I have had many potential and existing clients come to me for advice on their old life insurance policy. They may say to me that it is an investment dog. Or they may be asking if they are paying too much for it. No matter what the story is, there are still several things to consider before you cash in a life insurance policy.
1. Life Insurance is still life insurance no matter how you squeeze it. Do you need the coverage?
My answer is always the same. Life Insurance is still life insurance no matter how you squeeze it. It can be used as asupplemental retirement income plan however you will need to always remember that you are still paying for life insurance. That being said you will always need to ask yourself if you need this coverage or not. One potential client came to me asking for $100,000 of life insurance. He was about 65 years old. I asked him if he still had a mortgage. He said no. In fact he had no debt. He was not married and his kids had great jobs. He had enough in the bank to easily cover final expenses. There was not going to be any estate taxes to pay as his estate was well under the limit. I told him, “You don’t need the life insurance”. I told him that I have a license to sell it but you don’t need it. He walked out without it.
2. Get your policy reviewed. The Cost of Insurance is cheaper now than it used to be.
After doing a needs assessment, if you come to the point of needing to keep the amount of life insurance that you have, you can have a policy review. As shown on the graph aside, we are all living longer. Because of this, you would expect that the cost per thousand has come down. Also with the development of some of the newer policies there may be a chance of higher returns to support more cash value thus providing the ability to exchange an old policy for a new one and have more coverage for the same price. In some circumstances I have actually been able to assist some folks move from one policy to another and receive up to 50% more coverage paying the same premium and lasting for the same amount of time or for life. I remember one of my client’s situations well. He was 52 at the time and had a $100,000 policy that was going to lapse at his age 77 on a current interest and mortality basis and it would go to age 70 on a guaranteed basis. We switched it to new policy using the newer mortality table available at that time and he now has a $150,000 policy paying the same premium and it will last to age 82 on a guaranteed basis. Wow, that is a 50% increase in benefits for the same premium. Why would he not do this?
3. You can exchange your policy without incurring a tax penalty.
At times I will do needs assessment and I will determine that my client does not need life insurance anymore like the 65 year old mentioned above. In that case you can just cash the policy out for its cash value and then look for a suitable investment. However if you find that you have put into this policy more than what it would cash out for then you might consider a 1035 exchange to an annuity, either indexed or variable depending upon your risk tolerance. The reason for the exchange is that you can carry the cost basis of the life policy over to an annuity. Let me share with you one example from one of my clients. He was age 55 at the time and after assessing his needs, we realized he did not need the life insurance he was paying for. It was originally set up for income replacement and now he and his wife had come to a point at which if he died his wife would not need any income replacement. They had rental income and her pension etc. We executed a 1035 exchange from a life policy with $17,000 of cash value that had a basis of $35,000. We moved it to a variable annuity where there would be upside potential and had an income rider available as well. The net result is he did not have to pay premiums for something that he did not need and he put the cash value to work in a tax deferred program. Since it had a basis of $35,000 he could then grow the $17,000 to that amount and if he cashed out would pay no taxes on the gain up to his basis. Now it is important to note with a variable annuity, past performance is not indicative of future results. Still, that is much better than just cashing it out when it was surrendered and losing that higher cost basis.