Rescuing a whole life policy with a large loan

[wergild]

I need help thinking through a whole life policy with a significant policy loan. My wife received this policy as a gift from her grandfather when she was 13 years old, in 1985. After various reconfigurations and partial surrenders over the years, here are the current stats:

Paid up status (no more premiums due)
Cost basis: $0.00 (due to previous partial surrenders)
Net death benefit: $322,683
Accumulated value that would be taxable if surrendered: $205,448
Net cash value that she would receive if surrendered: $60,289
Policy loan: $146,919
Loan interest (variable market rate): 5.73%

We have no dependents and do not need the death benefit. So we are evaluating what the best course of action is primarily through the lens of minimizing additional cost.

My initial thought (scenario 1) was that she should surrender the policy ASAP and take the tax hit while she still gets some cash to offset it. Otherwise she’ll need to keep paying the loan interest, or at least some of it, to stave off the risk that it will exceed the total value and force a surrender with no cash payout. I'd calculate the expected tax hit (minus the $60K cash out) to be roughly $20K. Given other income, this is mostly landing in the 35% tax bracket.

Alternatively, she does have $93K of paid up additions on the policy that could be surrendered and applied to the policy loan, which would reduce the interest payments. So an alternate idea (scenario 2) is to surrender some of those and change the dividends to apply to the loan instead of buying paid up additions. Unfortunately, both the one-time surrender and the yearly dividend would be taxable since her cost basis is down to zero.

The goal with this second scenario would be to keep the policy somewhat stable with no additional new money going in. The upside is maintaining a death benefit that we could leave to a charity. The downside is the initial tax cost for a meaningful partial surrender would probably equal the net tax for a total surrender, there would be yearly tax on dividends, and it would require ongoing monitoring and potentially the addition of more funds if the loan interest rate goes up and/or the dividend payment goes down.

I keep trying to puzzle out if there’s anything good to make of this policy. I’ve gotten numerous illustrations from the insurance company exploring these scenarios with different partial surrender amounts and I am honestly pretty confused by them. I can’t quite make sense of the assumptions they provide regarding dividend changes and growth in future years. The whole thing feels more confusing than I want it to be.

I feel like I’m spinning my wheels trying to find a scenario where the policy is able to be stabilized/maintained with cost outlays that end up being similar to a total surrender. Part of me feels that even though we don’t have dependents, we should be good stewards of this and direct the death benefit to a charity if there’s a scenario that doesn’t cost much more. Another part of me just wants to be rid of it. What would you do? What am I not thinking of?

[Chuck]

What is your tax bracket?

Does your policy dividend have direct recognition of the loan balance? If so, what is the spread between the loan rate and the direct recognition dividend rate? If this spread is not large, it wouldn't cost much to sit on it while you're thinking about it, or wait until you're in a lower tax bracket and surrender it then, or do partial surrenders over time to stay in a good tax bracket.

[Chuck]

Let me toss out an example. Let's say your AGI is $69,450 (making it easy for myself). The 12% tax bracket is $89,450, so you could surrender $20,000 and pay 12% tax ($2400) and use the remainder ($17,600) to pay down the loan. Repeat this every year until it's gone.

It would take 10 years to unwind it this way, but in the end you'll only pay 12% tax (which is 40% of the cash value) instead of potentially 22% tax (or 75% of the cash value), given this set of tax bracket assumptions.

This also assumes the premiums and dividends are more or less fair. If the policy contract is a raw deal, then taking the full tax hit and getting out while you can may still be the play.

[wergild]

We're in the MFJ 32% tax bracket and any significant surrender would push into 35%. We don't anticipate being in a lower bracket for the medium-term.

[Chuck]

Yeah, that's tough. People talk about whole life policies "blowing up" due to loans, and I'd say this is a pretty good example of blow'd up.

The net tax hit is around $11,000 then, I'd just eat it and forget all about it. Your annual income is around $400,000, so this is small beans for you.

[BruDude]

Work with an agent to run quotes for a new cash value policy with a 1035 exchange to see if a “loan rescue” can be done. Otherwise your options are to cash out and pay the tax bill or keep paying the interest or pay back the loan.

[Rex66]

this is the typical situation when taking money out early. Its one of the reasons why using WL for retirement can just be a disaster. If you live long enough the withdrawls and loans come back to haunt you. You wind up paying taxes on phantom gains.

It is not super likely that a new policy is going to work out. Which company is going to take this policy without creating boot? You have all the startup costs and negative years for someone who really doesnt have any need for a death benefit and is like i guess we can leave it to charity.

Its pretty hard to predict this one going forward but id just take the tax hit and move forward. Since you dont care that much for the death benefit I cant see taking the risks of having a bigger bomb down the line since thats what is happening as the loan grows.

