Earlier this month, I saw a great tweet from Financial Planner Carl Richards, author of the Behavior Gap:
In Fee-Only Financial Planning circles, it is a continual struggle to avoid blasting the insurance industry for their elaborate marketing of life insurance as anything other than insurance.
In working with clients in their 20’s all the way into their 90’s, we’ve seen countless examples of permanent life insurance sold to people who didn’t need it. Most of these are Whole Life policies that our clients come to us decades after purchasing, but while they are still paying premiums.
If you find yourself with an unnecessary, expensive Whole Life policy, you may feel like you don’t have any options. However, depending on your situation, there are several things you can do to turn this bad purchase into an advantageous option.
Good Options to Consider
1. Surrender the Policy
You may be in a situation where you do not have a life insurance need any longer and you want to stop paying for insurance all together. In this case, you can contact the Whole Life insurance agent and request to Surrender or “turn-in” your policy. You will receive a check for the cash value that you have accumulated over time.
One important thing to remember is that much of this cash value will be from gains and you will need to pay taxes on the money you receive by surrendering the policy. For this reason, we rarely recommend on outright surrender of the policy, but it can still work in some situations.
QUICK SIDE BAR ON 1035:
There is an option to exchange one insurance product for another, called a “1035 exchange”, named after the provision in the tax code allowing tax-free insurance contract transfers. With this in mind, let’s look at a few more options to get out of a bad Whole Life contract:
2. Single-Premium Immediate Annuity (SPIA)
The first option that many consider with a 1035 exchange is to a Single-Premium Immediate Annuity (SPIA). This is essentially trading a current value into an income-stream for the rest of your life.
The upside of a SPIA is that you cannot outlive the income stream. No matter what happens to the stock market or economy, the insurance company is guaranteeing to pay you each month that you are alive.
The downside is that in aggregate, you are likely giving up some investment upside and the insurance company will end up better off by taking your upfront cash and investing it on their own.
For clients that have very little retirement income, we tend to at least look into a SPIA. However, if you already have a healthy level of Social Security and/or Pension income, this may not be the best option.
3. 1035 Exchange to Variable Annuity
Maybe you want to get rid of the policy, but you do not need the cash now and you do not want to just surrender the policy. Maybe you also like creditor the protection that many states provide for insurance money. In this case, it may make sense to exchange this Whole Life policy for a low-cost Variable Annuity.
While this is an “annuity”, it performs differently than the SPIA mentioned above. In this case, it acts like an IRA, allowing for investments in stocks and bonds in a tax-deferred vehicle. Only once you withdraw money from the Variable Annuity will you be taxed, which allows you spread out the taxes over time.
4. 1035 Exchange to Hybrid Long-term Care Policy
Many clients worry about significant Long-term health care costs eating up their retirement savings and look to purchase Long-term Care (LTC) Insurance.
While most are familiar with a “stand-alone” LTC policy, you may not know that there are Hybrid Annuity and Life insurance policies with Long-term Care Provisions. You can complete a 1035 exchange with your Whole Life policy and purchase a new Hybrid LTC policy with the cash value, again without triggering taxes.
5. Convert to Paid-Up Life Insurance
Through most of the other options, it is assumed that you do not need to continue to carry life insurance. However, what if you still have an insurance need? Whether for estate planning purposes or another long-term life insurance need, you may want to consider converting your Whole Life Insurance to a “paid-up” policy.
In this case, you will use the accumulated cash value to eliminate future premiums, so that the policy is self-funding. This way you keep life insurance in place, but avoid any out-of-pocket costs.
All of these options make sense in certain situations. There is, however, one bad option, which unfortunately is the path that most take.
6. (Bad Option) Do Nothing
Life insurance can be confusing and there are many rules and tax implications to take into account. That is why most “double-down” on their poor decision to buy Whole Life by continuing to pay the premiums year after year, even if they don’t need it.
Whether you need life insurance or not, I rarely find a client situation that the best recommendation is to purchase or maintain a Whole Life policy.
As a Fee-Only Financial Planner, I work with qualified 3rd party insurance brokers find the right insurance policy for all of our clients, without receiving any commissions for the advice or purchase. If you have a question about your current insurance and want to know if there is a better way to use this money, please reach out!