Planning Matters (January 2018) – The Changing Landscape of Life Insurance Planning

by David Cechanowicz, JD, MSFS, AIF®, Senior Financial Planner
REDW Stanley Financial Advisors, LLC

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One of the cornerstone principals of financial planning is the need to adequately evaluate risks to achieving long-term goals and objectives. Oftentimes that process is referred to as risk management. At its core, the management of “life” risks is often divided into the following: dying too soon, becoming disabled, living too long, or not having enough assets.

The foundational product that has been developed to meet the risk of dying too soon is life insurance. Outside of the shorter focus of term insurance, life insurance is usually sold as a product that can meet many changing needs over an individual’s lifetime. Some of those needs include providing for a spouse and/or children, protecting a mortgage or a business and/or accumulating assets for retirement.

Additionally, life insurance can be used to protect against estate taxes, although in recent years, increases in the unified credit have caused over 99% of all estates to become exempt from the estate tax.

One common denominator for all risk management products is that changing circumstances, needs and net worth may cause the re-evaluation of whether or not a given insurance product is needed. In some cases, individuals come to the conclusion that they will terminate their insurance coverage. In the case of term insurance, all that is required is to stop payment of the premiums and the policy will lapse.

In those situations where a longer term product exists, such as whole life, universal life, or variable life, the situation can become a bit more complicated and additional planning may need to be done to sidestep tax traps and/or generate the greatest value for the policy owner.

We would like all of you to know about tax issues and ways that your policies may lose significant value if you do not understand all of your options. These issues may occur if you surrender a policy or if the policy lapses (whether intentionally or not).

If you are encountering any of the following circumstances, we may be able to help you evaluate your options and select the best outcome for your particular situation.

1. Surrender or cash in your life insurance.  Two possible problems may arise in this scenario.  First, you may be subject to ordinary income taxes if you receive more money back from a company than you have paid in.  Generally this happens when a traditional whole life policy is surrendered, especially one that has been paying dividends.

Secondly, a policy may have more value as an investment than it has if it is surrendered to the company that sold the policy.  Today, groups of investors are willing to purchase life insurance policies under the “right circumstances.”  Usually that means that the insured is older or is in poor health.  In some cases a policy may be sold for up to 2 or 3 times the value that would have been received upon surrender.  Term insurance can also be purchased if the circumstances are right.

Because of the extremely low interest rates over the past decade, many policies that were sold 20 years or more ago are currently underperforming.  When an annual statement is issued, you may notice that the cash value of the policy is declining in value.  While your initial reaction might be to just cash in the contract, you may want to explore your other options.

2. Whole life insurance with a loan. Thirty or forty years ago many policies were sold with the promise that if you couldn’t pay the premium, you could just “skip it” and the policy would borrow against itself. That’s all well and good if the policy has significant cash surrender values. However, policies that continue to accrue loans also accrue loan interest, and the combination of falling dividends and increasing loans may destroy the economics of the policy, causing a “lapse” in coverage.

When that happens, the insured usually receives more bad news in the form of a 1099 that indicates that he or she received taxable income. This “phantom” income is created because the IRS considers the forgiveness of debt to be ordinary income, and taxes it as such. However, those same loans are extinguished at death, without any current income taxation.

If you find yourself in a situation where you are contemplating the surrender or other termination of a life insurance policy, REDW Stanley Financial Advisors, LLC may be able to help you navigate the choices before you. We have an insurance credentialed expert on staff who can work with you to explore all of your options. Please give us a call if you need assistance in this or any other wealth planning area.


Copyright 2018 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only and should not be construed as investment, financial, tax, or legal advice.