Help a Reader: Universal Life Insurance Decision

Here's an email I recently received from a reader:

I am recently married, and my husband's parents took out a Universal Life Insurance policy for him when he was six (6) years old.  Yesterday, we met with the insurance agent to transfer the policy into my husband's name, and add me as a beneficiary.  After growing for 20 years, the policy is now worth $58,000 and the premium is $17/month.

I know from reading your blog that 1) buy term and invest the rest is usually the better way to go; and 2) you don't need life insurance until you have dependents who rely on your income.  We currently have no children (but hope to in a few years), and neither of us relies on the other's income to survive.  So, normally, I wouldn't even think about buying life insurance until kids came around.

But--given that he has had this policy hanging around... is it worth keeping?  I hate to "throw good money after bad" and spend $17/mo on a bad investment, but wonder if there is any value to maintaining what he's been building for so long.

What's your advice for her?

Comments

[Don Current]

My recommendation to you would be to cash in that policy and #1, use it to pay off any debt you have other than your mortgage. Secondly, I would invest any remaining funds in a diverse portfolio of mutual funds. You'll get a much better return on your money by doing that.

As far as a term life policy, make sure you do have enough coverage to take care of any of the funeral expenses, etc. If you have a policy through your employer, that maybe adequate. Also you should keep in mind that your rates will be lower the earlier in life you get the policy, so if you plan on having children in the future, you may want to consider getting a policy while the premiums are still low. Another consideration would be what would happen if one of you were to lose your job and then something would happen to the employed spouse. The cost of a good term life policy is very low. I would highly recommend you go ahead and establish a policy.

I hope this information helps. You can contact me through my website if you have more questions.

[Travis@Plain Money Talk]

We need more info here. While typically it is a bad idea to get permanent insurance over term this policy may be worth keeping. You have a cash value of $58K but what is the death benefit? How does that benefit/premium compare to an equivalent term policy today?

Most children's policies don't require health screening and you may have a better rating on the existing policy that makes it worth keeping as opposed to cashing in and buying term. This is especially true if he has any health issues or smokes.

[Budgeting in the Fun Stuff]

I'd also cash in the policy and use it for debt or investment. I do believe you can do more with your money than the insurance company will give you in time...

[Original poster]

Thanks for your suggestions! Some additional info... we have are 100% debt-free, although we do plan on buying a house in the next couple of years. I also might take out some student loans for an MBA program next year.

And I believe that $58K is how much the death benefit is, rather than how much we'd get for cashing it out right now. I'm not sure what amount that would be.

[Kevin]

Agree w/ more info needed. You locked in a rate 20 years ago, and those 20 years of payments are a sunk cost you don't need to be concerned about. Your parents probably overpaid, but this is probably a good deal now.

How does the cash value grow? What is it tied to, what has the performance been? What is the death benefit? This is the big question... if you are being covered for a few hundred thousand for that 17/month, then its probably worth it to just keep the policy.

[Travis@Plain Money Talk]

@Original Poster

You should find out for sure what the cash value is and what the death benefit value is as these are two separate things. Compare the death benefit/premium to that of a 20 or 30 year term policy. That should tell you if it is worth it to switch.

When you inquire more about the policy you also need to ask what the lowest premium is that you can pay and if there is enough cash value built up to cover premiums. I recently purchased a whole life policy on my son (term vs whole life were essentially the same cost). The initial premiums were $25/mo but that included a built in investment amount. The actual premium that I needed to pay was $18/mo. Also after 20 years there may be enough cash value to cover the premiums and thus you now have a free life insurance policy.

Lastly remember that if you cash out the policy you will have tax implications. Once you determine the cash value you should check with an accountant or financial advisor to determine your potential tax liability.

[Apex]

Agree with Kevin, it may not have been the best choice up front but probably worth keeping now after all the sunk costs have already been paid. It also benefited from a much higher interest rate environment when it was first taken out. It may even have been than market rate underlying interest rates that are still being used to calculate some of its returns now but it will likely grow at a much slower rate going forward due to the current interest rate environment.

