We speak with a CFP who says they should be treated like an asset
What Should You Do With Life Insurance Policies You No Longer Need?
by Gary Foreman
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Your kids are all grown and you're heading for retirement. So, why are you still paying for life insurance that you probably don't need any more? That's a good question! What should you do with long held insurance policies that you no longer need?
To help us understand what options are available, we contacted Dan Moisand. Mr. Moisand is a Certified Financial Planner™ and a principal in Moisand Fitzgerald Tamayo, LLC. He has also written about dropping an insurance policy.
Q: There's a temptation for baby boomers and retirees to drop life insurance policies. Yet, you recommend doing some homework before taking any action. Why is that?
Mr. Moisand: Most life insurance for working-age people is bought to replace employment income that would be lost when one dies. When one retires, that need ends so it makes perfect sense to reevaluate the amount of coverage and often people decide they need less. An insurance policy is a contract. The terms of the contract provide options and some of those options make the policy a more valuable asset than the owner realizes.
Q: Figuring out how much tax might be due looks complicated. Is that something that the insurance company can help with or should the insured contact a qualified financial advisor?
Mr. Moisand: Both. Sometimes dumping or changing a policy results in a taxable event. The insurance company is supposed to keep track of all those factors. They will report taxable income. It is wise to consult a qualified advisor before executing an insurance transaction so you know the tax ramifications and double check what the insurance company intends to report.
Q: How can a consumer know which life insurance benefits are taxable? And, at what rate they're taxed?
Mr. Moisand: This can get very complex particularly if there are dividends or loans involved, but as a general principle and a ball park estimate, if you would receive a check for more than what you have paid to the insurance company, that excess is taxed as ordinary income. It is added to all your other income and taxed at the same rate it would be if you had been paid additional salary.
Calculator: How much life insurance do I need?
Q: If you can't afford to keep paying premiums, are their other options besides cashing in the policy?
Mr. Moisand: Yes. Depending on the policy, you may be able to have the cash value keep the policy in force for some time. You may be able to reduce the death benefit and the premium that goes with it. Some policies allow you to reduce premiums as you wish. You could execute a 1035 exchange to another policy or an annuity. These and other choices all have pros and cons.
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Q: What is a 1035 exchange and how does it work?
Mr. Moisand: It is the insurance version of a rollover. 1035 refers to a section of the tax code. It allows you to transfer cash value from one life insurance policy to another without incurring the taxes that would result if you cashed out one policy and bought a new one. You can also exchange from a life policy to an annuity contract.
Q: What's the most common mistake that people make when deciding what to do with an old life insurance policy?
Mr. Moisand: They just take the cash surrender value without understanding the taxes and without considering their other options. Instead of just focusing on minimizing the expense of premiums, they should look at it as an asset to be maximized.
Reviewed August 2017
Dan Moisand is a Certified Financial Planner™ and a principal in Moisand Fitzgerald Tamayo, LLC. Mr. Moisand is regarded by many as one of America's top financial advisors. He works from offices in Melbourne and Orlando, Florida. He is a happily married father of two great kids.
Retirees and those approaching retirement will have a hard time finding a firm better equipped to serve them and their families than Moisand Fitzgerald Tamayo and Dan is part of why that is the case. He producesa weekly Q&A as a "Retirementor" for MarketWatch, a personal finance site of the Wall Street Journal. He is a frequent source to a variety of publications and media and has appeared in Smart Money, NY Times, Wall Street Journal, Forbes, and USA Today among others.
Dan received his Bachelor of Science in Finance from Florida State University and has over 25 years of experience. Visit here for more on Daniel Moisand.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.
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