It’s always a good idea to regularly review your life insurance policies to make sure they still meet your needs. But changes in tax law provide extra incentive to reassess your policies’ costs and benefits.
The new tax law roughly doubled the federal estate-tax exemption, to $11.18 million in 2018. So people who purchased policies to help cover any estate tax that might be due are no longer subject to it. The new law also created more favorable tax treatment for people who sell their policies to investors.
That doesn’t mean you should rush to dump your policy. Some state estate-tax exemptions remain relatively low, and the federal exemption is scheduled to revert to $5 million, adjusted for inflation, in 2026. And even if your policy no longer fits its original purpose, life insurance may offer other benefits — such as creditor protection — that are important to you. You may also be able to modify the policy to make it more attractive as an investment vehicle or exchange it for another policy better suited to your goals.
The bottom line: Policyholders should keep close tabs on their insurance and weigh all their options before surrendering or selling the policy.
Start by getting in-force illustrations on permanent policies every year. Review the projection of the policy’s future value, and check whether the coverage will run out at some point.
Once you’ve studied the numbers, you may be reluctant to keep paying hefty premiums for a policy that no longer suits your needs. But before dumping it, weigh the tax consequences. If you surrender the policy to the insurance company, you’ll have a taxable gain to the extent the cash value exceeds the premiums paid.
Whole life policyholders might instead take their policies to “paid-up status,” meaning they stop paying premiums and get a reduced death benefit.
Another option: Use a tax-free 1035 exchange to swap your policy for a hybrid product that often combines a whole or universal life policy with a long-term-care rider. If you don’t use the long-term-care coverage, your heirs get the death benefit.
Policyholders who can’t find any attractive alternatives might consider a life settlement — meaning you sell your policy for a lump sum, and the buyer becomes responsible for paying future premiums and gets the death benefit when you die.
Transaction costs can be high, and sellers often receive just a fraction of their policy’s face value. But in some cases, a life settlement may be the only reasonable choice. For example, many people who purchased life insurance for estate-tax purposes have guaranteed universal life policies, which have little or no cash value, says Scott Witt, a fee-only insurance adviser in New Berlin, Wis. For those who don’t want to hang on to these policies, a life settlement may be “the only real exit strategy,” he says. “You’re not going to get good value,” he says, “but it’s better than walking away and getting nothing.”
Tax reform also improved the tax picture for people selling their policies in life settlements. Previously, the seller’s cost basis was reduced by mortality, expense and other insurance charges, resulting in a larger taxable gain. The new tax law removes that adjustment, trimming the tax bill for policy sellers.
(c) 2018 Kiplinger’s Personal Finance; Distributed by Tribune Content Agency, LLC.