National Association of Insurance Commissioners Model Rule 275 That Reclassified Accelerated Death Benefits
For years, accelerated death benefits (ADBs) occupied a gray zone in insurance regulation. Insurers marketed them as tax-free advances against a policy's death benefit, but the underlying classification varied by state and carrier. Some treated ADBs as loans, others as partial benefit accelerations. Policyholders sometimes received unexpected 1099 forms at settlement, and estate plans built on assumed tax treatment fell apart. In 2021, the National Association of Insurance Commissioners (NAIC) adopted Model Rule 275 to standardize the classification. The rule, effective in most adopting states by 2023, redefined ADBs as partial death benefit accelerations, not loans. The change rippled through tax treatment, Medicaid planning, and agent disclosure practices. But did it go far enough? And why does so much conventional advice still reflect the old framework?
The Rule That Rewrote a Policy’s Tax Status
NAIC Model Rule 275 emerged from years of state-level regulatory confusion. Before 2021, insurers in different states classified ADBs inconsistently. Some carriers reported accelerated benefits as third-party loans, with interest accrual and repayment terms. Others treated them as outright benefit accelerations. The IRS had issued conflicting private letter rulings, and policyholders often had no clear guidance on whether their accelerated payout was taxable income or a tax-free advance.
The rule itself is straightforward: an accelerated death benefit is a partial payment of the death benefit before the insured's death, not a loan. As such, it does not create a debtor-creditor relationship. No interest accrues, and no repayment is required. The benefit reduces the remaining death benefit dollar-for-dollar. The NAIC intended the rule to eliminate the 'loan loophole' that allowed some carriers to avoid insurance reserve requirements and to give policyholders a consistent tax treatment across states.
Downstream, the reclassification had significant tax implications. Under IRC Section 101(g), amounts received under a life insurance contract due to the insured's death are generally excludable from gross income. The IRS had long held that accelerated death benefits paid to a terminally or chronically ill insured are treated as death benefits, not loans. But state-level classification as a loan sometimes triggered taxable income on the 'forgiven' portion. Model Rule 275 aligned state insurance law with federal tax treatment, reducing the risk of unexpected tax bills.
As of late 2024, roughly 40 states had adopted the rule or substantially similar provisions. The remaining states are expected to follow, though the timeline varies. The NAIC's model rule is not binding; each state must enact its own version. This patchwork creates residual ambiguity for policyholders who move between states or hold policies issued in non-adopting jurisdictions.
Before the Rule: The ‘Loan’ Loophole That Sold Policies
Before Model Rule 275, the 'loan' classification was a marketing tool. Insurers promoted ADBs as tax-free advances, often using language that suggested the payout was a loan that would be forgiven at death. This framing made the benefit attractive: policyholders could access cash without incurring debt, and the 'loan' would never need to be repaid. But the tax treatment was less clear.
Some carriers reported accelerated benefits as loans on their financial statements, allowing them to avoid setting aside full reserves for the accelerated portion. This practice drew scrutiny from state regulators, who worried about solvency risks. Policyholders, meanwhile, sometimes received a Form 1099-C (Cancellation of Debt) when the loan was forgiven at death, treating the accelerated amount as taxable income. The IRS's position was inconsistent: some private letter rulings treated the acceleration as a loan, others as a benefit payment.
The NAIC stepped in to standardize classification after a series of consumer complaints and state audits. In 2019, the NAIC's Life Insurance and Annuities Committee began drafting a model rule that would define ADBs as insurance, not loans. The goal was to eliminate the regulatory arbitrage that allowed carriers to treat the same product differently depending on their state of domicile.
The rule also addressed a practical problem: policyholders who received accelerated benefits under a loan structure sometimes had to pay interest on the 'loan,' reducing the net amount available. In some cases, the interest accrued at rates comparable to unsecured personal loans, eating into the benefit. By reclassifying the payment as a partial death benefit acceleration, the rule eliminated interest charges and made the full amount available to the insured.