[Stinky]

I’d follow your instincts and get out of this policy now.

Before things get any worse and before you pay even more policy loan interest.

[petulant]

DW is only 50. Why was this policy borrowed against so heavily with no plan to pay it back while in prime working years? Why was its basis gutted at such a young age? That is a management problem on the policyholder's part.

Get an illustration of what it looks like if you just pay the loan back. Look at the IRR through age 65 and through the death benefit. I imagine it will show that if you weren't taking out loans willy nilly, the IRR from today to DW's age 65 is at least 4%, but probably higher.

DW is 50. You should almost certainly have a fixed income allocation. Why are you blowing up a workable fixed income asset? The policy would be a fine substitute for a bond fund for the next 10-20 years with emergency fund access to boot--just don't take out $140,000 loans with no plan to pay them back so young.

A better exit plan would be to pay back the loan, wait until retirement, and then evaluate surrender all in 1-2 years to flush out the gains or adopt a strategy of sustainable loans. With no heirs, it might even work to 1035 to a SPIA.

Taking out policy loans so early with no plan to repay them was a deliberate choice that murdered the economics of this policy. You can either figure out the burial or you can repay the loans.

[Valuethinker]

I feel like I’m spinning my wheels trying to find a scenario where the policy is able to be stabilized/maintained with cost outlays that end up being similar to a total surrender. Part of me feels that even though we don’t have dependents, we should be good stewards of this and direct the death benefit to a charity if there’s a scenario that doesn’t cost much more. Another part of me just wants to be rid of it. What would you do? What am I not thinking of?

Caveat: this is philosophical advice, not financial. I really don't know/ understand the economics of this product (and I am not US based).

Just a point about human beings and "myopic loss aversion".

Roughly speaking we feel twice as much pain when realising a loss as when experiencing a gain -- in the short term.

Thus we tend to "Sell our winners too early. And run [stick with] our losers too long".

This is something that can be observed in every aspect of life if you are paying attention. Relationships. Jobs. Bad purchases.

The way to fight it is to use precommitment strategies (don't buy snack foods in the weekly grocery shopping, because then you can't engage in short term gratification when you want a snack).

In investing, the key is to recognise bad decisions, and rather than procrastinating, just resolve them.

I don't know what is financially the best course of action in this case, I am not that familiar with whole life policies.

However:
- you don't need the life insurance on your wife's life (if you did, cheap level premium term is the way to go)
- it sounds like the money is neither here nor there to you
- this was a bad decision, made a long time ago (but there are emotional ties eg "grandfather, when she was 13" *)
- the policy borrowing rate is high

(There's a lot of pretty sniffy criticism going on in this thread about the Policy Loan. We all make bad financial decisions. For example we get divorced. We choose financially dependent in-laws etc. We are not even conscious of these as financial decisions when we make them. The point is not to judge others it is to learn from our own mistakes - and to provide the best advice we can).

The key is to recognise that that is the past. A sunk cost. Closing off the bad bet will cost you pain in the short term - but only in the short term.

Would you invest in this product *now* given the financial position it is in right now?

As long as there is not a meaningful adverse impact on your financial position by closing out the policy-- I would.

Close it out. Stop the pain. Chalk it up to experience and thank the deities for making you well enough off to be able to do that. To walk away from a mistake.

You are trying to invent reasons, I think, not to take that pain? To make something which is wrong, right. "Good stewardship" etc. But the reality is you can't make a wrong right, any more than one can make a bad relationship right.

You can't take your money with you when you go. This investment is causing you pain. It is diminishing the quality of the time you do have on this Earth.

* a thing about grandparents and parents. They would never have wanted her to stick with a bad decision. It's not a gift if it comes with strings attached. My father did not agree with all I did, but he did let me grow up and make my own mistakes. I was, and I am, devastated by the suddenness and manner of his death. But he knew how to shrug his shoulders and move on -- and he would have wanted me to do the same.

Your wife's grandfather's advice would no doubt be "If it's a bad investment, then sink it".

[Stinky]

I like Valuethinker’s philosophical post.

To briefly summarize, there have been two bad financial decisions in the past -
—- Grandpa’s original decision to buy the whole life policy.
—- Someone’s decision to heavily loan out the policy cash value.

Now, in 2023, there’s no reason to tie yourself in financial knots to try to “fix” those two past mistakes.

Agreeing with Valuethinker - surrender the policy, pay any taxes due, go in your way, live your life without this stress.

[petulant]

- you don't need the life insurance on your wife's life (if you did, cheap level premium term is the way to go)

This is not a point about surrendering the policy, this is a point about how to evaluate it. If life insurance's early death risk reduction is not needed, then it should just be reviewed under an IRR standard.

this was a bad decision, made a long time ago (but there are emotional ties eg "grandfather, when she was 13" *)

Where was the bad decision? The policy was plundered much more recently.

the policy borrowing rate is high

Without knowing the company (likely MM or someone like that), it is likely that the policy loan rate is only about 1% more than the internal growth of the cash value.

