Keep or Surrender - Life Insurance Eval Help

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Topic Author
LearnFin
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Joined: Mon Oct 18, 2021 10:12 pm

Keep or Surrender - Life Insurance Eval Help

Post by LearnFin »

I am 55, and my DW is 50. I had taken a whole life from SBLI for 500K 20 years back. Thankfully, I do not need life insurance coverage now, since my kids are in college, and have sufficient savings to cover their education. My DW doesn't need my life coverage either, due to being gainfully employed, and have sufficient savings to cover all future expenses.

The only reason for me to continue the life insurance will be to consider this as a 'bond' portion of my portfolio. Based on reading other threads, I had requested the in-force illustration, and the net-gain report from SBLI, which is attached below. Net Gain shows as $45K. I do have a lot of taxable losses that I am carrying forward (long term and short term) which, I believe, could be used to off-set the $45K gains.

Note - I pay $5885 per annum as premium.

Question is:
1. Considering the growth illustrated here, does it make sense to continue to keep this as a 'Bond' portion of my asset allocation. ?

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Thanks in advance for your comments.
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Nate79
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Location: Delaware

Re: Keep or Surrender - Life Insurance Eval Help

Post by Nate79 »

The guaranteed return looks horrible to me even ignoring the fact of the problems with life insurance as a bond substitute (its not).
exodusNH
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Re: Keep or Surrender - Life Insurance Eval Help

Post by exodusNH »

LearnFin wrote: Thu Sep 22, 2022 12:10 pm I am 55, and my DW is 50. I had taken a whole life from SBLI for 500K 20 years back. Thankfully, I do not need life insurance coverage now, since my kids are in college, and have sufficient savings to cover their education. My DW doesn't need my life coverage either, due to being gainfully employed, and have sufficient savings to cover all future expenses.

The only reason for me to continue the life insurance will be to consider this as a 'bond' portion of my portfolio. Based on reading other threads, I had requested the in-force illustration, and the net-gain report from SBLI, which is attached below. Net Gain shows as $45K. I do have a lot of taxable losses that I am carrying forward (long term and short term) which, I believe, could be used to off-set the $45K gains.

Note - I pay $5885 per annum as premium.

Question is:
1. Considering the growth illustrated here, does it make sense to continue to keep this as a 'Bond' portion of my asset allocation. ?

Image

Image



Thanks in advance for your comments.
You have a guaranteed interest rate of 1.97%. The optimistic rate is 2.83%. You can calculate these yourself by subtracting the cash values of years n+1 and n, subtracting from that your annual premium, and dividing by the year n cash value.

Your return will wind up being somewhere between the two values, probably pretty close to the non-guaranteed value for the next couple of years.

If taking the taxable gain wouldn't cause you an inordinate tax burden, I'd probably surrender the policy. You could also go to "reduced paid up" status, which would freeze the cash value and allow you to use the premium on something else. If you die before cashing it out, your be beneficiaries will get the current cash value plus any later dividends (if you continue to reinvest them) tax-free.

I have an old policy, too. It's projected to pay out over 4% over the next couple of years; I'm keeping the policy for now, but will evaluate it yearly.
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Stinky
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Re: Keep or Surrender - Life Insurance Eval Help

Post by Stinky »

I agree with the calculation by exodusNH of a 2.83% expected ROI for the next policy year. OP, if you have any questions about how that was calculated, please post back.

That 2.83% is much lower than the ROI on other whole life policies from NWML and others. And it’s lower than the rate on some CDs and MYGAs. Given that and the fact that OP doesn’t need the insurance, I’d surrender the policy.

Just to clear up one possible misconception by OP - the taxable gain on the whole life policy is ordinary income, and cannot be offset by capital losses.
Retired life insurance company financial officer who sincerely believes that ”It’s a GREAT day to be alive!”
petulant
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Re: Keep or Surrender - Life Insurance Eval Help

Post by petulant »

I do not believe the guaranteed column is reasonable for evaluating this policy. Yet looking at the current assumption column, the growth rate on cash value is around 2.8%. If we tax adjust the figures so that we look at the growth in net surrender value after paying taxes (assumed at a marginal tax rate of 22% plus 4% state for demonstrative purposes), it's right about 2%. The policy is probably not worth keeping as a long-term bond substitute for cash value purposes only; it might be debatable to keep it as an emergency fund if OP uses policy loans for emergency fund/liquidity purposes and planned to keep the policy until passing away to avoid taxes--again, debatable in that scenario.