What the Rule Actually Changed in the Fine Print
The most concrete change is in policy language. Before Model Rule 275, many policies included a section titled 'Accelerated Death Benefit Loan' or 'Living Benefit Loan.' After the rule, those policies must use language like 'Accelerated Death Benefit Payment' or 'Partial Death Benefit Acceleration.' The change is not cosmetic: it affects how the benefit is treated under state insurance codes and, by extension, federal tax law.
The rule also requires insurers to disclose that the accelerated benefit is not a loan and that no interest will accrue. Policyholders must receive a statement showing the reduction in the death benefit and any remaining cash value. The disclosure must be signed by the policyholder, acknowledging that the benefit may affect eligibility for means-tested government programs like Medicaid.
Timing matters. The NAIC adopted the model rule in 2021, but most states did not enact it until 2023 or later. Policies issued before the effective date in a given state are generally grandfathered, meaning they may still use loan language. Policyholders with older policies should check their contract language; if it says 'loan,' the old tax treatment may still apply.
IRS Notice 2023-43, issued in response to the NAIC rule, confirmed that the IRS would treat accelerated death benefits paid under a state-compliant policy as excludable under Section 101(g), provided the insured is certified as terminally or chronically ill. The notice also clarified that the exclusion applies regardless of whether the policy uses loan language, as long as the benefit is in substance a death benefit acceleration. This aligns federal tax treatment with the NAIC's classification, reducing the risk of double taxation.
Why the Conventional Advice on ‘Living Benefits’ Is Stale
Many financial advisors and insurance agents still cite pre-2021 tax memoranda and treat accelerated benefits as loans. A common piece of advice: 'Accelerated death benefits are tax-free because they are treated as a loan that is forgiven at death.' That advice is now outdated in adopting states. The loan treatment no longer applies, and the tax exclusion is based on the insured's medical condition, not the loan structure.
The change also affects estate planning. Under the old loan structure, the accelerated benefit reduced the death benefit but did not affect the policy's cash value or the insured's ownership rights. Under the new classification, the acceleration is a partial surrender of the death benefit, which may trigger a reduction in cash value and affect policy loans or withdrawals. Policyholders who planned to use the cash value for other purposes may find their options limited after acceleration.
Medicaid eligibility calculations also shifted. Before the rule, some states treated accelerated benefits as loans, meaning the cash received was not counted as income or an asset for Medicaid purposes. After the rule, the benefit is treated as a partial death benefit payment, which may count as an asset in the month received. Policyholders approaching Medicaid eligibility should consult an elder law attorney familiar with their state's rules.
Advisors must update their disclosure language. The NAIC model rule requires that policyholders be informed that the accelerated benefit may affect eligibility for government benefits and that the benefit reduces the death benefit. Many advisors still use old disclosure forms that reference 'loan' treatment. Using outdated forms could expose advisors to liability if a policyholder relies on incorrect tax advice.
For more on how policy definitions can shift benefits, see our article on disability policy fine print.
The Revisionist Take: Rule 275 Didn’t Go Far Enough
Critics argue that Model Rule 275, while a step forward, left significant gaps. The rule applies only to traditional accelerated death benefits for terminal or chronic illness. It does not cover chronic care riders that pay benefits for long-term care needs without a terminal diagnosis. Those riders often straddle the line between life insurance and long-term care insurance, and their classification remains ambiguous.
Hybrid policies—life insurance with a long-term care rider—are particularly problematic. Some carriers classify the long-term care benefit as an accelerated death benefit, while others treat it as a separate rider with its own tax treatment. Model Rule 275 does not address these hybrid products, leaving carriers free to choose the classification that minimizes their reserve requirements.
The rule also lacks federal codification. It is a model law, not a federal regulation. Each state must adopt its own version, and the IRS's guidance in Notice 2023-43 is not binding on states that have not adopted the model rule. Policyholders in non-adopting states may still face the old loan treatment, creating a geographic disparity in tax outcomes.
