The new tax law is prompting policyholders to review their life insurance to see if the coverage still makes sense.
By Eleanor Laise, Senior Editor
September 1, 2018
From Kiplinger’s Retirement Report
It has always been a good idea to regularly review your life insurance policies to make sure they still meet your needs. But the changes in tax law provide extra incentive to reassess your policiesā costs and benefits.
The new tax law roughly doubled the federal estate-tax exemption, to $11.18 million in 2018. So the vast majority of people who originally purchased policies to help cover estate tax are no longer subject to the tax. The new law also created more favorable tax treatment for people who sell their policies to investors.
That doesnāt 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 benefitsāsuch as creditor protectionāthat 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 policyās health 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 policyās future value, and check whether the coverage will run out at some point.
Once youāve 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, youāll have a taxable gain to the extent the cash value exceeds the premiums paid.
Whole life policyholders might instead take their policies to āpaid-up status,ā meaning they stop paying premiums and get a reduced death benefit. You avoid the tax bill, and the policy may become āa modestly appealing quasi-fixed-income investment,ā says Scott Witt, a fee-only insurance adviser in New Berlin, Wis.
Another option: Use a tax-free 1035 exchange to swap your policy for a hybrid product that blends life insurance with long-term-care coverage. These products come in various forms, but they often combine a whole or universal life policy with a long-term-care rider. If you donāt use the long-term-care coverage, your heirs get the death benefit. āThat can be a very strategic retirement-risk planning strategyā for people who no longer need a large death benefit, says Jamie Hopkins, director of the retirement income program at The American College of Financial Services.
Policyholders who canāt find any attractive alternatives might consider a life settlementāmeaning 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 eat up a big chunk of the gross purchase price, and sellers often receive just a fraction of their policyās 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 ha