Life insurance provides an extremely valuable form of protection; however, due to changes in a person’s life, there may no longer be a need for coverage. Maybe you are a policy owner who no longer wants or needs your life insurance policy but are not sure what to do. Perhaps you are an advisor who has a client looking to offload a policy because of divorce or other life-changing event and you want to make sure you help them make the best decision possible.
Regardless of the reason, policy owners have solutions beyond surrender to make the most out of their unwanted life insurance policy and capture the embedded value within. Below are ten ways to do just that.
Donate to Charity
Life insurance is an asset often not considered for donation to charity. However, it can be a win-win way to support a charitable organization. When a policy is donated to a charity, the policy owner gains a charitable deduction, and the charity picks up a valuable asset. Unfortunately, many charities do not like these donations because they must wait until the insured's death to receive the benefit. However, by donating the policy to the “Insuring a Better World Fund (IABWF)” the policy owner receives the charitable deduction and the charity of choice receives a benefit they can use. To learn more, click here.
Unfortunately, there are times when policy owner’s cash flow situations have changed. For those who can no longer afford life insurance premiums, the premium return option may be a good solution for them. This method is ideal for those with old whole life policies that have significant cash values. The policy owner may be able to access cash within the policy equal to their premiums paid and the policy stays in force due to future dividends. This may be a great alternative to a reduced paid up scenario, which may have unintended tax consequences.
Reduce the Premium
A second solution for those struggling to keep up with premiums is to reduce them by using the policy cash value to take a premium holiday. This strategy works best for those with policies with significant cash surrender value. The policy may continue to run for some time with a reduced premium or even no premium at all. This option can provide additional time, allowing the policy owner to determine what the best course of action is for the policy.
Reduce the Death Benefit
If reducing the premium is not an option, policy owners may have another viable option. A solution similar to reducing the premium is to lower the death benefit. This is an excellent choice for those that have guaranteed policies, those with little to no cash value or old whole life policies. Reducing the death benefit may alleviate premium all together or it may allow the policy owner to pay the same premium but have the benefit last longer, which may be ideal for policies that have significantly under-performed over time.
If the policy owner no longer needs the policy death benefit, an alternative to cashing the policy in with the insurance company is selling it to an institutional buyer for cash. A policy becomes saleable if the insured has had a health change or they are over age 70. For example, let's say Mr. S had a $10 million policy that he took out in 2005 and has paid $2.3 million in premiums but due to an estate tax law change, the policy is no longer needed. He may be able to sell the policy to an institutional buyer for an amount equal to his premiums paid or even more. The price for the policy will be dependent on the age and health of the insured at time of sale. There may be some tax due on the sale, depending on the cost basis of the policy.
If the policy owner is not looking for cash, they can still take advantage of this situation. In lieu of cash, policy owners may also be able to sell their policy for a retained death benefit. The buyer will take on the responsibility of premium payments and the policy owner’s beneficiary will still receive a benefit at death.
Future Tax-Free Income
Sometimes guaranteed income for life can be more valuable than death benefit. In these cases, a policy owner can trade in the cash value of a policy for a single premium immediate annuity with an annual payout for life through a 1035 exchange. The income provided would be based on the age at the time of exchange and any potential taxation of the income would be determined by the value of the policy and its cost basis.
Capture A Loss
A policy owner cannot recognize a loss for tax purposes when surrendering a life insurance policy. However, a scenario for these policyowners to consider would be to exchange a life insurance policy with large loss for an annuity. The loss from the life insurance can offset gains within the annuity or be recognized when the annuity is surrendered. Utilizing this loss may be beneficial for a client to offset gains they have earned elsewhere.
Bad Irrevocable Life Insurance Trust Bailout
Trusts with “bad provisions” that no longer meet the grantor’s and/or beneficiaries’ wishes can also cause undue stress on trustees who are trying to fulfill their fiduciary duties. While it may seem like a dropping the life insurance policy within the trust is the only way out, there are options. A new life policy is not always needed. Clients with poor trust provision may choose to sell the policy from a bad trust to a new trust for a note. This allows the policy to be moved to a trust with improved provisions, providing better value for the client and their beneficiaries.
Insureds going through a divorce and with a second to die policy may be able to split the policy into their own individual policies subject to terms in the policy. This may provide each insured with their own death benefit without having to go through the underwriting process again. This may be particularly beneficial if one or both of the insureds has had a significant decline in health.
Lastly, applying for a rate reconsideration with the life insurance carrier may be an option. This works for those who have quit smoking, lost weight or had any other health improvements. Obtaining an improved rating on the policy will reduce charges and ultimately may allow the policy owner to reduce or eliminate premium.
Policy owners should never feel “locked” into their life insurance policy. The above options show there are different avenues for folks to explore when they have an unwanted or unneeded policy. While each of the scenarios can provide a desired benefit, they also come with their own set of risks and pitfalls. We at TDC Life are experts on the above techniques and can help to implement one of the 10 ways to leave a policy. Feel free to reach out to us today.