Consumer advocates point to residual ambiguity in contract language. Some carriers have rewritten their policies to comply with the model rule but have added provisions that reintroduce loan-like features, such as 'interest adjustments' that reduce the accelerated benefit if the insured lives longer than expected. These adjustments are not interest in the traditional sense, but they function similarly, reducing the net benefit over time.
For a look at how insurers reclassify conditions, see chronic illness reclassification.
Practical Trade-Offs for Policyholders
Even with the rule's improvements, policyholders face trade-offs. Accelerating a death benefit reduces the amount paid to beneficiaries. For a policy with a face value of, say, US$ 500,000, accelerating US$ 100,000 leaves only US$ 400,000 for heirs. If the insured lives longer than expected, the reduced death benefit may not cover final expenses or estate taxes. Policyholders should weigh the immediate need for cash against the long-term impact on their beneficiaries.
Another trade-off involves cash value policies. Whole life and universal life policies accumulate cash value that can be borrowed or withdrawn. Accelerating the death benefit may reduce the cash value proportionally, limiting access to funds for other needs. For example, if a policy has a cash value of US$ 50,000 and the death benefit is reduced by 20%, the cash value may also drop by roughly 20%, leaving US$ 40,000 available. Policyholders who rely on cash value for retirement income or emergency funds should consider alternatives, such as policy loans or withdrawals, before accelerating the death benefit.
Tax treatment also depends on the insured's condition. Under IRC Section 101(g), only terminally ill (life expectancy 24 months or less) or chronically ill (unable to perform two of six activities of daily living for 90 days) individuals qualify for tax-free treatment. If the policy allows acceleration for a critical illness that does not meet these criteria—such as a heart attack with full recovery—the benefit may be taxable as ordinary income. Policyholders should obtain a certification from a licensed physician before accelerating benefits to ensure tax-free treatment.
State Medicaid rules vary widely. In some states, an accelerated death benefit is treated as an asset in the month received, potentially disqualifying the policyholder from Medicaid. In others, it may be considered income. The NAIC model rule does not dictate Medicaid treatment, leaving that to each state's Medicaid agency. Policyholders should consult a qualified elder law attorney to understand the impact in their state.
How Policyholders Should Read Their Contracts Now
If you own a life insurance policy with an accelerated death benefit rider, the first step is to check the language. Look for the words 'acceleration' or 'partial death benefit' versus 'loan' or 'advance.' If the policy uses 'loan' language, it may be grandfathered under the old rules, and you should ask your carrier whether the policy has been amended to comply with Model Rule 275.
Request your carrier's state filing approval letter. Insurers must file their policy forms with state insurance departments, and the approval letter will indicate whether the policy has been reviewed for compliance with the model rule. If the carrier cannot provide such a letter, or if the letter predates 2023, the policy may not be compliant.
Compare the tax treatment under IRC Section 101(g). The IRS exclusion applies only if you are certified as terminally ill (life expectancy of 24 months or less) or chronically ill (unable to perform at least two activities of daily living for 90 days). If you accelerate benefits for another reason—such as a critical illness that is not terminal or chronic—the tax treatment may be different. Some policies allow acceleration for heart attacks, strokes, or cancer diagnoses, but those benefits may be taxable as income unless the insured meets the Section 101(g) criteria.
Update beneficiary designations after acceleration. Because the death benefit is reduced by the accelerated amount, your beneficiaries will receive less than the original face amount. If you have multiple beneficiaries, you may need to adjust their shares to reflect the reduction. Some policies allow you to designate a specific percentage of the death benefit to be accelerated, preserving the original allocation for the remaining benefit.
Seek advice only from advisors who cite Model Rule 275. If your agent or financial planner still refers to accelerated benefits as loans, they may be relying on outdated information. Ask whether they have updated their training to reflect the NAIC rule and IRS Notice 2023-43. A knowledgeable advisor should be able to explain how the rule affects your specific policy and state of residence.
For more on how benefit structures affect payouts, see annuity broker commissions.
Disclaimer: This article is for informational purposes only and does not constitute personalized legal, tax, or financial advice. Consult a qualified professional regarding your specific situation.
