Should I Cash-In my Life Insurance (How CNN Got it Wrong and Why you should Care)?

Recently I cam across an article on the CNN Money Help Board posted from someone who was looking for some advice on deciding what to do with two life insurance policies he and his wife had.  The central sticking point for the individual was that the kids were gone and now he was trying to decide if it made sense to keep the life insurance policies he and his wife had.

Here's the Article

Now, trust me when I say that I don't live in some idealistic fantasy land were I remain oblivious to the point of a financial help desk run by a major media outlet.  Answers need to be succinct and generally broad.  More-over since CNN is more worried about acquiring “followers” (which I'll define as individuals who have decided that they like the CNN brand and choose to consume their news from them) than it is being thorough and correct, the shoddy, generally useless, and potentially dangerous take-away from this piece is simply a product of their business model (please note, this is not a direct attack towards CNN, all of the financial press is just as likely to take an opportunity such as this and blow it).

You Can't Advise if you Do Not Know

The information the poster has provided is nothing more than vague.   Sure we know his and his wife's age, the fact that they have no children, and that they identify themselves as “fairly” financially secure (whatever that means).  We also know that they own some sort of cash value product that has a $100k face value and $60k in cash (so they say, rule number one of advising on insurance is never take the policy owner/insured's word on what they have).

At this point we really don't have enough details to truly make any suggestion to these people.  What they have provided is analogous to someone's stating: I have a 15 gallon gas tank and half a tank of gas in my car, do you think I could make it Albuquerque?  If you're confused I'll take a moment to state the obvious:

  1. You don't know how far they can go with those assumed 7.5 gallons
  2. You don't know how they know they have a half tank and if there are really 7.5 gallons
  3. You don't know how far from Albuquerque they are
  4. You don't know what route they plan to take to get there
  5. You don't know the condition of the car they are driving and if it would make it to Albuquerque

Here's what we don't know about this couple:

  1. We don't know what type of policies they have
  2. We don't actually know if the numbers we're told are in fact true (they even sound a little dubious to me)
  3. We have no idea what “fairly” financially secure means
  4. We don't know what sort of assets they have
  5. We don't know how social security income plays into their life
  6. We don't know if there is pension or annuity income that is part of their plan
  7. We don't know the cost basis of the policies they are thinking about surrendering (though I'll give CNN credit, they did sort of speak to this)
  8. We don't actually know if premiums are still due on these policies
  9. We don't know what kind of return they are earning on the money in the policies
  10. We don't know what kind of return they are earning on the death benefits of these policies
  11. We don't know if any other forms of life insurance exist
  12. We don't know about any riders that might exists on these policies that could be helpful in avoiding a financial catastrophe
  13. We don't really know why they've even asked the question about “cashing them in.”

Lapsing a policy is a serious irrevocable move, and it generally requires a lot of consideration.  CNN would have done this couple and the whole world a much bigger favor if they had merely responded with, “We need way more information in order to even begin to answer this sort of question.”  Of course, that probably wouldn't fit the editor's paradigm for content.

Transfer to the Kids?

This was a ridiculous suggestion that calls into question Erika Safran's competence.  I'll give her the benefit of the doubt and assume she's a victim of journalistic miss-quoting here.  Transferring a cash value life policy has a gift tax implication which is based on the Cash Surrender Value of the policy transfered.  If they transfered these policies to their children, they'd have (according to the numbers and information provided) a $60,000 gift each, which can be split up among the children at $13,000 per child, but transferring ownership of a life policy to more than one person gets messy without a trust involved.  In any event, they would need 5 children to successfully transfer the policies  without using gift tax credits.

The suggestion that the kids might not have the means to pay the income tax due on the surrendered policies was very strange.  If they surrender the $120,000 and owe taxes on it, they'd simply use part of the surrendered cash value, eliminating any additional need to gift more money as per the suggestion in the article.

Why are We Quoting a Financial Planner in New York Anyway?

Another point that I found odd about all of this was that CNN chose to use a Financial Planner from New York to advise a couple who live in Ohio.  Safran, who owns Safran Wealth Advisors is based in New York and she appears to hold a CFP.  According to a query of the Ohio Department of Insurance's Licensed Agents Database she doesn't hold an Ohio Insurance License.  It's weird that CNN would choose someone like this to provide commentary on the topic.

Show Off

Even though I don't know nearly enough to make any recommendations on this situation.  I do  want to point out that there are plenty of better options than what CNN presented.

Leave it Alone

First, anyone with an older cash value policy should look into simply leaving it alone.  If the premiums aren't a problem, take a look at look at IRR (internal rate of return) and compare that to what you could get else where, and seriously ask yourself if you think you need to make a change.  In most cases you'll discover that IRR on the life policy smokes alternatives especially given the tax benefits and risk exposure.

In a lot of cases, older policies may not require any premiums to be paid.  You'd have to check with the insurance company, and your best off discussing this with a qualified agent (you can always contact us for personal advice or a referral to an agent if you don't have one).  This way the policy can remain growing cash value (and often times death benefit) and leave the death benefit intact as well.

The Transfer Idea

One way in which CNN really missed the mark here, was in their failure to mention the tax distribution treatment of a life insurance policy.  Life policies have First in First Out (FIFO) distributions.  Meaning, just like a Roth IRA.  The policy owner can withdraw their contribution basis (i.e. all of the money he or she put into the policy) first.  Then once the basis is withdrawn, the owner would then begin to withdraw the taxable growth in the policy.  Instead of trying to transfer the policy, the owner could simply withdraw the basis and then choose what to do with the rest.  Couple of options:

  1. Withdraw it and put it into a traditional IRA: Not really the best option, but it would most likely work.  As long as there is still earned income, the individual is eligible to contribute to an IRA, and could immediately deduct the realized income as an IRA contribution.
  2. Gift the Taxable Portion to a Charity of Non-Profit: Depending on the size of the taxable portion (larger would be better) the owner could set up a Charitable Remainder Trust (CRT).  The money goes to a non-profit, the grantor gets a tax deduction that he or she can carry over if need be to later tax years, which is the amount of the gift, and the grantor receives money from the trust in a specified amount (this one's a little more advanced and honestly requires a lot more to be said, which is a topic for another day)
  3. Give it Away: The taxable potion could just be donated, skip the CRT and feel good about yourself and your contribution to mankind.
  4. 1035 Exchange: This one is so simple, I don't know why they didn't bring it up.  Literally Life Insurance Planning 101 material here.  One could simply transfer money through a 1035 exchange to either another life policy like a Single Premium Whole Life Contract or a Secondary Guaranteed Universal Life Policy Endowed with a single Premium (we will be discussing both of these and when you would want to use one or the other in a few weeks) or it could go into an annuity.  There would be no taxable event (read it's like rolling your 401k into an IRA) and the money remains.  The cost basis is preserved so still only the growth is taxable.  This would probably be the most common choice in a “cash in” scenario, and it's really strange that it wasn't brought up.

Competency Makes all the Difference

By now you've hopefully learned a lot more than you would have by reading that CNN article.  Keep in mind that people who dabble in the financial world in the media rarely have the depth of understanding that a true practitioner has.  Sure there are a lot of bad practitioners, but please be very careful about where you go for advice.  Just because the media is disinterested in your situation from a personal financial gain perspective, doesn't guarantee that they will give you good advice.

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