You said it is worth 58K now (death benefit). I am guessing it's a 50K face value policy that has grown 8K in death benefit after 20 years. Given that about 4K would have been put in over the 20 years that's not actually too bad of growth.

You could also probably let the policy carry itself off the dividends that the growth will generate and stop making payments but if it doesn't grow enough it could go backwards if you do that, you would have to verify.

I would say for this small amount of payment and the sunk costs that are already there that I would just keep it and either keep paying the 17 per month or see if you can let it carry itself.

I would guess the cash value to cash it in is not that great, probably around 10K or maybe less.

[jim]

Do you *want* to invest your money or have your money invested into an insurance policy? If you don't then cash it in.

If you DO want to invest your money in an insurance policy then I think it depends on your cash value. The amount of cash value will tell you how well this investment has performed over the 20 years. If it has performed well then you might want to keep doing it, but if it hasn't performed well so far then I wouldn't keep putting money into it. Cash value insurance should be a safe return and I'd expect something about 4% range roughly. If your cash value is >$7000 level then thats not too bad and represents about a 5% growth rate over 20 years (assuming the $17 month has been constant) you might want to keep the policy. But if your cash value is under $6000 then your return has been 3% or less and thats not very good performance as an investment.

[Diana]

Whether you ever have children or not Life Insurance is always a good idea. Due to the low premium each month, I would keep it. Term insurance is a good idea for supplemental insurance as when children are growing up and you need additional insurance protection, then you can drop this term insurance when the additioanl coverage is no longer necessary. I have seen many advise buying term instead of whole or UL policies only to find out that it gets too expensive to continue purchasing the insurance and your left you with no coverage. Term gets more and more expensive as you age or develop health conditions. You are never gonna get a cheaper policy. Get some estimates to check out what I am saying. You should ask your insurance company to run a projection report on what happens to the policy in the future. If
interest rates were high when the policy was purchased, your policy may need additional premium to carry the policy in the future. If your policy is still in good shape at today's interest rate, you may also have the opportunity to take a loan against the policy that will never need to be paid back. This of course will lower your death benefit. Something to consider.

[Barry]

I disagree with the last post -- if you have enough savings to cover your family's needs after you're gone, why buy life insurance? And if you're worried about term insurance becoming too expensive, buy a level term policy. I bought 20-year level term because by then, I expect to have enough savings to drop the policy. Agreed it can become too expensive if you are not saving for a self-sufficient retirement and therefore need to keep the policy forever.

[Bob]

I haven't seen anyone talk about the tax implications. If you cash it in you'll probably have to pay income taxes on the difference between what was paid in premiums and the received cash value.
You might instead consider a "1035 exchange" into a newer and larger life insurance policy.
Firstly, the mortality tables have improved, so the internal expenses should be less.
Secondly, your needs are probably greater than the face amount on the current policy provides.
Thirdly, available accounts to "invest" the funds in have increased and improved over the last 20 years.
Fourthly, there is so much money in the current policy that you guys probably would NOT have to pay additional premiums for the coverage.
Fifthly, the new policies have loan features that permit cash withdrawals WITHOUT having to pay taxes - thereby providing a nice tax-free retirement income supplement or a way to help cover any children's college education costs. (If you get the student loans first, then use the universal life insurance policy cash to make the student loan payments, you'll be using tax-free cash to make tax-deductible loan payments. Also, the cash value of this policy would probably not be includible when calculating assets to qualify for loans and grants!)
Sixthly, newer policies have "living benefits" that allow people to use the face amount - while alive - in the event of a terminal illness. This is great because it permits a higher "quality of life" and access to possible life-saving treatments that otherwise would be unaffordable.
Beware of people who tell you to "buy term and invest the difference." That was a great concept forty years ago but this is the 21st century and things have changed. Back then, people were buying "whole life" insurance with guaranteed values and premiums that had to be paid "whole life". The internal rate of return (IRR) was low because of the guarantees. These days, we're seeing IRR's much higher with participation in different investment sectors. I know of one policy that guarantees a minimum of 1% return on internal investments in three different international economies with a 13.25% maximum capped return. Another has no cap, but has accounts managed by the same people who handle the millionaires' money - able to "turn on a dime" as the markets go through their gyrations with an average of about 25% annually over the last ten years.
Your husband's parents did a big favor for you guys!

