Eastman & Smith Alert: What to Do With Life Insurance Policies That Are No Longer Needed
Life insurance policies often outlive the need for which they were originally purchased. For example, the policy may have been purchased for:
- family needs, but the owner has now accumulated sufficient assets to self-insure;
- a debt that was being secured, but which has been paid off; or
- previously-anticipated estate taxes which no longer are payable because the federal estate tax exemption is now $5.34 million (in 2014) for an individual and is portable between spouses.
If the policy is term insurance, you can simply discontinue premiums. If the policy is permanent insurance (whole life or universal life), you might assume that the policy should merely be surrendered, but this may not be the best option. A policy that is no longer needed simply should be considered an investment that can be compared to other available investments. The policy, especially if no further premiums are needed, functions much like a bond, except that the maturity date (the death of the insured) is unknown. Whether or not further premiums will be needed, you or your advisor can easily calculate the internal rate of return (IRR) for the policy at various assumed ages of death. The IRR will be the annual after-tax rate of return you would need to earn on the net surrender proceeds (after any income taxes on the gain) and any future premiums in order to reach the death benefit at the assumed age of death. If the IRR exceeds the projected after-tax rate of return you would expect to receive on your alternative investment of choice, as is often the case in today's investment climate, and if you do not expect to need the funds during your lifetime, it is probably better to retain the policy even though the original purpose for the policy no longer exists. If the IRR is unattractive, or if you cannot afford the premiums necessary to continue coverage for life, and if the IRR is unable to reduce the policy sufficiently that it will continue for life, another alternative is a life settlement, that is, the sale of the policy to a company which purchases policies for investment. A successful life settlement will often provide an amount significantly larger than the cash surrender value. Generally, the policy must be for at least $250,000, you must be over age 65 and in substandard health. As the above makes clear, as the owner of a permanent life insurance policy that has outlived its original purpose, you should evaluate all available courses of action before simply surrendering the policy. Should you have any questions regarding old life insurance policies, please contact an attorney in our Estate Planning Practice Group.