One of the first financial decisions made by many of us is to buy life insurance. This usually happens after getting married and almost certainly after having children. You bought it to protect your family from your premature death. We believe that life insurance is needed for three reasons: replace income; pay debts; and/or to help pay estate taxes. We generally recommend term insurance to our clients unless the insurance need is permanent. But now you are retired and you still have that life insurance. Why? Because you have always had it and you just can’t give it up. What else should you consider?
First, you can always keep it assuming you can continue to pay the premiums, but if your spouse doesn’t need the money at your death, you may want to change the beneficiary to the children/grandchildren. If it is a dividend paying policy, you might use the dividends to help reduce and perhaps even pay the premium. Next, if it is a cash value policy, you may want to consider setting up a withdrawal program to supplement your retirement cash flow. Another option is to have the company convert it to a paid up policy at a lower face amount.
If you have a concern about long term care, then you may want to consider a 1035(a) tax free exchange to a new policy that provides an advance on the death benefit in the event you are confined to a long term care facility. Sometimes home health care is also covered. There are considerable issues that need to be considered before replacing life insurance such as, but not limited to; commissions, fees, expenses, surrender charges, premiums, and new contestability period.
Life insurance proceeds are income tax free, but not estate tax free. If you have a large estate, how can you get it out of your estate? You can set up a life insurance trust and make a gift of the policy to the trust. If you live three years after the gift, it will not be included in your estate. You can then make gifts to the trust each year to pay the premiums. It may be just as convenient to gift the policy to the children/grandchildren directly. They can continue to pay the premiums, or cash it in. You can also gift it to a charity where you will get a tax deduction. In each case, the gift’s value will usually be equal to terminal interest (about the value of the cash) which can be obtained from the insurance company.
But what if you don’t want to keep the life insurance? What are your options? Here are a few ideas. You can cancel the policy and take the cash value for investment elsewhere. Be sure to check on the cost basis of the policy because any amount over this will be taxed as ordinary income and this might put you into a higher tax bracket.
What if you want to spread the taxes out over a period of time? You can do a 1035(a) tax free exchange to an immediate annuity over a set number of years or even your lifetime. In today’s world of low interest rates, the fixed rate annuities are not an exciting investment, but it may be worth it to spread the taxes out. If you do not need the income you can delay paying the taxes by doing the exchange to a deferred fixed or variable annuity. This will delay the taxes until the money is taken out during lifetime or at death.
Another approach is to consider selling your policy to a third party in what is known as a viatical settlement. In this case an investor will buy the policy from you and perhaps pay you more than the cash value of the policy. At death, the investor receives the proceeds. The older you are and the less healthy you are the more the investor will generally pay you for the policy.
Like any asset you want to maximize its value for your benefit and eventually to your heirs. These are just a few ideas to consider in accomplishing that goal. If you would like to look at these alternatives, we are pleased to provide you with a complimentary meeting with one of our thirteen financial advisers. Please give us a call.
The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and are subject to change.
Investment Advisory Services may be offered through ProVise Management Group, LLC.