Whole Life Insurance and Long-Term Care: How Cash Value Works, the Tax Rules and the Medicaid Catch

What Is Whole Life Insurance?

Whole life insurance is a type of permanent life insurance. As long as premiums are paid, it stays in force for your whole life and pays a death benefit when you die.

Three things are usually guaranteed:

• The premium. It stays level for life.
• The death benefit. The amount your beneficiaries receive.
• The cash value. A savings component that grows at a guaranteed minimum rate. Some policies from mutual companies also pay dividends, which can add to cash value but are not guaranteed.

Here is the uncomfortable truth. Most people buy whole life for the death benefit. They never think about long-term care. Then care starts, and that policy becomes one of the first places the family looks for money. It is also one of the first things Medicaid counts.

Whole life can be part of a care plan. It just works very differently from long-term care insurance.

How Whole Life Insurance Works

1. You buy the policy and pass health underwriting. You agree to a level premium, usually paid for life or until a set age.
2. Part of each premium pays for the insurance. Part goes to cash value. Early premiums also cover commissions and fees, which is why cash value starts slowly.
3. Cash value grows tax-deferred at a guaranteed minimum rate, plus dividends if the policy pays them.
4. You can use the cash value while you are alive by borrowing against it, withdrawing part of it or surrendering the policy for it.
5. At death, your beneficiaries receive the death benefit, minus any unpaid loans and interest.

5 Ways to Use Whole Life to Pay for Care

1. Policy loans

You borrow from the insurance company using your cash value as collateral. There is no credit check and no required repayment schedule. The policy stays in force.

But it is still a loan. Interest builds. Anything not repaid is subtracted from the death benefit. If the loan plus interest ever grows larger than the cash value, the policy can lapse. That can end the coverage and create a tax bill.

2. Withdrawals

Some policies let you take out part of the cash value, often by cashing in dividend-purchased additions. Withdrawals reduce the cash value and the death benefit. Unlike a loan, they are not paid back.

3. Surrendering the policy

You cancel the policy and take the cash surrender value. The money is yours to use for care. The death benefit is gone. In the early years, surrender charges can make this a costly choice.

Before you surrender, compare it with a life settlement, which sells the policy to a third party for a cash lump sum. A settlement can pay more than the cash surrender value. See the Life Settlement card in Financial Tools.

4. Accelerated death benefit or chronic illness rider

Many whole life policies offer a rider that pays part of the death benefit early if you are terminally or chronically ill. Read the fine print. Some riders require the condition to be permanent. Some discount the payout based on life expectancy. Ask how much it would actually pay per month.

5. Exchanging the policy for long-term care coverage

Since 2010, the Pension Protection Act has allowed a tax-free 1035 exchange of life insurance cash value into qualified long-term care coverage, including many hybrid life/LTC policies. If you have an old policy you no longer need for the death benefit, this can turn it into dedicated care coverage. You must still qualify medically, not every insurer accepts 1035 exchanges, and the money must move directly between insurance companies.

The question is not "Do we have a policy?" The question is "Which way of using it leaves the most for care, and the most for the family?"

Tax Rules You Should Know

• Cash value grows tax-deferred. You pay no tax on growth while it stays in the policy.
• Policy loans are generally not taxable as long as the policy stays in force and is not a modified endowment contract.
• Withdrawals are generally tax-free up to what you paid in premiums (your "basis"). Amounts above that are taxable.
• Surrenders are taxable to the extent the cash you receive is more than the premiums you paid, according to the IRS.
• Lapse with a loan can be the worst surprise. If a policy lapses with a loan larger than your basis, the difference can be taxable income, even though you receive no cash.
• Modified endowment contracts (MECs). A policy funded too quickly can become a MEC under 26 U.S.C. § 7702A. Loans and withdrawals from a MEC are taxed as gains first and may carry a 10% penalty before age 59½.
• Death benefits paid to beneficiaries are generally income-tax-free.

Talk with a tax professional before you borrow, withdraw or surrender.