(There's a lot of pretty sniffy criticism going on in this thread about the Policy Loan. We all make bad financial decisions. For example we get divorced. We choose financially dependent in-laws etc. We are not even conscious of these as financial decisions when we make them. The point is not to judge others it is to learn from our own mistakes - and to provide the best advice we can).

It is relevant to get to the root of errors to get to the best advice. For example, is the biggest problem here that whole life products are bad, as suggested by some, or is it that the policyholders mismanaged this policy, which included not spending the time to learn how to manage and sustain what was likely at least a $300,000 asset before partial surrenders and loans began? It is analogous to having a major foundation or roofing issue that ultimately causes significant damage to a house--was the problem because houses are bad products, or because somebody didn't respond to the first sign of danger when there was a leak? That is a critical difference that directly affects OP going forward--is OP going to actually do the research to understand the product to fix the situation, or not?

Would you invest in this product *now* given the financial position it is in right now?

This is absolutely not the right question. First, the economics and structure of whole life insurance policies can change significantly based on the age when taken out. A 50-year-old will struggle to buy a policy with the same characteristics as this one, and would almost certainly need to be paying premiums across several years. Second, major caveats to this kind of thinking are always tax consequences and transaction costs. Consider a limited stock ETF purchased many years ago and now with large built-up gains, like a FTSE 100 or S&P 500 ETF, when the investor now has a perspective that more broad diversification is required. It is not a complete analysis to ask whether someone would buy the same product today, and that kind of reasoning would lead directly to the wrong place. The question is how close the S&P 500 or FTSE 100 ETF is to the desired asset allocation, and whether the large tax cost of exit is worth it.

The tax cost of a surrender right now is on the order of around $80,000. If the policy is properly rehabilitated (i.e. the loans are paid back) that tax can be deferred and potentially never experienced if surrendered in a retirement year or managed with sustainable, small loans in retirement. The situation is not painful because it was imposed by an outside force that OP needs to cut off. The situation is painful because OP was handed a $300,000 asset and did not learn how to manage it. This is not a typical situation found on Bogleheads where somebody purchased a poorly designed whole life insurance policy, spent $150,000 in premiums over 15 years and now only has a policy worth $170,000 (if that) where it is easy to say they should just surrender it. This is a policy that was economic over a long period of time, was looted, and now poses a material tax cost that can be avoided and managed.

[Rex66]

Wait a second this policy was sold exactly to do this

This is super common

Grandpa gets policy for college. Grandpa is tricked into thinking it’s a great investment and isn’t in fasa as why to buy. The illustration at that time would have supported these loans bc dividends were much higher.

Agent doesn’t get any commission after 10 years so they stop caring

There is no way the OP figured out to surrender to basis then loan out without the agent presenting it

This isn’t a client problem. It’s an industry wide issue and it’s always downplayed by agents.

[petulant]

Here's a start to a quantitative analysis. Assume the OP has a separate $146,919 that would be allocated to fixed income. (These are reasonable assumptions for a couple with no heirs in their 50s, but this specifically is needed for an apples-to-apples comparison.)

In option 1, couple surrenders policy, receives $60,000, pays $80,000 in taxes, and now has $126,919 allocated to fixed income. If that was in a taxable account invested in a municipal bond fund (due to 35% tax bracket) for 15 years until DW is age 65, OP might be able to compound the returns at 3.13% (cf. VWIUX's 3.13% SEC yield). At the end of 15 years, OP has $201512, mostly untaxed.

In option 2, couple pays back the loan, either all at once or over the course of the next couple years. We will model this by reducing the fixed income available. In this scenario, the policy would start with $205448 in cash value with no separate bond asset. The policy is likely to experience cash-on-cash growth of at least 4%, but I expect it will be closer to 4.5% until DW's late 60s or early 70s. At DW's age 65, the cash value will be around $397599 using 4.5%. (This could get filled in with an in-force illustration.) Assume that OP then surrenders the entire policy in one year. OP would still have no basis, so the entire amount would be taxable gain.

For the bond alternative to match paying back the policy loans, OP's tax rate on the money in 15 years would have to be 50%. That is preposterous, and with a minimum of effort the policy would be worked into a system of efficient tax management to be considered in a mix of Roth conversions and otherwise. I would expect OP to be able to pull the money out at an effective tax rate of no more than 15%.

