Cash Value Life Insurance: Should you surrender your policy?

In Asset Allocation, Estate Planning, Insurance by Chip Hymiller

Dear Beacon,

I currently own a cash value life insurance policy (whole or universal life) that I have been paying premiums on for years.  Increasingly, I am finding that paying the premiums on this policy is a cash flow drag.  At the age of 65, do I still need this policy?

The above question is one we have received quite a bit recently. On the surface, the answer to this question seems pretty straightforward—cash out this policy and use the proceeds for a nice trip!  However, the reality is that liquidating a cash value life policy may not always be the best decision.

As with most financial matters, there is no “one size fits all” solution and this is particularly true when it comes to life insurance planning. Not only does each individual have varying personal circumstances, but each life insurance policy can have different provisions that impact the decision.  With that disclaimer in mind, here are a series of questions to consider that will help you evaluate the role of life insurance for you.

  • Is there a current insurable interest?  In other words, what tangible expenses would your policy cover in the event of your death? And, do you have an asset base that is large enough to cover these expenses without this coverage? Is life insurance necessary to cover funeral expenses, current debts, estate liquidity and emergency fund replenishment, or do you need life insurance to cover these expenses?
  • What impact does the insured’s death have on the retirement of the surviving spouse?  Normally, in the event of the death of one spouse, the surviving spouse may lose a pension, Social Security or other retirement benefits.  Will the surviving spouse have to adjust their standard of living as a result of the loss of these benefits?
  • Can the current cash value policy be converted into a more productive and necessary type of insurance?  It is now possible to convert, on a tax-favored basis, cash value life insurance policies into certain types of long term care insurance or annuities.  This conversion could be appropriate for those who would prefer to take advantage of the benefits that other types of insurance products provide and who no longer require life insurance coverage.

After answering the questions listed above, it may be obvious as to how you should handle your existing life insurance policy.  If not, you may need to think of your policy as an “investment” and determine the approximate rate of return assuming your life expectancy.  Here is an example:

Life Insurance Policy

Jack is 65 years old and owns a life insurance policy with a death benefit of $50,000.  The current surrender value (the money Jack would receive if he liquidated the policy) is $35,000.  It has been determined that in order for the policy to remain in force for his lifetime that Jack will need to pay annual premiums of $1,000.

In this example, should Jack pass away at age 70 his heirs would receive “net” life insurance proceeds of $10,000.  That is, Jack would have paid $40,000 in premiums ($35,000 + $1,000 for 5 years) to receive a death benefit of $50,000.  Of course, over time, the “rate of return” of most life insurance policies decline as premiums continue and, in some cases, increase.

Evaluating and developing a cohesive insurance strategy can be complex and involve financial planning implications impacting retirement, estate, tax and other financial decisions.  Please let us know if you have any questions.