Whole Life and Medicaid: The Catch Most Families Miss

Long-term care can drain savings fast. When the money runs out, Medicaid is often what pays. To qualify, a person must be at or under the state's asset limit, which is typically $2,000 for an individual. Limits vary by state. See your state's rules in LTCareNav's Medicaid Long-Term Care Guide.

Here is where whole life gets complicated.

Cash value usually counts. Medicaid generally follows the federal SSI rule: if the total face value of all life insurance policies on a person is $1,500 or less, the cash value is not counted. Above that, the cash surrender value counts as an asset (Social Security Administration). Rules can vary by state. Term life insurance has no cash value, so it generally does not count.

That means a policy with $30,000 in cash value can keep someone from qualifying for Medicaid until that value is spent down.

Giving the policy away can trigger a penalty. Transferring ownership to a child counts as a transfer of assets. Medicaid reviews transfers made during the look-back period, which is 60 months in most states (CMS). California uses 30 months. A transfer in that window can create a penalty period with no Medicaid coverage.

There are planning options. Depending on the state, families may use cash value to pay for care, prepay funeral costs through a funeral trust, which is exempt from Medicaid asset limits (see the Funeral Trust card in Financial Tools), or restructure the policy. These moves have rules and deadlines. Talk with an elder law attorney before you change, cash in or transfer a policy. Find one in the LTCareNav Care Connections.

The uncomfortable truth: the policy you bought to protect your family can be the asset that delays your care benefits. Planning early keeps it working for you.

Already Own a Whole Life Policy? Check These 6 Things

Pull out the policy, or call the insurance company, and find:

• The cash surrender value today. Not the death benefit. What you would actually receive.
• Any outstanding loans and the interest rate.
• Whether the policy is a modified endowment contract.
• Riders. Is there an accelerated death benefit, chronic illness or long-term care rider? What does it pay?
• The total face value of all policies on the person, for Medicaid purposes.
• Who owns the policy and who the beneficiaries are.

Then enter the numbers in the Affordability Calculator as part of your liquid assets to see how far they stretch.

Whole Life vs. Term vs. Hybrid vs. Traditional LTC Insurance

Compare every option side by side in Financial Tools, including the Whole Life Insurance and Hybrid Life/LTC Policy cards.

What Does Care Cost Compared With Your Cash Value?

A policy's cash value can sound like a lot of money. Care costs put it in perspective. Here are the national medians, based on the 2025 CareScout Cost of Care Survey.

National median long-term care costs

Source: the 2025 CareScout Cost of Care Survey, as shown on LTCareNav Care Costs by State. Last updated March 2026.

Now compare that with how long care can last. According to the U.S. Administration for Community Living, someone turning 65 has almost a 70% chance of needing long-term care. Women need it for 3.7 years on average and men for 2.2 years. About 20% will need it for more than five years.

A whole life policy can buy time. On its own, it rarely covers the whole cost. Costs also vary a lot by state, sometimes two to three times. See the numbers where you live on Care Costs by State.

Pros and Cons of Whole Life for Long-Term Care

Advantages

• Guaranteed cash value growth. It builds over time regardless of the market.
• Access without a credit check. Policy loans are available when you need them.
• Tax-advantaged. Growth is tax-deferred, and loans are generally not taxed while the policy stays in force.
• Flexible. The money can be used for any kind of care, including family caregivers, home modifications or costs a long-term care policy will not cover.
• Death benefit for estate planning. If you never need care, your heirs receive it.
• Level premiums for life. No rate increases.

Considerations

• Premiums are much higher than term life insurance for the same death benefit.
• Slow cash value growth early on. In the first several years, cash value is often less than the premiums you paid.
• Surrender charges. Cashing in early can mean getting back much less than you put in.
• Loans reduce the death benefit if unpaid, and a lapse can create a tax bill.
• Not designed for long-term care. There is no benefit trigger and no dedicated care pool unless you add a rider.
• Medicaid counts the cash value in most cases, which can delay eligibility.