We could do a lot of permutations on this with more specific information about OP's financial situation (including messing with asset location between 401(k)s and taxable), but the bottom line is that repaying the loan is the only way to rehabilitate the policy, and doing so is likely a good idea. To just assume that surrender needs to happen without any more analysis is wrong.

EDIT: Here's an option 3. The policy loan rate is 5.73% on $146,919, or $8418. That could be paid for 15 years to stop the loan value from growing, but the cash value overall, not just the net available, would keep growing at 4.5%. So at the cost of $8418 per year, the policy in 15 years might be $397599 (again assuming 4.5% internal growth and NDR treatment a la MM). Assume now that the $8418 comes out of the separate fixed income balance of $146919, so that instead of growing to $201512, the muni portfolio ends up at about $75,200 (try =FV(0.0313,15,8418,-146919)). If OP then surrendered the policy in one year, the gain would be $397599, and it would pay off the loan balance of $146919 before being added to the $75,200 fixed income. For option 1 to be better than option 3, the tax rate at age 65 would have to be 31%. Again, it is unlikely OP would have that as an effective tax rate that year, but it is closer to the margin. You can see that option 2 is better because paying down the loan at 5.73% beats holding fixed income earning lower amounts. But it also shows that the benefits of option 2 aren't just from paying back the loan immediately; doing anything that just stops the loan from compounding *by putting in more money today* can beat the alternative of holding fixed income elsewhere.

[petulant]

Wait a second this policy was sold exactly to do this

This is super common

Grandpa gets policy for college. Grandpa is tricked into thinking it’s a great investment and isn’t in fasa as why to buy. The illustration at that time would have supported these loans bc dividends were much higher.

Agent doesn’t get any commission after 10 years so they stop caring

There is no way the OP figured out to surrender to basis then loan out without the agent presenting it

This isn’t a client problem. It’s an industry wide issue and it’s always downplayed by agents.

Given the tax situation in the 1980s and how long dividend rates took to come down, it is not at all clear to me that this was a college plan or that grandpa even made a mistake.

When this policy was purchased, interest rates were higher (so taxes mattered more), DC plans were rare, there were no Roth plans, there were no such thing as qualified dividends, and the '86 tax law hadn't even passed.

[Rex66]

I don’t have a problem keeping an old policy but you must want to keep until death and there just isn’t that here.

There is 150k of loan on it and like you said that needs to be paid back to make this work. For someone who is like I guess I can give it to charity, that’s not an awesome plan. WL is also going to continue to trail other fixed income for a while.


I think it’s clear the policy was set to do something like this by the agent, they even made it paid up so no further premium due but kept pua going. This is just not a client problem. Only about a dozen of us here in bogle nation coukd understand how to do this and it’s pretty obvious the OP isn’t one of them.

As I’ve said before, don’t take loans out early in WL. If you have decades before you die you are creating a problem.

[Stinky]

I need help thinking through a whole life policy with a significant policy loan.

OP, you’ve received a lot of input in this thread. Do you have a better sense of how you’d like to proceed?

By the way, I note that these are your first posts to the Forum. Welcome!

Please let us know what you’re thinking (and what questions you might have) when you can.

[petulant]

I don’t have a problem keeping an old policy but you must want to keep until death and there just isn’t that here.

There is 150k of loan on it and like you said that needs to be paid back to make this work. For someone who is like I guess I can give it to charity, that’s not an awesome plan. WL is also going to continue to trail other fixed income for a while.


I think it’s clear the policy was set to do something like this by the agent, they even made it paid up so no further premium due but kept pua going. This is just not a client problem. Only about a dozen of us here in bogle nation coukd understand how to do this and it’s pretty obvious the OP isn’t one of them.

As I’ve said before, don’t take loans out early in WL. If you have decades before you die you are creating a problem.

I don't see why you think it needs to be held until "maturity." Most people with any money on BH already end up looking at bridge years between retirement and social security where they clean up assets with Roth conversions and otherwise. I see no reason why this policy couldn't be cleaned up in OP's bridge years with better results, as my initial quantitative analysis pointed out. Again, this is a large policy with lots of gain built in and no basis. This is not somebody with a $100,000 basis and policy worth $110,000.

[Rex66]

Because if you don’t keep until death then you are just kicking the tax can down the road hoping u find a better tax time all the while paying loan interest and trailing your other fixed alternatives

[wergild]

OP, you’ve received a lot of input in this thread. Do you have a better sense of how you’d like to proceed?
By the way, I note that these are your first posts to the Forum. Welcome!

Thanks! Longtime reader, first time poster. I really appreciate all the discussion and analysis in this thread.

Caveat: this is philosophical advice, not financial.

I appreciate your philosophical guidance. There is an emotional component to this, but luckily not in the sense that my wife is committed to keeping the policy alive at all cost, just because it was a gift. She is aligned with me that we just want to do what's financially sound now, given where the policy stands and knowing that we don't plan have dependents relying on the death benefit.

