When you were younger, a life insurance policy with a large death benefit made sense. You had a mortgage. Mouths to feed. Bills to pay. The loss of the primary breadwinner would have been devastating to your family’s financial security.
Today, things are different. The mortgage has been paid, the kids can support themselves, and your financial situation has never been brighter.
In these situations, clients often ask me what they should do with an old life insurance policy they no longer need. Often, it’s a whole life or universal life policy that has considerable cash value and requires a hefty monthly premium that seems to go on forever.
In my last post, I had cautionary guidance: “Are you absolutely, 100% sure you really, really don’t need your old life insurance policy any more?”
If you answered, “Yes!” to that question, then there are at least 7 things you could do to with that old cash value life insurance policy.
First, quit paying premiums. No one minds the idea of an insurance company providing a large pile of tax-free cash to their family after they die. It’s the life insurance premiums, people must pay in the meantime, that they have a problem with. If your life insurance has a significant cash value, you may be able to simply stop paying premiums. That way, you get to stop paying premiums and they may still receive a life insurance death benefit.
If there is enough cash value in your policy, your policy may stay in force indefinitely – even without premium payments. More likely, however, the policy will eventually lapse, as the cost of insurance required to keep the policy in force will eventually eat away that cash value, causing the policy to expire at some point in the future.
That future date, however, may not be for many years. To determine how long your policy will last if you cease paying premiums, ask your agent or contact the insurance company directly. They should be able to provide something called an “in-force illustration” which will show how long the policy lasts under various guaranteed and assumed circumstances.
Second, reduce the death benefit. Unless you have significant cash value, your life insurance will eventually lapse if you don’t make any more premium payments. However, if you reduce the death benefit you may extend the life of your policy significantly without requiring any additional premiums.
A reduced death benefit lowers the actual cost of the insurance since the insurance company has less risk (i.e. they must shell out less money when you die). Reduce it enough and your new, smaller life insurance policy could become a “paid-up” policy in which the existing cash value is enough to pay the cost of insurance indefinitely. This allows your policy to continue offering a death benefit to your family.
Your insurance agent or financial advisor can help you figure out what the new policy death benefit should be and how long it will last if you make no additional premium payments.
Third, consider transferring your old life insurance policy to a new company. This step is a little more drastic, but the insurance industry has changed a lot in the past 20 years. Sometimes new policies are based on newer, more accurate actuarial tables that estimate your life expectancy to be longer than what your old policy is based on.
If your existing insurance company can’t offer a competitive product, it may pay to shop around. Transferring the cash value from your old policy to a new policy is a simple process. Known as a 1035 exchange, insureds (that’s you) can transfer their cash value from one policy to another without adverse tax consequences. The new policy is issued with the cash value from the old one. The new policy can be designed with a lower death benefit allowing you to reduce or even eliminate the premium payments.
Another option – transfer your life insurance cash value to an annuity. Also considered a 1035 exchange, this option works best if you have significant cash value with a sizable taxable gain. Transferring the cash value to an annuity avoids this tax and allows the cash value to continue to grow tax deferred until you begin making distributions (your original principal is always tax free, but the interest will eventually be taxable).
Of course, annuities and new life insurance policies come with new surrender periods, a slew of additional expenses, possible taxes and other considerations to keep in mind. Be sure to seek advice where appropriate and read the fine print before signing on the dotted line.
Fourth, transfer ownership to someone else. No one says you have to be the one to continue making premium payments. Let someone else carry the load. If the beneficiary is an adult other than your spouse –for most people this would be their adult kids – maybe they can pick up where you leave off. If they are the beneficiary, they may want to keep the policy in force. If so, perhaps they would also be willing to continue making the premium payments.
Changing ownership isn’t a difficult process, but there could be some issues with gifting a large asset. The asset in this case is the cash value in the policy. The IRS allows individuals to gift up to $14,000 per year to another person without any gift tax consequences. If you are married or your adult kids are married, you may be able to gift more.
The downside with this strategy is that your adult kids could cash out the policy, fail to make premium payments or allow the policy to lapse anyway. This strategy works best when the future owner(s) of your policy have the cash flow (and foresight!) to continue making premium payments. Before you transfer ownership of your life insurance policy have a conversation with the other party about your expectations.
Fifth, change your beneficiaries. Your life insurance will provide a tax-free lump sum of cash to whoever is listed as the beneficiary on your policy. Maybe you and your spouse no longer have a need for the insurance but what about your adult kids, your grandkids, or other family members or people you love that you would like to help in future? Maybe you have a child or adult child with special needs or grandkids that hope to go to college one day? Your old life insurance policy could be used to provide the financial resources to meet these goals.
Sixth, donate your life insurance to charity. If you currently provide a financial gift to your church or favorite charities, your life insurance cash value or even the death benefit could be used to ensure this will happen. When you donate your life insurance policy to a 501(c)3 non-profit, you receive an income tax deduction for your cash value. If the non-profit becomes the new owner of the policy, they are free to cash it in or change the beneficiary to themselves and continue to make premium payments.
Since you are still the insured, the policy won’t pay a death benefit until you die, but the death benefit will likely be much larger than the cash value the non-profit would receive if they cash out the policy upon receipt of your gift.
If you want to really leverage your life insurance for charitable purposes and retain maximum control over your charitable giving, consider keeping the policy in your name and simply changing the beneficiary to the non-profit of your choice. That way you retain control of the cash value and future death benefits (in case you change your mind or want to pick a different charitable beneficiary later).
Seventh, cash it out and reinvest or spend the proceeds. Hey, it’s your money and your life. There is no rule that says you should keep your life insurance forever. If you really don’t need it anymore and none of the above alternatives appeal to you, there is nothing wrong with using the cash value for whatever purpose you like: payoff a mortgage, update your home, buy a car or boat, treat the family to a once-in-a-lifetime vacation.
Heck, you could even go crazy and invest the cash value in the stock market, open some type of college investment account or use it to pay the taxes on your Roth IRA conversion. If you decide to do that, let me know. I have a few ideas along those lines as well.
So, if you have decided that you are absolutely, 100% sure you really, really don’t need your old life insurance policy any more you have some options. Canceling a life insurance policy is a major financial decision with significant consequences for your family. Before you do anything be sure to consult with your insurance agent, financial planner and other appropriate professionals.