Who Whole Life Fits

Whole life may be worth a closer look if:

• You want a death benefit that lasts your whole life.
• You can afford the premium for decades without strain.
• You want a flexible pool of money that could help with care, without a "use it or lose it" policy.
• You have already maxed out other savings and want a conservative, tax-deferred option.

It may not be the right fit if:

• Your main goal is paying for long-term care. A hybrid or traditional LTC policy usually buys more care coverage per dollar.
• The premium would strain your budget or drain your emergency fund.
• You have limited assets and are likely to need Medicaid.
• You are older or in poor health, which makes premiums high and cash value slow to build.

The question is not "Is whole life a good product?" The question is "Is it the right tool for our care risk, our budget and our family?"

How to See If Whole Life Fits Your Care Plan in 4 Steps

1. Project the care. Use the Health Trajectory tool to see what level of care may be ahead and for how long.
2. Price the care where you live. Look up home care, assisted living and nursing home costs on Care Costs by State.
3. Check your budget and your runway. Use the Affordability Calculator to see how far income and savings go, your monthly gap and how much premium you can carry without strain.
4. Model the policy. Open the Whole Life calculator in Financial Tools. Choose the situation closest to yours (monthly income, liquid assets, home value and age range), then adjust the monthly premium and the number of years held. You will see an estimated cash value, what percent of your premiums it equals, an estimated death benefit and how likely you are to qualify. Create a free account to enter your real numbers. Then take them to a licensed insurance professional for real illustrations.

The calculator uses conservative estimates. Actual values depend on your age, health, the carrier and dividend performance. If you surrender in the first five years, actual cash value will be much lower because of surrender charges and front-loaded commissions. It is a starting point for the conversation, not a quote.

Questions to Ask Before You Buy or Borrow

• What is the guaranteed cash value in year 5, 10 and 20? What is projected with dividends?
• What are the surrender charges, and when do they end?
• What is the policy loan interest rate? Is it fixed or variable?
• What happens to the death benefit if a loan is not repaid?
• Is there an accelerated death benefit, chronic illness or long-term care rider? Does the condition have to be permanent? Is the payout discounted?
• Could this policy become a modified endowment contract?
• What is the carrier's financial strength rating?
• How would the cash value affect Medicaid eligibility in my state?
• Would a 1035 exchange into a hybrid or long-term care policy serve us better?

Find vetted financial professionals and elder law attorneys in the LTCareNav Care Connections.

Frequently Asked Questions

A Policy Is Not a Plan

A whole life policy can be a real asset when care starts. It can also be the asset that delays Medicaid, shrinks the inheritance or creates a tax bill nobody saw coming.

The difference is planning. Know what the policy is worth, how you would use it and how it fits with everything else.

• Model a policy with the Whole Life calculator, and compare it with every other option in Financial Tools.
• Find out how long your money will last with the Affordability Calculator.
• See how much care may be ahead with the Health Trajectory tool.
• Check care costs where you live with Care Costs by State.
• Connect with a vetted professional in LTCareNav Care Connections.

It is free for families.

Sources

• U.S. Administration for Community Living: How Much Care Will You Need?
• Medicare.gov: Long-Term Care
• LTCareNav Medicaid Long-Term Care Guide
• Social Security Administration POMS SI 01130.300: Developing Life Insurance Policies
• CMS: Transfer of Assets in the Medicaid Program
• IRS Publication 525: Taxable and Nontaxable Income (Life Insurance)
• 26 U.S.C. § 7702A: Modified endowment contract defined (Cornell LII)
• American Association for Long-Term Care Insurance: 1035 Exchanges for Long-Term Care Insurance
• LTCareNav Care Costs by State (the 2025 CareScout Cost of Care Survey, updated March 2026)

LTCareNav provides general educational information, not insurance, legal, tax or financial advice. Policy features, tax rules and Medicaid rules vary by carrier and state and change over time. Talk with a licensed insurance professional, a tax advisor and an elder law attorney about your situation.