Here's a start to a quantitative analysis.

Thank you for the analysis!

I agree that the loan has been mismanaged, and that the policy is not necessary a bad one if the loan hadn't grown to this size. The lesson for others is to not take out a loan so young and/or do not let a loan grow to such a large portion of the policy value. But all that is water under the bridge, and happened many years before my wife and I met. Given a career change, and a long graduate education, she has only recently reached her high earning years and is now focused on righting the financial ship.

For all these years, she has been under the assumption that she had to pay back the loan, and now that I'm helping her think through the options we realize that's not the case. Looked at from that perspective, what she previously viewed as a large liability can be done away with through a $20K tax bill. Until now, I had no experience with whole life insurance, so I've been on a rapid learning curve. I see how this policy could be a valuable asset in retirement — if the loan wasn't weighing it down — and have been learning about the potential for a tax bomb as outlined in this post by Kitces.

Your option 2 isn't feasible right now, as she is not in a position to pay off the loan all at once or over a short period of time. Your option 3 is something I've been evaluating (paying just the interest to keep the loan from growing) but it makes me nervous that it's an adjustable rate loan, so I don't feel comfortable assuming the interest rate will stay at 5.73% for the decades to come. Until this year the loan had a fixed rate of 8%, because she was unaware that a lower adjustable rate was available.

It seems to me that the primary room to maneuver is if she sustains the policy until a point where the surrender happens in the 24% tax bracket. The tax difference between 35% and 24% on $205K is ~$22K. But that's less than just 3 years of interest on the loan, so would only make sense if we were planning for sure on being in the 24% bracket soon. A more likely outcome is that our income will only increase in the short-term.

After listening to what everyone has said, I'm leaning towards surrendering now. This policy has been an emotional albatross for my wife and I think there is a psychological benefit being rid of the "mistakes" from the past and starting clean with an investment strategy that is more fully under her control.

[Rex66]

Over 85% surrender policies. You won’t be the last.

[Stinky]

After listening to what everyone has said, I'm leaning towards surrendering now. This policy has been an emotional albatross for my wife and I think there is a psychological benefit being rid of the "mistakes" from the past and starting clean with an investment strategy that is more fully under her control.

Personally, I think that it’s a good answer.

While you might be able to squeeze some more value from this turkey through continued financial maneuvers which would require keeping it for years (or decades) to come, you and your spouse need to feel emotionally good about your investments.

Best to you.

[petulant]

Consider option 4, a payment plan approach akin to catch-up retirement contributions. At a rate of 5.73%, the monthly payments to pay off the loan in 15 years would be $1218.46 (try =PMT(0.0573/12,180,-146919,0)). Again, at that point, the cash value might be $397599. The hypothetical fixed income asset (municipal bonds) to make these payments (in order to keep apples-to-apples status on our analysis) would be depleted with 35 months left (try =FV(0.0313/12,180-35,1218.46,-146919) showing almost 0). So let's imagine that no more payments are made that point, so that the loan balance remaining at that point of $39180.47 (=FV(0.0573/12,180-35,-1218.46,146916)) grows to $46289.07 in 35 months (=39180.47*(1+0.0573/12)^35). If the policy were surrendered in that year, it would take an effective tax rate of around 37% for the hypothetical fixed income alternative to beat the policy (just solving for 397599*(1-n)-46289=201512). Again, I find that unlikely, especially with some savvy tax management, or with occasional windfalls going to pay down the loan faster. (I don't propose this to actually stop payments at any point; it's just an illustration to keep the comparison apples-to-apples.)

I understand the risk that the policy loan is variable, but understand that a high variable loan rate is tied to higher prevailing interest rates for long-term corporate bond debt. (If you review the policy documents, they will explain the relevant index published by Moody's.) Hence, at this time, the insurance company is likely buying significant amounts of corporate bonds in the BBB/A range which per my Fidelity brokerage account include bonds ranging from 6-6.6% just for 10 year issues. For 30 year issues, some BBB bonds are getting as high as 7.22%. So even with a drag of 1-1.5% per year for expenses and mortality, it is likely that the cash value growth rate will climb, which will happen through higher dividends. (Guardian already announced a small increase in dividend rates this year.) If the dividends are set to "purchase paid-up dividends," no tax obligation will be owed in the year of the dividends, and it will just contribute to growth. This higher growth will apply to the entire cash value, not just the surrender amount net of loans. (Again, this is assuming NDR treatment at a major carrier like MassMutual.) I'm not saying that an uptick in growth will capture all of the increase in loan rates per se; I'm just saying that it's not like carrying a variable margin rate against a fixed Treasury bond.

