Surrender Whole Life Policy?

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Topic Author
investor2741
Posts: 3
Joined: Mon May 03, 2021 11:00 am

Surrender Whole Life Policy?

Post by investor2741 »

First, many thanks to all the Bogleheads who have helped me better understand the investing & personal finance landscape. This site has been invaluable to me over the last couple years.

I was hoping some of you could double check my math regarding a decision to take the cash value of my whole life policy, learn an expensive lesson, and stop the bleeding. I started a $150k 20-Pay Whole Life policy in October 2017 with the mistaken understanding (shame on me) that the Guaranteed Cash Value and Current Dividend schedules were indexed to inflation. The plan was sold to me as a "life insurance now, college fund later" vehicle, although I now understand (thanks to you all) how misguided that advice is. I got married in 2019, and in 2020 my wife and I both took out $500k 30-year term life insurance policies in anticipation of becoming parents (we're both 34 years old now). Seeing the monthly premium of $47 clarified for me exactly how much of my Whole Life premium was not a life insurance cost but rather an enormous investment fee, and after a few months of dragging my feet it's time to act.

Whole Life Policy details:
$150,000 death benefit
$2927 premium per year (240 months of premiums, 43 of which [$10,500] are sunk)
Guaranteed Cash Value @ Year 30 (61 years old): $73,300
Current Dividend schedule @ Year 30: $117,900
Current Cash Value: $2800 today
Inflation assumption: 2% per year

Other information that may be relevant:
$120k mortgage balance, with 14 years remaining @ 2.875% (I don't plan to pay this down or pay off early, but I am using it as my personal risk-free rate for comparison)
All tax advantaged space is being used, so the Whole Life premium will be diverted to a taxable retirement & a 529 to be opened later this year when our first is born (!)

Assumptions
I'm paying $47/mo ($564/yr) for a $500k policy, so I'm considering the invested portion of my Whole Life policy is [2927 - 150/500 * 564 = $2758].
The remaining premiums and cash values are adjusted into 2021 dollars
There's nothing I can do about the 43 sunk premium payments, so this analysis evaluates the utility of future payments using the future cash values.

Results
The present value of the remaining 197 premiums is ~$40,600. The present value of the hypothetical $150k life insurance cost over that time period is ~$2400. Therefore, the present value of the "invested portion" is ~$38,200. The present value of the guaranteed cash value, at year 30, is [73,300*0.98^27 = $42,500]. The present value of the current dividend schedule, at year 30, is [117,900*0.98^27 = $68,300].
If $38,200 is invested over the next 197 months, then in 27 years, the real rate of return is 0.7% for the guaranteed value and 3.3% for the current schedule.

My question is if my math is correct regarding the rate of return calculation (0.7% real or 2.7% nominal, up to 3.3% real or 5.3% nominal)

Even considering that I've paid a flat 10,500-2,800 = $7,700 commission, the invested portion of the policy, as of now, promises a return below my risk-free rate. If the current dividend schedule holds up, I'm making 5.3% nominal average over 3 decades, which is less than I expect my invested portfolio to return, and it includes the risk that the current dividend schedule is maintained, which I can't quantify, and in addition, zero control over that liquidity in the interim.

Hopefully I've provided enough details without too much extraneous info. Any input/verification will be greatly appreciated!
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Stinky
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Re: Surrender Whole Life Policy?

Post by Stinky »

investor2741 wrote: Mon May 03, 2021 12:50 pm
I was hoping some of you could double check my math regarding a decision to take the cash value of my whole life policy, learn an expensive lesson, and stop the bleeding.
Welcome to the Forum! Glad that you posted your question.

I agree with your (tentative) decision to lapse your policy now, not throw any more good money after bad, and move forward. I agree that buying term life is far more useful than whole life of any type, and I would encourage you to consider whether the $500k is enough for you. (But that could be the subject of another thread.)

If you've looked at the Forum, you'll see that I post frequently about life insurance and annuity topics. I was a senior financial person with a major life insurance company for my entire career, and I have a lot of familiarity with whole life policies.

I've never looked at a policy quite like you're trying to, so I'm not going to comment on your approach. But here's the way that I would look at it:
--- You've paid $10,500 into the policy so far, with only a $2,700 cash value. I agree that's a sunk cost. (I'm sure that it's painful.)
--- I'll bet that the increase in the cash value for the next policy year is less than the $2,797 premium that you're paying. Maybe it's $2,000 or so. If that's the case, you're going deeper into the hole.
--- For a few more policy years, your increase in cash value will be less than the premium that you pay. But after a while, it will turn around.
--- By the time you get out to policy year 10 or so, you'll be making a "return" on your cash value. I'd calculate that as [Increase in cash value for this policy year minus premium paid], all divided by beginning of policy year cash value. I expect that that calculation might be in the range of 3-4%, maybe in little more, as the policy years increase. But that's all you'll ever get - a nominal "return" on your cash value.