[Janet]

I don't know what the death benefit is but $17/month is fantastic for permanent life. If your husband were to cancel this and apply for life insurance now at an older age, the premium be higher, even if it's term, and that is he even qualifies for life insurance (don't know his health). Also think about this down the road, investing in mutual funds means you would have to PAY TAXES on your gains. Whereas the money in his cash value in the universal life can be taken out TAX-ADVANTAGE (no tax), if taken out the right way, and since it's been about 20 years, there's should be no more surrender charges (depending on the company). That's great for retirement. I'm sure you and your hubby wouldn't want to pay taxes down the road. The only two vehicles that allows TAX-Advantage is Roth IRA (don't know if your income qualifies) and Cash Value policy.

"Buy term and invest the difference" doesn't work for everyone. There are many things to consider. Taxes as above. $17 a month, how much difference can you squeeze to investing? Now that you're married and could start a family, you might need more insurance. Your hubby could add a term policy of 30 years for that need, and I WOULD NOT cancel the universal life. Also, get something to cover yourself to protect him in case something happens to you. Depending on your health,

Another you might consider for yourself if you're healthy, IUL (index universal life), and it depends on the company you're with, it generally ties to the performance of the S&P 500 and gives a minimum guarantee and cap or no cap on the gains. For example: let's say the S&P 500 does -10%, the company will give the minimum guarantee of 1%. If the S&P 500 does +10%, you would get all the 10% gain on your account. You get the gains without actually being participate in the market, and you're protected from the down market with the minimum guarantee. I recommend you watch a clip from Douglas Andrews on YOU TUBE on his explanation on IUL. Here's the link http://www.youtube.com/watch?v=_jZxp7i36Xg.

Hope this helps!

[Nick]

Without kids and without a need for the money I would cancel the policy if I could get $58K and fix my housing costs for the next 15 or 30 years at or below my rent. At 26, I think you're probably young (and presumably healthy) enough to get a good term policy when you need it at a very low rate. So I would take the $58K and buy a home if it didn't make me house poor.

But do a comparison term plus cash out versus leaving it in moving forward and see what's best for you. Definitely check an apples-to-apples death benefit though. If the policy is less than $500,000 I would guess that the math would tell you to cancel, but it depends on your health and location (and other things).

There amy be other tax-advantaged ways to invest the cash value (real estate, 529 (you can have you as a beneficiary and then change it to your kids when you have it, ROTHs, etc.). So you may also want to consider your other life goals and whether there are better places - outside of insurance - to park the cash value until you need insurance.

Good luck!

[Apex]

The last couple posters are not paying attention.

The death benefit is 58K. The cash value is unknown but much lower than that, probably lower than 10K.

17/month for 58K in death benefit is actually not cheap at all. I pay 33/month for 750K in death benefit, level term for 20 years taken out when I was 34. This policy was taken out when the person was 6 (cheapest time you can take it) and it was 17/month for 50K which would be 34/month for 100K making it nearly 8 times more expensive than my term taken out when the person was 30 years younger than me.

And to be clear I suggested above keeping the policy since the returns in the policy can probably pay for itself now, but don't confuse this with a cheap policy. It is nothing of the kind.

[Bob]

OK. I missed the post that clarified the $58K is the death benefit, not the cash value. The original phrase that the policy is "worth $58,000" had me believing it was the cash value.
Nevertheless, that face amount is indicative that the policy is set up pay out cash value PLUS level death benefit at death.

My notes stand basically unabridged except for "Fourthly". It looks to me as though there's about $8,000 cash that could be transferred to a newer, better, variable or global indexed universal life policy.

I'm partial to Western Reserve Life's VUL or GIUL because of the low internal costs and great accounts for growing the cash in it.

[Apex]

@Bob,

My comment wasn't to you but in reading your comment you said this:

"Another has no cap, but has accounts managed by the same people who handle the millionaires' money - able to "turn on a dime" as the markets go through their gyrations with an average of about 25% annually over the last ten years."