I understand that DW has negative feelings toward the loan and policy, but let's put this in perspective. We don't know your overall financial situation, but let's say that without this policy, you would only be able to realize $100,000 (in real dollars) for spending and Roth conversions from DW's years 65 to 69. The total annual income to be realized in the current 12% bracket for MFJ couples who are both 65+ in 2023 is $89450+$27700+$6000=$123150 (that's top of the 12% bracket, MFJ SD, and add'l SD for 65+ taxpayers). So you would have 5 years' room to realize $23150 real in the 12% bracket and then more in the 22% bracket. The cash value of $397599 reduced for 15 years' inflation at 2.5% would be about $351,419, divided by 5 would be $70,283. If $23150 was realized in the 12% bracket and the remaining $47133 in the 22% bracket, that would be a net tax cost of $13147 per year, or $65735. 351419-65735=285684. The fair municipal bond comparison of $202419 at age 65 after adjusting for inflation at 2.5% would be $139763. That is a difference of a real $146,000, which discounted at a rate around 3% would be $93600.

As you can see, the order of magnitude on the NPV of this decision can easily be around $100,000. While DW's feelings and the sense of this policy being an albatross are important considerations, I believe the size of this issue requires further study. (I do not intend the previous paragraph to be a hyperrealistic representation of what will happen with interest rates, tax rates, or otherwise. It's just quick math to show that the NPV of the decision using reasonable tax assumptions might be six figures.)

[HootingSloth]

Here's a start to a quantitative analysis. Assume the OP has a separate $146,919 that would be allocated to fixed income. (These are reasonable assumptions for a couple with no heirs in their 50s, but this specifically is needed for an apples-to-apples comparison.)

Seems like an important assumption, and we need to know more about the rest of OP's fixed income assets and/or fixed liabilities (e.g., mortgage) to evaluate. OP, do you have $147k in munis or other readily available fixed income assets sitting around that you don't really need to be holding for liquidity/emergency fund/avoiding or paying off some other high interest rate debt/etc.? If so, paying the loan off quickly could be a good idea, and then you can decide what to do with the policy afterwards. There is no sense borrowing money under the policy at ~5% and then effectively loaning it out at ~3%. So, what is the rest of your fixed income picture?

[petulant]

Here's a start to a quantitative analysis. Assume the OP has a separate $146,919 that would be allocated to fixed income. (These are reasonable assumptions for a couple with no heirs in their 50s, but this specifically is needed for an apples-to-apples comparison.)

Seems like an important assumption, and we need to know more about the rest of OP's fixed income assets and/or fixed liabilities (e.g., mortgage) to evaluate. OP, do you have $147k in munis or other readily available fixed income assets sitting around that you don't really need to be holding for liquidity/emergency fund/avoiding or paying off some other high interest rate debt/etc.? If so, paying the loan off quickly could be a good idea, and then you can decide what to do with the policy afterwards. There is no sense borrowing money under the policy at ~5% and then effectively loaning it out at ~3%. So, what is the rest of your fixed income picture?

While a fair analysis required making some kind of assumption like that, it's not technically necessary that they actually have $145,000 sitting around. Similar analyses could be performed comparing the household having no other alternative assets but saving at some rate (like $1500 per month) in various types of accounts, or even to a household with a tax-deferred account and some taxable savings, shifting assets around among accounts. The options are intended to illustrate the point that there are economics in the policy to be realized, but they require putting money in at some point, from somewhere, to pay off or reduce the growth of the loan balance. The economic functions at work are that reducing debt at 5.73% and deferring taxes to a year with a lower marginal rate (or forever) will beat many other uses of money.

By calculating these options, I am also not actually saying that it is optimal to surrender the policies in one year or at all; it is possible that OP and DW would be even better served by rehabilitating the policy and taking sustainable loans over some period from age 70 to age 95, thereby reducing SS taxation, or even just purchasing a SPIA.

[Rex66]

It is absolutely not guaranteed that it will beat other fixed. Heck even currently it doesn’t. If the US does go into recession and interest rates fall again then more insurance companies could be in trouble. Ohio national pretty much killed all their policy holders using WL as an investment vehicle. All the companies have reduced gusts on new policies bc the industry felt it was necessary. Banking on this to do great when one doesn’t care for the death benefit is a risky maneuver.

[Chuck]

I kind of agree with everyone so far.

• There is a simple beauty in surrendering the policy. You will be free of the shackles of this thing. No more agonizing over what to do. Financially, this decision is either pretty good, almost optimal, or optimal.
• A raw number-crunching approach may reveal that the IRR is higher if you keep the policy, and do some things. Financially, this decision is either really bad, ok, pretty good, almost optimal, or optimal.