Often, the advice on this Forum to someone who is in duration 10+ on a whole life policy is to keep the policy if they want to consider it as part of their "fixed income" allocation. But that's not your case. You're looking at many future years of negative-to-poor returns on your money, while you throw more good money after bad, until it becomes even a reasonable fixed income investment.

I affirm your thought. I'd lapse this policy, collect the cash value, and regard this as a lesson learned.

All of us have made financial "mistakes" in our lifetimes, and I've made mistakes that are multiples of the size of this "mistake". If this is the largest one that you make, you'll have led a charmed life.

Please post back with questions.
It's a GREAT day to be alive! - Travis Tritt
Rex66
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Joined: Tue Aug 04, 2020 5:13 pm

Re: Surrender Whole Life Policy?

Post by Rex66 »

In your relatively longer post, you never mentioned needing or wanting a permanent death benefit.

That right there make this a no go any further.

You are in year 4 and while nobody knows for sure, it is very likely dividends will continue to fall for some time. None of the companies have really turned that around and ohio national which was a mutual just declared it is demutalizing (that means the policy owners are going to see their dividends go even lower). The situation for ohio national isnt necessarily unique although their situation likely was worse than some other companies. Thus i wouldnt have a lot of faith at this time in whole life companies to increase dividends.

Beyond the issues mentioned above by stinky whom i think is right on, for you to access money out of this policy while alive is going to cost you substantially in loans. The rates are not competitive and if its a direct recognition company then they further cut your dividend on the loaned amount (how nice of them). If you surrender later on then any gains (assuming you got that far) would be taxed at income rates. If you happen to surrender after taking out loans then even that interest is taxed. You mentioned college fund. That is one of the main ways people get into trouble with what i just outlined. You think hey ill use this to put bobby through college. The loan costs add up and eat away the policy and you get nothing but trouble from there on.

You know what to do.
Topic Author
investor2741
Posts: 3
Joined: Mon May 03, 2021 11:00 am

Re: Surrender Whole Life Policy?

Post by investor2741 »

Stinky,

Many thanks. It's actually some of your posts elsewhere that caused me to take a second look. I'm pretty embarrassed that I didn't realize how awful this policy is and let myself be convinced to sign up, but... live and learn!

You mention that $500k may not be enough, and now that there's a baby on the way (and not just a hypothetical one) I think I agree with you. I'll have to double check, but I think my term policy has the option to increase the coverage without another medical exam. Is it generally cheaper to increase existing coverage rather than going somewhere else and starting another policy? Even before this fun little realization I haven't been thrilled with our current home/umbrella/auto/whole/term insurance provider.

Thanks again for your insight, I continue to benefit from it.
Topic Author
investor2741
Posts: 3
Joined: Mon May 03, 2021 11:00 am

Re: Surrender Whole Life Policy?

Post by investor2741 »

Rex66 wrote: Tue May 04, 2021 5:00 pm it is very likely dividends will continue to fall for some time
Just out of curiosity... Is this because these companies are using fixed income investments themselves (rather than a more aggressive investment strategy) to fund the dividends offered to customers? IE, expectations of low interest rates going forward is essentially the writing on the wall for dividend payouts?
Rex66
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Re: Surrender Whole Life Policy?

Post by Rex66 »

They have a higher percentage in bonds and treasuries

Some of that is required

Bottom line is low interest rate environment hurts them
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Stinky
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Re: Surrender Whole Life Policy?

Post by Stinky »

investor2741 wrote: Tue May 04, 2021 5:08 pm Stinky,

You mention that $500k may not be enough, and now that there's a baby on the way (and not just a hypothetical one) I think I agree with you. I'll have to double check, but I think my term policy has the option to increase the coverage without another medical exam. Is it generally cheaper to increase existing coverage rather than going somewhere else and starting another policy? Even before this fun little realization I haven't been thrilled with our current home/umbrella/auto/whole/term insurance provider.

Thanks again for your insight, I continue to benefit from it.
Two thoughts about your additional questions.

First, if you have your term life through the same company where you have your auto/home, etc., it’s possible that your current policy is more expensive than it needs to be. Some multi line companies, especially State Farm, sell pretty uncompetitive life products. Others may be better than SF.

