-of-life expenses, like medical bills and funeral expenses.
Pros and Cons of Graded Benefit Life Insurance
Guaranteed issue life insurance allows people with health issues to secure guaranteed life insurance coverage. You do not have to take a medical exam or answer invasive health questions to prove eligibility. Approval is guaranteed to all those who meet the age requirements.
Nonetheless, as useful as guaranteed issue life insurance is, it has significant downsides. For one, you will pay more than a fully-underwritten plan because guaranteed issue life insurance is the most expensive type of life insurance.
Secondly, you cannot purchase a lot of guaranteed issue coverage, even if its high cost is not an issue. That’s because the coverage is typically capped at $25,000 or $50,000.
Graded Benefit Life Insurance vs. Traditional Life Insurance
Graded benefit life insurance plans are more expensive than traditional policies. They also have limited payouts, sometimes no more than $25,000, which is not the case with traditional life insurance. With the latter, you can buy as much coverage as you reasonably need.
In the case of graded benefit life insurance, the beneficiary is entitled to the full benefit amount only after the policy has been in place for a certain period, typically two or three years. In contrast, traditional life insurance plans pay the full amount from the start.
Typically, graded benefit plans are purchased only as a last resort by people with severe underlying health issues who cannot otherwise get life insurance. They have a much shorter approval process — often you can get the policy within 2-3 days — than traditional policies.
The Cost of Graded Benefit Life Insurance
The cost of graded benefit life insurance is two to three times the cost of comparable traditional life insurance plans.
Why are they so expensive?
The reason is simple: The insurer is taking a risk by writing you a policy without first learning anything about your current health or pre-existing illnesses.
Higher premium rates and a tired payout structure allow insurance companies to issue coverage to even applicants who are likely to pass within the next two or three years.
Having a life insurance policy with a graded benefit simply means your beneficiary will not receive the full death benefit if you pass from disease, illness, or old age within the first two or three years after taking the policy. Guaranteed issue plans, which do not require taking a medical exam, often have graded death benefits.
Consider such a plan if poor health disqualifies you from buying a standard term or permanent life policy.
Want to learn more about your insurance options? Schedule a free call with a Dundas Life licensed advisor today.
Frequently Asked Questions (FAQs)
What happens if I die within the waiting period of a graded benefit life insurance policy?
Graded benefit policies include a waiting period, usually two years. If you pass within this period, your beneficiary will get a tax-free benefit, but not for the full amount. Instead, they will receive the premiums paid till then plus interest or a portion of the death benefit, like 30%.
Does graded benefit life insurance build cash value?
Yes, it does. Graded benefit life insurance is simply a whole life insurance plan with a waiting period and a tired payout structure. In all other aspects, it is no different from a standard whole life policy. So your guaranteed issue policy will build cash value the same way other whole life plans do, i.e., at a rate fixed by the insurer.
What is the maximum coverage amount for graded benefit life insurance?
The maximum amount of protection you can buy with a graded benefit plan may vary by insurer. That said, usually the death benefit is capped at $25,000 or $50,000.
Can anyone be denied a graded benefit life insurance policy?
Guaranteed issue life insurance typically has graded benefits. Since guaranteed issue plans involve minimal medical underwriting, almost everyone who applies gets approval. One situation in which graded benefit life insurance can be denied is when you do not meet age requirements set by the insurer. Typically, life insurance companies do not write guaranteed issue plans to people who are over 80 or under 40 years of age.
Can a graded benefit life insurance policy be converted into a traditional life insurance policy?
No, you cannot convert a graded benefit plan into a standard life insurance policy. Though what you can do is apply for a medically-underwritten policy in case your health has improved significantly and, if approved, drop the existing policy.