The policy could also be evaluated for the IRR on death benefit. For example, there may be actuarial arbitrage from keeping the policy. What I mean is that if OP has developed any medical conditions since buying the policy where the life expectancy assumed in the policy is longer than OP's actual reasonable life expectancy, it might be valuable to keep the policy anyway. For example, if OP passes away at a possible but relatively early age 78, the beneficiary receives $693,393, which would be an IRR of 4.63% as things stand today. OP could try to discover a reasonable estimate of personal life expectancy and see how the IRR looks for the death benefit for years as of that date. Here's another angle for the IRR on death benefit. Depending on OP's sources of income in retirement, holding out for the death benefit can be beneficial even if not completely necessary--for example, if both spouses will have significant social security benefits and OP would have a pension, OP's early mortality would reduce these income sources significantly. In that case, life insurance offsets early mortality risk, and it might be reasonable to evaluate the policy in terms of spouse's retirement funding if OP passed away at age 73 or 74. (Of course, if all retirement wealth is in investment accounts and OP's social security benefit would be materially higher than spouse's, then early mortality risk is very low and death benefit does not provide special value here.)

OP should also determine if there are any living benefit riders included in the policy, which again might entail valuable rights and warrant closer review.

Regarding tax offsets, I assume OP means he believes that he can offset the ordinary income from surrendering the policy against capital losses on stocks or bonds or funds. I do not share OP's position that gain on a whole life policy can be offset against such losses (except for the general deduction of capital losses against ordinary income up to $3000 per year). OP should expect to pay income taxes on surrender. OP can minimize or defer the tax consequences by performing a 1035 exchange into an annuity such as a multi-year guaranteed annuity (MYGA) or Fidelity's Personal Retirement Annuity and realize the income later. A MYGA (also sometimes called a deferred fixed annuity) might be able to earn 3.5-4.5% depending on credit risk appetite.
Topic Author
LearnFin
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Joined: Mon Oct 18, 2021 10:12 pm

Re: Keep or Surrender - Life Insurance Eval Help

Post by LearnFin »

Thanks to all for your feedback. I also learnt today, that the Gain inside Life Insurance is 'Ordinary Income' and not 'capital Gains'.

So my options could be summarized as below:


1. Surrender the Policy - Pay income taxes on $45K as Ordinary income. Take the proceeds and invest in an after tax account.

2. Perform a 1035 Exchange into a Fidelity Personal Retirement Annuity Or a MYGA. If I perform this exchange, will my cost basis get carried forward to the Annuity vehicle from the life insurance?

Thanks
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Stinky
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Re: Keep or Surrender - Life Insurance Eval Help

Post by Stinky »

LearnFin wrote: Mon Sep 26, 2022 3:40 pm Thanks to all for your feedback. I also learnt today, that the Gain inside Life Insurance is 'Ordinary Income' and not 'capital Gains'.

So my options could be summarized as below:

1. Surrender the Policy - Pay income taxes on $45K as Ordinary income. Take the proceeds and invest in an after tax account.

2. Perform a 1035 Exchange into a Fidelity Personal Retirement Annuity Or a MYGA. If I perform this exchange, will my cost basis get carried forward to the Annuity vehicle from the life insurance?

Thanks
Those sound like two reasonable options. The cost basis would carry forward to the annuity.

Be aware of the following if you go the annuity route -
—- Withdrawals from an annuity are treated as “interest first, then basis” for tax purposes.
—- Any withdrawals of interest before your age 59.5 will be assessed a 10% penalty tax, in addition to regular income tax.
—- Annuities do not receive a basis step up at death. So, if you don’t withdraw before you die, your heirs will pay the tax.
—- All earnings on an annuity, including gains on equities within a variable annuity, are treated as ordinary income (when withdrawn) for tax purposes.
Retired life insurance company financial officer who sincerely believes that ”It’s a GREAT day to be alive!”
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