6 Options for a Life Policy I No Longer Need

financial planning for attorneys financial planning for retirement May 18, 2020

By Glenn J. Downing, MBA, CFP®

A lot of thought goes into planning for the retirement years.  Typically, people like to have the mortgages on their primary residences paid off, to go into retirement clean and with no debt.  This often begs the question; Do I have to keep paying on this life policy? 

To answer the question, I’ll ask you to think back on why you bought the policy in the first place.  Is someone still depending upon you for a living?  If so, and you dropped dead today, would there be sufficient financial resources without the policy?  If not, then you still need it.  If so, then here are six good options. 

You Can Cash the Policy In

In this case you simply turn it back to the insurance company, which cuts you a check for the policy’s cash value.  If the cash value exceeds your basis in the policy, then you have a taxable gain.  Your basis is the sum of all the premiums you’ve paid in.  The gain is ordinary income, as insurance policies are not capital gains property.  See Ordinary Income vs. Capital Gains. 

If You are Terminally Ill you Can Viaticize the Policy

That is, you can enter into a viatical settlement.  This means you sell your policy to a viatical settlement company.  They purchase it from you for an amount that exceeds the cash surrender value of the policy but is less than the policy’s death benefit.  The viatical company makes the ensuing premium payments, and eventually collects the death benefit.  In the case of a viatical settlement, the seller has no taxable gain.

The whole viatical industry originally came about during the AIDS epidemic in New York City.  Terminally ill patients who needed the cash in their policies were glad to sell them for more than the cash value.  The viatical companies were glad to purchase the policies to get the death settlement payday.  In effect, the viatical industry turned the life insurance policy into a security. 

If you are simply old, you can do a Life Settlement. 

That is, you can sell it to a life settlement company.  This is the same concept as the viatical settlement, except that you are not terminally ill.  Just old.  If you’re old and sick, that’s a bonus.  The life settlement company will continue to make the premium payments, and eventually collect the death benefit.  So the sicker you are, the fewer payments they are likely to make, which means they should be willing to pay you more for the policy than otherwise.  Shop around, as this is an enormously competitive market.  Once again, a term policy may be eligible for a life settlement.  

The taxation here is different than the viatical settlement.  The region from basis to cash surrender value is still your taxable gain, at ordinary income tax rates.  But the region from cash surrender value to selling price is taxed at your long term capital gains rate.  This is the only circumstance of which I’m aware where there is LT capital gains taxation in the insurance world.

You can annuitize the cash value of the policy

In this case you work with the existing insurer, and get quotes for settling the policy, i.e. turning the values into a stream of income.  This can be for a period of years (i.e. 120 monthly payments) or over your lifetime.  In this case each payment represents part return of basis (not taxable) and part gain (fully taxable).  The insurance company will calculate an exclusion ratio for you, so you’ll know exactly how much of each payment is taxable. 

If the intent is to turn the cash values into a stream of income, we recommend you shop around and get several quotes from different insurance companies, as quotes can vary considerably.

You can do a 1035 exchange to an annuity

This is a tax-free exchange of policy values from your life contract to another life contract or to an annuity contract.  If you move the cash value to an annuity you are getting rid of the underlying costs of the life insurance death benefit, so the funds can potentially grow faster.  In other words, you are getting rid of the cost of insurance drag to earnings. 

The ownership and insured must be the same:  the original owner and insured on a life policy can 1035 exchange to an annuity contract with the same owner and the same insured being the annuitant.  It rarely makes sense to do a life to life 1035 exchange, simply because we’re none of us as young as we used to be, meaning a new policy will likely cost more than the one you already have.  Where we do see this making sense is in the case of the new policy having long term care benefits than the exchanged policy did not.

You can make a charitable gift of the policy 

No need for the death benefit nor the cash value in the policy?  Consider gifting it.  You’d make an absolute assignment of the ownership to a new charitable owner (your church, synagogue, or alma mater, for example).  The new owner makes itself the beneficiary.  You will get an upfront tax-deduction for the cash value of the policy.  If the policy values are large, this could be a large deduction, which can be carried forward for five years.  If you want to continue making the premium payments, you make tax-deductible contributions to the charity sufficient to make those premium payments.

Have more life insurance questions?  Please refer to these previous blog posts:

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