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Outliving Your Life InsuranceSubmitted by Townsend Asset Management Corp. on May 3rd, 2016
You buy life insurance to protect your family in the event of your death. But what do you do when you have outlived the original intent of your policy? Your family is now grown and moved on, your investment assets have increased, your mortgage is small or paid off, and you’re wondering what to do with your old policy. You have a number of alternatives.
Do You Still Need Life Insurance Protection?
First, consider carefully why you acquired the life insurance in the first place, and determine whether you still need some or all of your insurance. If your investments are sufficiently large and you’ve paid off your debts, perhaps there is no economic reason to keep the insurance. On the other hand, if you have taken advantage of today’s low interest rates and pulled equity from your home, you may still have a substantial mortgage balance. In addition, through job losses, health problems or the market woes of recent years, your investments may not be quite what you earlier hoped for – so don’t be too hasty to drop your protection.
Change the Policy
Before discontinuing your policy, you might also consider ways to retain the policy, but reduce your annual cost. Your insurance company might lower the death benefit, which would reduce your annual premium. Alternatively, it might utilize your existing cash value to continue to provide you with a death benefit for a number of years in the future, without the necessity of making any future premium payments.
Surrender the Policy
On the other hand, if you’re convinced that you just don’t have a need for the life insurance, you can always simply surrender the policy. If it is a term-life policy there is no “cash surrender value”, so there is nothing to recoup upon surrender, except perhaps a few months of unearned premium that would be returned to you. If your term policy is a “level-term” and you still have some years to go before premiums ratchet up, you might consider retaining the policy until the end of the lower-premium period.
If your policy is a “cash-value” policy, you’ve built up a savings account within the policy that will be returned to you upon surrender. You may or may not owe income taxes upon surrender of a cash-value policy. Ask your insurance company what taxable income – if any – you would have upon surrender. In general, the sum of all the premiums you’ve paid into the policy becomes your “cost” or “tax basis” in the policy. If your surrender check exceeds this cost, the difference is taxable as ordinary income.
Alternatively, borrowing the cash value may result in a better tax situation than surrendering the policy, while still maintaining some degree of death benefit.
Exchange the Policy
If you have a cash-value policy and you’re facing a significant amount of taxable income if you surrender the policy, another option to consider is a non-taxable “1035” exchange of the policy into another life insurance policy or annuity contract. Moving your cash value into an annuity allows your money to continue growing tax-deferred while saving you the expense of any future life insurance premiums. In addition, an exchange into a new life or annuity “hybrid” policy that also has long-term-care benefits would be a tax-effective way of shifting your focus from insurance death benefits to long-term-care living benefits. However, before considering moving to a hybrid policy, first review your current policy to see if it already provides “accelerated death benefits” or “living benefits.”
Gift the Policy
If you have a favorite charity, you might also consider using your policy to benefit the charity. You could always continue owning and paying premiums on the policy, but naming the charity as the beneficiary. Alternatively, by donating your policy to the charity, you might receive an income tax deduction, approximately equal to the cash-surrender value of the policy.
Sell the Policy
A final option is to consider selling your policy. Known either as “viatical settlements” or “life settlements,” you would be selling your policy to a company for cash. Keep in mind that selling your policy may have tax consequences.
For any of these alternatives, I suggest you discuss them thoroughly with your spouse and financial advisors before making any final decision.
Gerald A. Townsend, CPA/PFS/ABV, CFP®, CFA®, CMT is president of Townsend Asset Management Corp., a registered investment advisory firm offering comprehensive wealth management expertise to its clients. Email Gerald@AssetMgr.com for more information. For the latest news and updates, follow Townsend's growing platforms on Linked In, Facebook and Twitter.