Your clients are empty nesting. In reviewing their situation, you come across a cash-value life insurance policy they purchased a long time ago. Now that the kids are gone (along with the supposed need for the insurance), the clients are wondering if they can either cash it out or let it lapse.
Before you answer, consider these reasons to hold it:
1. They might still need it.
Even a couple who seems to be financially-independent will find that an “unneeded” life insurance death benefit may actually come in handy down the road.
Start with the fact that when the first member of the couple dies, the lesser of their two Social Security checks will disappear, and there may be a reduction or elimination of any retiree pension checks. The survivor’s expenses, however, will probably not decrease as much as the monthly income does.
The life insurance proceeds could also help replenish savings exhausted by spending in retirement, be it for a long-awaited trip or for uncovered health care and nursing home expenses. In fact, some policies might have an option to use some or all of the death benefit to pay for costs related to certain kinds of health care.
2. Keep it in the family.
A policy that’s almost a nuisance to the current owners could be quite valuable to others near and dear to the insured.
Descendants might like the idea of inheriting the tax-free proceeds, whether it’s for the money itself, or to add liquidity and flexibility to an estate that might otherwise lack those attributes.
In fact, it may even be advantageous to have the younger generations of the family pay any premiums needed to keep the policy in force.
3. Give it away.
A charity favored by the client could also be interested in the policy. The easiest method to help out an organization is for the client to maintain ownership of the policy and name the charity as the eventual beneficiary.
Although there is no immediate tax advantage to this strategy, it allows the client to maintain access to the accumulated cash value, and change beneficiaries in the future, if necessary.
If the client is less interested in keeping the policy and more concerned with cutting taxes, he can donate the policy to the charity. The charity then becomes both the owner and the beneficiary, with the client remaining on as the insured. The client may be able to deduct the cash value of the policy, or the amount paid in premiums—whichever is less.
In addition, the donor may be able to deduct any premiums he pays in the future to keep the policy in force for the benefit of the charity.
4. It might be a good investment.
Depending on the policy as well as the insured’s health and life expectancy, leaving the tax-free death benefit to the beneficiary may be better than taking out whatever cash value may have accumulated so far.
Some clients with more money than time may even find that they’re getting a superior return on their investment by paying the premiums necessary to keep policy in force, rather than cashing it in or letting it wither and expire.
Even if the insured is in good health with no plans to pass away in the near term, it might make investment sense to hang on to an older policy.
For a fixed-rate policy, check the status of the current rate. Chances are that an older policy could still be paying 3 percent annually or more. (Often that’s the original minimum guaranteed rate.) That probably didn’t sound like much when the policy was purchased decades ago, but on a risk-reward basis, that’s a very attractive rate in today’s climate.
And although the safety of the insurance company is not up to FDIC levels, most insurers are stronger than the typical corporate or municipal bond issuer.
Variable policies may not have an attractive fixed-rate option available. But any desire to cash these in must be weighed against the potential income tax cost—especially if the cash value of the policy greatly exceeds the premiums paid.
5. They can have the policy and the money.
The clients may also want to consider keeping the policy in force, but borrowing against the accumulated cash value. The loan is usually tax-free, and unlike borrowing from a traditional lender, there is no need for an application or approval.
There may be interest charges on the money borrowed, and if/when the death benefit is paid, it will be reduced by the amount of the loan outstanding at the time. However, if the loan balance ever grows higher than the accumulated cash value, the policy may be terminated unless the clients repay some or all of the borrowed amount.
Keep in mind that borrowing from a policy that is considered a “modified endowment contract” can incur significant tax costs and penalties, so check with the life insurance company to determine the policy’s status.
There’s a good chance you don’t know everything you need to know to help clients evaluate their life insurance policies. But there are independent resources at your disposal—for a price.
The Consumer Federation of America (www.consumerfed.org) has a service that analyzes both current policies and prospective purchases. Usually the cost is no more than a few hundred dollars. The policy owner then receives a report on the options the client might have with a current policy, and would-be buyers will be alerted to any less-expensive choices available.
You can pay a little more to get more in-depth evaluation and consultation from an independent expert like Peter Katt (www.peterkatt.com) and Glenn Daily (www.glenndaily.com).
Although this process should be both careful and deliberate, the longer the clients take to decide, the more likely it is that the decision will be made for them.