Second, I’d make an objective determination about the cost of increasing insurance coverage. For example, if you have $500k of term now and want to increase to $1 million, then go to Zander.com or term4sale.com and price out $1 million of level term, in the same risk class as your current policy, for a level term period that most closely matches the remaining term on your current policy. Compare that premium to what you would pay under the current policy at $1 million.

Go with the cheaper alternative. If the cheaper is the brand new policy (as I think it will be), make sure to get the new policy in place before you lapse the old.

Post back with questions.
It's a GREAT day to be alive! - Travis Tritt
exodusNH
Posts: 156
Joined: Wed Jan 06, 2021 8:21 pm

Re: Surrender Whole Life Policy?

Post by exodusNH »

investor2741 wrote: Tue May 04, 2021 5:08 pm Many thanks. It's actually some of your posts elsewhere that caused me to take a second look. I'm pretty embarrassed that I didn't realize how awful this policy is and let myself be convinced to sign up, but... live and learn!
I didn't realize it until 17 years later! You're doing way better than me! Take your lumps now and enjoy the compounding in a real investment.

As Stinky mentioned, for me, at this point, I'm treating it as part of my fixed-income allocation, where it's about 1/3 of the total. Once I get a better feeling of my 2021 tax situation, I may cash it out, pay the tax on the gains, invest it in taxable and buy a replacement amount in by 401K.
BatBuckeye
Posts: 46
Joined: Fri Jul 10, 2020 6:15 pm

Re: Surrender Whole Life Policy?

Post by BatBuckeye »

OP, you mention dividends. When is the next dividend paid. If is in the near future you may want to get the dividend and then cancel.
Put your $2,800 in some Index fund and let us know how this worked out for you 20 years from now. I believe you'll come out ahead with the Index fund.
Rex66
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Joined: Tue Aug 04, 2020 5:13 pm

Re: Surrender Whole Life Policy?

Post by Rex66 »

Read number 3 about dividends

https://theinsuranceproblog.com/top-thr ... lf-truths/

Some companies make it impossible to get the dividend if you don’t pay the next premium
tj
Posts: 4319
Joined: Thu Dec 24, 2009 12:10 am

Re: Surrender Whole Life Policy?

Post by tj »

Rex66 wrote: Tue May 04, 2021 5:00 pm In your relatively longer post, you never mentioned needing or wanting a permanent death benefit.

That right there make this a no go any further.

You are in year 4 and while nobody knows for sure, it is very likely dividends will continue to fall for some time. None of the companies have really turned that around and ohio national which was a mutual just declared it is demutalizing (that means the policy owners are going to see their dividends go even lower). The situation for ohio national isnt necessarily unique although their situation likely was worse than some other companies. Thus i wouldnt have a lot of faith at this time in whole life companies to increase dividends.

Beyond the issues mentioned above by stinky whom i think is right on, for you to access money out of this policy while alive is going to cost you substantially in loans. The rates are not competitive and if its a direct recognition company then they further cut your dividend on the loaned amount (how nice of them). If you surrender later on then any gains (assuming you got that far) would be taxed at income rates. If you happen to surrender after taking out loans then even that interest is taxed. You mentioned college fund. That is one of the main ways people get into trouble with what i just outlined. You think hey ill use this to put bobby through college. The loan costs add up and eat away the policy and you get nothing but trouble from there on.

You know what to do.
If Ohio National is demutualizing, the policyholders should receive stock, no?
Rex66
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Joined: Tue Aug 04, 2020 5:13 pm

Re: Surrender Whole Life Policy?

Post by Rex66 »

Yes but it historically is also associated with policies performing closer to guarantee levels

You can look at insurance agent forums to see how agents think this will shake out

I wouldn’t want to be in that situation
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Stinky
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Re: Surrender Whole Life Policy?

Post by Stinky »

tj wrote: Tue May 04, 2021 9:27 pm If Ohio National is demutualizing, the policyholders should receive stock, no?
Here’s a link to the Ohio National press release.

https://advancingohionational.com/resou ... tellation/

It appears that this is a “sponsored” demutualization, where one party will take ownership. It looks like current policyholders may get cash and other policy benefits, but not stock.
It's a GREAT day to be alive! - Travis Tritt
tj
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Joined: Thu Dec 24, 2009 12:10 am

Re: Surrender Whole Life Policy?

Post by tj »

I suppose it depends how long that process will take. Might be worth paying a few extra months of premiums to get free cash. But it might not.
Rex66
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Joined: Tue Aug 04, 2020 5:13 pm

Re: Surrender Whole Life Policy?

Post by Rex66 »

Probably

The problem is for people who developed health issues or are fairly old and wanted a death benefit. Those people had already seen dividends fall a long time. Relatively new policy holders who woke up to what they really purchased and want out might actually be a tad happier.
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