By surrendering the policy, you guarantee the outcomes of "pretty good" or better. By keeping it, you have an additional shot at finding the "optimal" but "really bad" is out there, too.

[petulant]

I kind of agree with everyone so far.

• There is a simple beauty in surrendering the policy. You will be free of the shackles of this thing. No more agonizing over what to do. Financially, this decision is either pretty good, almost optimal, or optimal.
• A raw number-crunching approach may reveal that the IRR is higher if you keep the policy, and do some things. Financially, this decision is either really bad, ok, pretty good, almost optimal, or optimal.

By surrendering the policy, you guarantee the outcomes of "pretty good" or better. By keeping it, you have an additional shot at finding the "optimal" but "really bad" is out there, too.

This is a false dichotomy. Here are the real options:

• Surrender the policy
• Keep the policy but put no or little money toward loan
• Keep the policy but put money toward loan that prevents its growth or pays it down

I would completely agree that the second bullet point could lead to a bad outcome. I have seen no analysis or reasoning that remotely indicates the third option could result in any "really bad" outcome. For example, consider if OP and DW just cover interest and pay small extra amounts against the loan, consistent with the third bullet point I identify. Then, instead of being able to keep going, they lose their jobs. In this case, they will still be better off because in that bleak scenario, they will have a low-income year and can almost certainly surrender the policy with less tax bite.

[petulant]

It is absolutely not guaranteed that it will beat other fixed. Heck even currently it doesn’t. If the US does go into recession and interest rates fall again then more insurance companies could be in trouble. Ohio national pretty much killed all their policy holders using WL as an investment vehicle. All the companies have reduced gusts on new policies bc the industry felt it was necessary. Banking on this to do great when one doesn’t care for the death benefit is a risky maneuver.

Here we go with moving the goalposts, which is always the next step in these threads after the original presumption for surrender is rebutted. Nobody said anything was guaranteed. While keeping the policy involves some risk, all financial decisions involve "some risk," and the question is how much risk is involved. I do not think paying down the loan and keeping the policy offers substantially more risk than fairly considered alternative fixed income assets.

[Rex66]

It is absolutely not guaranteed that it will beat other fixed. Heck even currently it doesn’t. If the US does go into recession and interest rates fall again then more insurance companies could be in trouble. Ohio national pretty much killed all their policy holders using WL as an investment vehicle. All the companies have reduced gusts on new policies bc the industry felt it was necessary. Banking on this to do great when one doesn’t care for the death benefit is a risky maneuver.

Here we go with moving the goalposts, which is always the next step in these threads after the original presumption for surrender is rebutted. Nobody said anything was guaranteed. While keeping the policy involves some risk, all financial decisions involve "some risk," and the question is how much risk is involved. I do not think paying down the loan and keeping the policy offers substantially more risk than fairly considered alternative fixed income assets.

Even MYGAs beat this WL now and for the next few years period. Don’t need to move any goalposts. And that’s guaranteed results not illuminated results.

[petulant]

Here's another factor, "philosophical" perhaps. It gets into OP and DW's terminal goals. Almost any retirement planning on BH involves some assets that are not annuitized and hence the assets are either exhausted or left to heirs. OP has said no heirs, and the beneficiary is charity. So the utility function for OP's situation is how to rationally meet plenty of consumption goals without risk of depletion, then leaving the rest of the money to charity. My observation is that this utility function is almost always maximized by avoiding taxes over a lifetime since any residual assets with untaxed gains, ranging from brokerage stock ETFs to IRAs to life insurance policies, will be left to charity with no tax owed. (That is contrary to cases with natural heirs that may benefit from Roth accounts or step-up in basis.) There is little point to realizing a taxable gain or income except where necessary to specifically minimize lifetime tax obligations, e.g. Roth conversions might be tactically useful but not as highly valued. RMDs are less to be feared since they can be carted off through QCDs. From this perspective, the burden is on anybody claiming a taxable gain should be realized now to prove that this reduces OP's lifetime tax obligations.

[petulant]

It is absolutely not guaranteed that it will beat other fixed. Heck even currently it doesn’t. If the US does go into recession and interest rates fall again then more insurance companies could be in trouble. Ohio national pretty much killed all their policy holders using WL as an investment vehicle. All the companies have reduced gusts on new policies bc the industry felt it was necessary. Banking on this to do great when one doesn’t care for the death benefit is a risky maneuver.

Here we go with moving the goalposts, which is always the next step in these threads after the original presumption for surrender is rebutted. Nobody said anything was guaranteed. While keeping the policy involves some risk, all financial decisions involve "some risk," and the question is how much risk is involved. I do not think paying down the loan and keeping the policy offers substantially more risk than fairly considered alternative fixed income assets.

Even MYGAs beat this WL now and for the next few years period. Don’t need to move any goalposts. And that’s guaranteed results not illuminated results.

