Opinion on cashing in life insurance policy

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Malachi
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Opinion on cashing in life insurance policy

Post by Malachi » Sat Dec 15, 2007 4:01 pm

My parents first bought life insurance for me when I was a child in the 70's. They made the payments until I was old enough (and responsible enough) to take over the payment which I've been paying now for many years.

The policy type is 'Modified Premium Whole Life'.

It currently has a $13,800 death benefit. Its cash value is $4700. The premium is $15.10/month.

I am 43 years old and have no family except for my Mother. My savings are well more than sufficient to cover my final expenses. To me there doesn't seem to be much of a need to keep this insurance.

So, I've been considering cashing it in. I figure I can put that $4700 to good use.

I thought I'd run it by you guys to get your opinions and get some thoughts on what else, if anything, I should consider.

Thanks.

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grabiner
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Re: Opinion on cashing in life insurance policy

Post by grabiner » Sat Dec 15, 2007 5:32 pm

Malachi wrote:My parents first bought life insurance for me when I was a child in the 70's. They made the payments until I was old enough (and responsible enough) to take over the payment which I've been paying now for many years.

The policy type is 'Modified Premium Whole Life'.

It currently has a $13,800 death benefit. Its cash value is $4700. The premium is $15.10/month.

I am 43 years old and have no family except for my Mother. My savings are well more than sufficient to cover my final expenses. To me there doesn't seem to be much of a need to keep this insurance.


This appears to be correct, so the next question is whether keeping the insurance is better than cashing it out and investing the proceeds. If you can earn 4% with little risk (about the rate on tax-free insured municipal bonds), it will take you 18 years of investing $4700 and $181.20 a year to get $14,200. Since you are much more likely than not to live another 18 years, you are better off cashing in the policy.

It is sometimes worthwhile to keep a larger whole-life insurance policy; even if it was a bad decision to buy it in the first place, the commissions have already been paid and the cash value accumulates more in later years. But your small policy has a very high cost of administration, which is why its returns, even now, are much less than you can get by investing the money on your own.
David Grabiner

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mephistophles
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HI MALACHI

Post by mephistophles » Sat Dec 15, 2007 5:35 pm

Assuming your policy is a dividend paying whole life policy, with no loans against it, you might want to look at two calculations to help you make your decision.

Contact the insurance company home office and have them run you an in-force illustration projecting policy results about 20 years into the future but have them show the annual divided to reduce the premium with the balance to purchase paid up additions. You might find that the annual dividend can pay each annual premium and any excess purchase PUA"s which adds to the annual increasing guaranteed cash value and to the death benefit. If this happens on your policy then you can calculate a yield by dividing the annual increase in total cash value divided by the total cash value. This should be all or mostly tax free internal cash growth and death benefit growth. (Exception, if you have a "cash rich" policy, or any part of annual dividend exceeding annual premium might be considered taxable have your insurance company let you know if they do not automatically do so.) This policy, if kept, would provide an ever increasing death benefit that you could donate to charity, an institution or use for your own final expenses thus freeing up your other assets to go wherever you wish.

The next calculation would be the after income tax amount of your cash surrender value if you let the policy go now. You can then calculate the before and after tax yield on that money based on where you would invest it and your assumptions to it's growth.

A third calculation might be 1035'ing the cash in your policy to a fixed or variable deferred annuity such as in Vanguard depending on what they have available for your amount of investment. You can then project out that growth based on assumptions.

Another option is to contact a CLU in your area who will do all these calculations for you for free. The downside to that is that the agent/broker may try to sell you something.

Now, if you simply do not want the policy and desire to spend the money on something else such as fast women, whiskey and fun then "go for it."
Good luck,

ole meph

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White Coat Investor
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Post by White Coat Investor » Sat Dec 15, 2007 5:52 pm

You may be pleased to know that the return on your "investment" (I did not subtract out the trivial cost of insurance but treated the entire payment as an investment) is approximately minus 1% assuming the policy was purchased in 1977. You could buy a risk-free 30 year treasury bond in 1977 that was paying 7.75%. Even if you assumed 1/2 of the premium went to the insurance/administrative cost, your return was only 3.5% (less than historical inflation, meaning a negative real return). Do you really want to continue to "invest" with these guys? I mean a negative return after 30 years?

If you want to know the mathematical answer you'll need to go through the steps Meph has illustrated, but my brain would be screaming at me to get my money away from them ASAP! I wouldn't tell your parents though, it would just make them feel badly.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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mephistophles
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HI DOC

Post by mephistophles » Sat Dec 15, 2007 6:27 pm

You are correct in your post concerning past returns being small. That is due in large part to the huge front end policy loads in the early years. But...and this is an important but....those loads have already been paid, or amortized if you will....by his parents. So looking at this asset (policy) from this point in time to a future point in time "might" show a positive cash flow and a favorable before and after tax rate of return.

I also agree that it would be a very rare person out there who could or would go through all these calculations and learn how to do them along the way. For the most part people just cash in their policies, spend the money and move on. My clients of the last four decades would get these calculations done by me, for free and it was a rare case that I recommended ditching a good whole life policy over 20 years old. I might note that the majority of insurance agents make a big chunk of their living by replacing the existing policies inforce, using that cash value and committed premium stream to finance a new policy. The agent makes money and the insured thinks they are better off. In reality most of these people get screwed and tattooed as they now get to pay heavy front end aquisition costs all over again.

Later,

ole meph

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