If you are over the age of 60 and are (or were) married with children, you may own life insurance that you purchased years ago. The life insurance industry sold (and still sells) life insurance to traditional families to protect them from financial insecurity in the event of an income-earning parent’s premature death.
For decades insurance agents promoted cash value (or “permanent”) life insurance – rather than term life insurance – as the best (and arguably only) way to protect the family and save for the future. Unlike term life insurance, which becomes more expensive over time or expires after a stated number of years (typically 10, 20 or 30 years), cash value life insurance was intended to remain in force for the entire life of the insured.
Term life insurance policies have a very low payout ratio (less than 1%) – the policies generally terminate before the insured passes away. But cash value policies in theory always pay out (unless the insured lets the policy lapse).
The premium payments for cash value life insurance are thus much higher than those for a term life insurance with an equivalent death benefit, because the insurance company needs to create and grow a reserve that will one day be large enough to equal the death benefit.
Many of our clients have one or more of these permanent life insurance policies and they occasionally ask us what they should do with them. We’ve shared below the thought process you can use to decide what to do.
The first question you should ask yourself is, “Do I still need life insurance?” Your immediate response might be, “I’m retired. My kids are grown. I don’t have a mortgage. Why would I need life insurance?” While life insurance is typically used to help replace income, pay off debts and/or fund large expenses (e.g. a child’s college education), it can certainly be used at the end of life to provide a financial benefit to family members, a religious organization, an educational institution, or other charitable entity.
Let’s assume that you don’t have any of these interests. What can you do with an old, unwanted cash value life insurance contract?
One option could be to “surrender” the policy and receive the cash surrender value in the policy. However, if the surrender value you receive is greater than the premiums paid, the difference will be taxed as ordinary income. If you are in a relatively low-income tax bracket, you may end up paying little income taxes on the surrender. So, this might be a very attractive option.
Another option would be to “exchange” the policy into a different insurance contract. The 1035 exchange rules (a section of the IRS tax code) allow the owner of a life insurance contract to transfer the policy into another life insurance contract, an annuity or even a hybrid insurance policy. These exchanges can be made tax-free, which can be very attractive if there has been a significant gain in your policy (the taxable gain, if any, is equal to the difference between the total cash surrender value less total premiums paid).
So, you could exchange your old life insurance policy into a no-load, low-cost annuity from a company like Nationwide, Vanguard or TIAA. You would no longer have the death benefit from the insurance policy. But you would preserve the value of the contract in another insurance vehicle that has tax advantages similar to life insurance. The value of the annuity will not be taxed until withdrawals are taken.
If you are interested in owning long-term care insurance, you could exchange your life insurance contract into a hybrid insurance product that provides both life insurance and long-term care insurance benefits. The policy would provide benefits for care, if needed, and a benefit at death.
Please contact us if you have an old life insurance policy and you would like to discuss what to do with it.