Practically only MYGAs are a reasonable comparison that could match keeping the policy (outside of us modeling lots of asset location issues with an IRA), and if the options were to keep the WL or 1035 into a MYGA, I could see the virtue in exchange. It might be able to be shown that a MYGA would win, but with some liquidity tradeoffs. But OP has said that the loan can't be immediately paid off, so the MYGA is not an option.

To see why, consider a new alternative I call option 5. This is like my previous option 1, but instead of surrendering the policy and paying taxes to invest in muni bonds, the next step is to put the remaining $126919 in a MYGA for 15 years (ignore the product availability for a moment). With a 5.5% return, the MYGA would compound to $283343 with a basis of $126919. That is a taxable gain in one year of $156424. For this option to beat option 2, where the loan is paid off and the policy kept until DW's age 65, the effective tax rate on surrenders would have to be north of 47%. It is hardly better than the municipal bonds.

Compare option 6, where the loan is paid off and the policy is 1035'd into a MYGA with the same terms. In that case, assuming the same 5.5% return, the MYGA will compound to $458657.83 with no basis, meaning it would most likely beat keeping the policy. To do so, the MYGA will have liquidity limitations particularly in the first 10 years, and this assumes that the policy's cash value growth does not pick up. So, it's probably a bit less "risk" in the form of uncertainty about growth, but a bit more in the sense that liquidity issues in the next 10 years are more of a problem. So it's a fair debate there, if OP could already pay off the loan.

(I'm just going to point out briefly here that the 5.5% is a "high" rate extrapolated from Stan the Annuity Man's quotes around 7 to 10 years. It is possible that longer terms might not actually be that high given the inverted yield curve, and I also observe that this high rate most likely reflects credit risk that is higher than DW's policy, which is probably issued by an AA carrier vs. lower tier carries offering MYGAs at the highest rate.)

Of course, in reality, there are a spectrum of options in here. OP and DW could make payments on the loan over the next 5-10 years, then 1035 into a MYGA at that point. I don't particularly think that's bad. In general, we can't estimate a true optimum without a total rundown on OP's and DW's assets, income, retirement goal, etc.

[Valuethinker]

Would you invest in this product *now* given the financial position it is in right now?

This is absolutely not the right question. First, the economics and structure of whole life insurance policies can change significantly based on the age when taken out.

Implicit in my point is identical cash payouts. There is such a thing as a sunk cost.

The tax point is germane, because it's a consideration in the cost of surrender.

A 50-year-old will struggle to buy a policy with the same characteristics as this one, and would almost certainly need to be paying premiums across several years.

But if the 50 year old doesn't need this policy, then why buy it, now?

Second, major caveats to this kind of thinking are always tax consequences and transaction costs. Consider a limited stock ETF purchased many years ago and now with large built-up gains, like a FTSE 100 or S&P 500 ETF, when the investor now has a perspective that more broad diversification is required. It is not a complete analysis to ask whether someone would buy the same product today, and that kind of reasoning would lead directly to the wrong place. The question is how close the S&P 500 or FTSE 100 ETF is to the desired asset allocation, and whether the large tax cost of exit is worth it.

Like a lot of your post, I think that is splitting hairs -- inventing distinctions that aren't there. And as I stated clearly at the start, my point was about philosophy & human psychology.

The relevant point is that (and we always make an exception for tax - transaction costs are usually trivial, and would be in this case) that what you paid for an ETF purchase 20 years ago is not relevant to your decision regarding it going forward. What matters is expected future returns.

The tax cost of a surrender right now is on the order of around $80,000. If the policy is properly rehabilitated (i.e. the loans are paid back) that tax can be deferred and potentially never experienced if surrendered in a retirement year or managed with sustainable, small loans in retirement. The situation is not painful because it was imposed by an outside force that OP needs to cut off. The situation is painful because OP was handed a $300,000 asset and did not learn how to manage it. This is not a typical situation found on Bogleheads where somebody purchased a poorly designed whole life insurance policy, spent $150,000 in premiums over 15 years and now only has a policy worth $170,000 (if that) where it is easy to say they should just surrender it. This is a policy that was economic over a long period of time, was looted, and now poses a material tax cost that can be avoided and managed.

OK that's new information and should bear on the final decision.

I agree btw about IRR. But the release of funds can seek out alternative IRRs, which may be higher.

his is not a typical situation found on Bogleheads where somebody purchased a poorly designed whole life insurance policy, spent $150,000 in premiums over 15 years and now only has a policy worth $170,000 (if that) where it is easy to say they should just surrender it.

This is not a typical situation for anyone? Let's not laud Bogleheads as The Chosen People, The Enlightened Ones. Plenty of messy money mistakes here.