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What To Do With Your Old Life Insurance

Many of you have purchased life insurance at some point because someone depended on you financially and you are a responsible person.  However, several of you were probably sold some sort of permanent policy that you don’t need anymore, if you ever needed it.  There are different types of permanent insurance, but this article focuses on whole-life insurance. 

Generally speaking, you don’t need life insurance anymore when you do not have anybody dependent on you or you are financially independent.  This describes many people in retirement or approaching retirement.  For this reason, there are a lot of people out there who own whole-life insurance and do not need it anymore.  Of course, there are always exceptions so you must do a proper analysis of your unique circumstances.  

You’re probably asking yourself why so many people own it if they don’t need it. One reason is the significant economic incentive life insurance agents have to sell it.

Conflict of Interest

A simple example illustrates this point. Life insurance agents earn a percentage of the premium you pay as a commission.  Term insurance premiums are significantly less than whole-life premiums.  An agent can make significantly more money by selling you permanent insurance than term insurance.  

This is perfectly legal even if you don’t need it because insurance agents do not have to act in your best interest like a Fiduciary financial advisor does. They are simply doing what any sales-person would do.  Fee-Only advisors are legally required to act in your best interest and don’t even own the licenses required to earn a commission, thereby eliminating this conflict of interest.

Your Options

So, what are your options if you already own whole life insurance and do not need it anymore? Thankfully, you should have several dividend options and non-forfeiture options. As you’ll see, the best option for you will likely depend on your specific situation.

Dividend Options

  1. Receive As Cash- This option means the insurance sends you a check in the amount of the dividend.  This option can make sense when you need the cash flow
  2. Reduce Premium- This option uses the dividend to reduce the amount of premium you pay out of pocket.  This option can make sense when you want to keep the policy but reduce your cost.
  3. Purchase Paid-Up Additions- This option uses the dividend to increase the cash value and death benefit of your policy.  This can make sense when you have significant cash flow and are looking to maximize the size of your policy.
  4. Accumulate at Interest- This option is where you leave the dividend with your insurance company to earn interest in a separate account.  You should evaluate alternatives to make sure you are maximizing your return.
  5. Extended Term- This option uses the dividend to buy a 1 year term policy in addition to the existing policy.  The amount is determined by the size of the dividend.  This can make sense when you need more death benefit and the terms of this option are more favorable than purchasing a separate policy.

Non-Forfeiture Options

  1. Cash Surrender- This option is where you cancel the policy and accept whatever cash value may be available. This can be a taxable event if the cash value is more than your basis. This option can make sense when you do not need the death benefit anymore and have a need for the cash.
  2. Reduced Paid-Up- This option reduces the cash value and death benefit but allows you to keep the policy without paying any more in premium.  This can make sense when you have a need for some death benefit.
  3. Automatic Premium Loan- This option is when you allow the cash value to pay the premium.  This option can make sense when you need the full death benefit but may not be able to continue paying the premium out of cash flow. Be careful with this option because it could result in a policy lapse and severe tax consequences.
  4. Extended Term- This option converts your death benefit into a term policy and eliminates your cash value.  The length of the term would be determined by the amount of cash value.  This option can make sense if you need the full death benefit for a limited time.

There is one other option that doesn’t fit into the categories above and is often overlooked.  The IRS allows you to do a 1035 exchange of a life insurance policy to an annuity or long-term care insurance.  This means you can convert your policy without tax consequences.

To recap, you may or may not still need a death benefit.  Even if you do, your policy may or may not still make sense for you.  A Fiduciary advisor without a commission conflict of interest can help you evaluate your options. Insurance policies are contracts and can be drastically different so it is important to know all the options available to you.  The best course of action depends on your need for a death benefit, available alternatives and the specifics of your policy.

Download our e-book 9 Mistakes to Avoid When Retiring Solo for more retirement guidance from a Fee-Only advisor.

A version of this post originally appeared on Sixty and Me.

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