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Life insurance: something you pay a lot for, then never get to use. At least, almost never. Check out this email…
I am about to drop my whole life insurance policy, and I feel that it was a total waste of money. I have been in it for over 11 years. I have no children, my house is paid off, and I have a modest amount of money in the bank. But I pay monthly for life insurance. I feel that when the time comes, my siblings can use my savings. I have absolutely no dependents. I hope this is enough information. Please tell me, what do you think?
This is a common question, Darlene. As I wrote in 8 Ways to Save on Life Insurance, it’s probably one of the least understood major expenses. And the insurance companies sure aren’t any help. Their apparent goal is more to stir up your emotions and fears rather than to provide you with education.
Let’s go over the basics.
Who needs life insurance
Darlene’s instincts are correct. Life insurance isn’t to protect you, it’s to protect those you love. If those you love don’t need protection, then you don’t need life insurance. Darlene tells us two things suggesting she can drop her policy…
- She has no dependents. Couples often consider dropping or reducing their coverage once the kids are out of the house and onto their own careers. And Darlene doesn’t have anyone who depends on her for their financial survival: Her death may be sad for those she leaves behind, but it won’t be financially catastrophic. This is the primary reason for life insurance, and she doesn’t need it for that purpose.
- Her house is paid off. When you die and leave your mortgaged house to a loved one, there are situations where they can automatically assume the mortgage and others where they can’t. In either case, however, the mortgage might not be affordable. So life insurance can come in handy by paying off the mortgage. Since Darlene’s is paid off, no life insurance needed.
Was it a waste of money?
The first sentence in Darlene’s email is, “I am about to drop my whole life insurance policy, and I feel that it was a total waste of money.” As we’ve noted, Darlene doesn’t need life insurance, but in her case it may not have been a total waste of money.
That’s because Darlene has a whole life policy, as opposed to a term policy. When you buy a term policy, you have to die to get money from the insurance company. But whole life combines a death benefit with a savings account. So part of every monthly premium Darlene paid went into an interest-bearing savings account, and she’s free to tap that money whenever she wants.
Like closing a bank account, she could just surrender the policy and take her money. There might, however, be surrender penalties – something she should definitely check out. She should also be aware of taxes. The interest she earned on the savings portion of her policy was tax-deferred, meaning she didn’t pay income taxes on it. When she takes it out, she’ll have to.
An option that bypasses taxes would be to borrow against the savings (called “cash value”) with a policy loan. Low-interest loans are often made available by the insurance company for this specific purpose. Since borrowed money isn’t counted as income, taking her money out via a loan means she doesn’t have to pay taxes. Whether this would make sense depends on the interest she’d have to pay for the loan, as well as how much interest she’s earning on her savings.
A final option would be for Darlene to stop making premium payments. In that case, the insurance company would use her accumulated savings to continue funding her death benefit until they’re used up.
What should Darlene do?
Darlene needs to contact the person or company that sold her the policy and ask a few questions…
- First, if there’s a surrender penalty, and if so, how much.
- Second, how much of her accumulated savings would be subject to income tax. (The money she put in isn’t taxable – only the interest it earned.)
- Finally, she should ask about the terms on policy loans.
If there’s no penalty and the taxes aren’t too brutal, she should probably take her money and move on. Otherwise, she’ll continue paying for life insurance she doesn’t need.
If the taxes and/or penalty are big, that makes the decision more difficult. If there’s a large surrender penalty, she’ll have to balance that expense against the cost of continuing to pay the policy. If the taxes are unmanageable, she could spread the burden out over multiple years by withdrawing the money gradually.
If the premiums are unmanageable, she could ask the beneficiary – the person who will benefit on Darlene’s death – to help make them. Then she could continue paying the policy and transfer the death benefit tax-free to the beneficiary.
Bottom line? If the money involved is small, Darlene should cash in the policy and be done. If the amounts are large, she should consider spending a little money on an accountant or fee-based financial planner to help her decide her best path.
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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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