Turning on a dime? 25% annually over the last lost decade? The millionaires' money? Oh you mean those genius millionaires that never do anything stupid with their money and can buy the secret fund managers who know the secret formula that gets them the secret returns of way more than the rest of us schmucks can get? Come on. Is this guy Madoff's brother.

Everyone is always looking for the secret and attracted to the promise of the big benefits of the big secret. Here's a tip, there is no secret.

If it sounds too good to be true, the secret is, it's a lie.

[zoranian]

I'm not sure where, but I've read that "generally" whole life policies AFTER 10 years, become a positive investment. I would find out how much the cash value is growing at this time for the premiums being paid.

Also, to repeat previous posts, consider keeping the policy in case health issues crop up at some point in the future making it impossible to renew term insurance. Even a "small" amount of life insurance such as $58,000 can go a long way towards final expenses and can be worth paying a little extra for.

I would never purchase whole life insurance, but I know I do have a policy that my parents bought when I was little specifically because my mom did have health issues and can no longer get insurance and did not want me to be in that position.

[MBTN]

A couple things...

Find out what interest rate is being used to accumulate the funds. If it is a standard UL, it will probably be some rate assigned by the insurance company every year. You can use that to determine if you are better off standing pat or cancelling the policy. Also, find out what the cash value is. If the cash value is less than the death benefit, the insurance company will use some of the premium to pay for the death benefit, so keep in mind that you get some additional benefit above and beyond the cash value.

Also, the cash value accumulates tax-free so keep that in mind when doing any comparisons.

To the person who is trying to compare the premium on a UL policy to that of a term policy, you can't do that. Part of the $17/month goes towards the cash value of the policy and part goes towards the death benefit. When you pay for term, you are only paying for the death benefit. Apples and oranges. my friend!

[janet]

@ Nick: 529 plan is for education purposes only, and hope you know this but generally when someone owns a 529 plan, they can only make their investment changes once a year. So if the market crashes, there it goes down the drain as well. I've seen articles that talked about that on people that own 529 for their kids and what they thought would be there for their kid's education is half gone, like people's 410k.

People, don't get confused with the different types of permanent life/cash value policy. ULs, IULs, GIULs, Whole life, are all permanent, but they work very different in terms of how the cash value get accumulated.

IULs, in most company, has a minimum guarantee rate of return, even if the market crashes and get a cap or no cap gain without actually participating in the market. And for people that makes more than what IRS allow to have a Roth IRA, their only other option is usually a cash value policy to have tax-advantage withdrawal.

Real estate? Are you for real? I'm sure you've read that there's a double dip in that area approaching soon. So you're telling me if I sell a house and made $ on it, I don't need to pay taxes on that gain?

[Apex]

@MBTN,

part of the premium goes to cash value? LOL, nearly all of it does, well cash value plus whole life overhead and sales commisions. A very small amount goes to the premium. That's the point. That's obvious. That's the whole point of the whole life to term comparison and why people come down on the different sides that they do.

Someone claimed that paying 17/month for life insurance was actually cheap. Of course it is not when it is getting you 58K in insurance which is why I was comparing it to insurance that is actually cheap.

So no it's not apples and oranges to make the comparison. It's not cheap insurance. If all you want is cheap insurance then you don't buy WL.

Sorry, but you are not telling me or anyone else who makes the arguments for term or whole life anything new with your apples and oranges comment my friend.

[Apex]

@janet

If it's your primary residence the first 250,000 of capital gains are 100% tax free (500,000 if married). So yes, if you sell a house and make a half million on it, you don't need to pay any taxes. Look into it, it's for real.

[Original poster]

I don't know if anyone is still reading this, but I just found out that the cash value is $1,250. Sounds like this is not worth cashing out, and that I should just keep the policy... but ask if I can stop making payments and let the dividends carry themselves (without causing the value to decrease). Does that sound right?

Many thanks, all!

[Larry Rossdale]

You shouldn't wait until you have children. Term life insurance is much more affordable the younger you apply for it. I ended up at a site my friend recommended, http://buytermlife.com/. They had a that was very helpful. I ended up finding a package that was very affordable. I would recommend them as a good place to start your search.