Your life insurance monthly premium can start looking less and less appealing once you’ve retired. It’s a scenario Dan Simon, a retirement planning adviser with Daniel A. White & Associates in Middletown, Del., has seen quite often, even with his own parents. “The cost of the insurance had risen to the point where it was getting unaffordable. They were wondering do we really need to keep this coverage now that the kids are all grown up?”
If you stop paying your premiums, you lose your life insurance coverage, and your heirs wouldn’t get anything back for what you’ve paid in. If you cancel a policy that has cash value, a reserve of money built up in some types of life insurance, the insurer sends you a check for that amount, though it will be far less than the listed death benefit.
Over the past 20 years, a third option went mainstream: selling your policy to a company, a practice known as a life settlement, with the buyer getting the death benefit when you die.
“It’s kind of morbid when you think about it. A group buys boatloads of policies from people that have fallen on hard times and can no longer afford their insurance,” profiting from the seller’s death, says Simon. “In theory, they want you to die tomorrow. If you live another 20 years, it’s a bad investment for them.”
Selling a life insurance policy generally isn’t a great deal for you either, and there are better alternatives worth exploring. Simon finds that people typically turn to selling a policy when they’re desperate. Usually, it’s because they’ve spent down their other retirement assets, or they might be dealing with high medical bills. “It’s a measure of last resort, like taking a reverse mortgage. I rarely see them working out well for people, and they could end up doing considerable damage to their estate,” he says.
It’s a Fire Sale
When you sell a life insurance policy, you’re unlikely to get anything close to the value of the death benefit, especially after factoring in fees. The amount you’ll receive depends on your age and health. “The older and sicker you are, the larger the payout,” says Chris Orestis, president of Retirement Genius, a retirement advice website based in Portland, Maine.
Ovid, a life settlement company, says that qualified applicants receive anywhere from 5% to 80% of their death benefit as part of a life settlement. If you’re healthy, you generally must be at least 65 years old to sell your policy.
“Any type of life insurance, including term life, can qualify for a life settlement with a typical policy size being $100,000 of death benefit or greater,” says Orestis.
A specific type of sale, called viatical settlements, applies to terminally ill policy owners who have less than two years to live. Compared with a life settlement, the typical payout on a viatical is higher but still only about 50% to 85% of the policy’s death benefit depending on your life expectancy when you apply, according to the Illinois Department of Insurance. Those numbers are before any brokerage and transaction fees to complete the deal. They shave roughly 5% off your total payout, depending on the company, says Aaron Maassel, owner and founder of Voyageur Advisory Group in Maumee, Ohio.
But FINRA, a nonprofit regulatory authority for the financial industry, warns fees can be as high as 30% of the total payout. These days, you’ll probably get even less money from the sale.
Payments for life settlements have fallen recently because of rising interest rates, Maassel says.
Life settlement companies usually borrow to finance your buyout. Higher rates cost the company more to borrow so it pays less for the policy.
Simon suggests selling a life insurance policy only if you don’t have any family members who could use the money, like a surviving spouse or children.
As it happens, however, there is no shortage of ways to handle a life insurance policy you can no longer afford. In some cases, you may be able to reduce the premiums while preserving the death benefit for your survivors, or even turn the policy into a source of income.
Check the policy for accelerated death benefits. If you need money because you have a serious or terminal illness, it’s possible the policy will pay out while you’re still alive. Many companies include something called an accelerated death benefit rider. If you are diagnosed with a qualifying illness, the insurer will pay you some or all of your death benefit. This money is tax-free for someone with a terminal or chronic illness. If the policy doesn’t pay the entire death benefit while you’re alive, anything remaining goes to your heirs.
Pay using the cash value. If your policy has cash value, those funds can be used to cover your future life insurance premiums. “This is a way to prolong the policy without paying out of pocket,” says Simon. He warns, however, that spending down your cash value reduces the policy’s overall death benefit. In addition, once you spend down all of that cash value, you will need to start paying the premiums again or else the policy will lapse.
Reduce the death benefit. Some life insurance companies give policyholders the option to convert their policy into one with a smaller death benefit. The insurer considers any cash value and what you’ve already paid before reissuing a smaller policy that no longer charges premiums. “This allows a policy owner to keep a portion of their death benefit without making any future payments,” says Orestis. You can also convert a lifelong permanent policy into a paid-up term policy with the same death benefit, but the coverage will have an expiration date, like five or 10 years.
Swap for another life insurance policy. A 1035 exchange lets you move money from one life insurance policy to another without owing taxes, says Simon. You could swap your existing policy for a cheaper one with a smaller death benefit this way. You will need to go through medical underwriting to set up the new policy, he warns. You could also switch to a policy with more desirable features. For instance, Simon finds that when his clients retire, they often become less concerned about life insurance and more concerned about the high cost of nursing homes. Your current policy can help pay for this bill. Using the 1035 exchange, you could get a hybrid policy that combines life insurance with long-term care coverage that pays out some or all of the death benefit for the cost of that care. If you don’t need longterm care, your heirs receive the full death benefit.
Convert to an annuity. A life insurance policy with cash value can also be converted into an annuity through a 1035 exchange. “You won’t owe any tax on the transfer or have to make future premium payments for the annuity,” says Maassel. Meanwhile, the annuity could pay you an income. You can start collecting payments from the annuity whenever you want. Otherwise, the balance will keep growing tax-deferred for your heirs. Maassel notes that some annuities offer an enhanced death benefit. If you die soon after making the transfer, the insurer pays out roughly an extra 25% to 30% to your heirs on top of what you put in. Annuities are less liquid than life insurance cash value. “The company might allow you to take out 10% of your deposit as a lump sum, but otherwise there could be penalties,” says Maassel. Also, your heirs will owe income tax on any annuity balance that exceeds what you paid in insurance premiums, whereas a life insurance death benefit would be free of income taxes.
Ask your heirs for help. Ultimately, it’s your heirs who will eventually benefit from your life insurance. If paying for it becomes too much for you, Simon recommends having a family conversation about what to do. Tell them: “We can’t swing this anymore. The benefit is for you guys. Do you want to take over paying the premium?” That way your family members and other heirs can decide whether the payout fits into their own financial plans. In Simon’s case, he and his siblings decided it didn’t. “I told my parents to take out their cash value and enjoy.”
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