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My parents gifted me a cash value life insurance policy when I was in the process of “adulting”. After purchasing a new policy to cover my needs, I decided to cash it out and buy a camcorder. Remember the big, bulky device you would set on your shoulder to capture your children’s every cute move? We lugged that thing around with the VHS tapes to soccer games and camping trips! Yes, I am dating myself.
As parents, we bought cash value life insurance on our kids when they were young to be gifted at the appropriate time. The eldest just made a partial surrender of her wedding gift to free up funds to manage life – post COVID strains and second baby.
Permanent insurance has cash value that builds. Unlike term insurance that is low cost and terminates after a specified period, there are many moving parts that can be changed for your benefit over time.
Three players in a life insurance contract are the insured, the owner, and the beneficiary. On most policies, the insured is also the owner. The two that can be changed are the owner and the beneficiary.
Life insurance is a financial tool and every few years, it is prudent to look at its original purpose, how the vehicle is performing, if it is still a fit and what your options are. As with my personal experience noted above, cashing a policy in or partially surrendering it are popular options. You can also borrow from them and use them as collateral. There are tax implications to understand on these more traditional opportunities.
Let’s get a bit more creative and explore three other ideas that may serve you as your financial life unfolds.
Paying for long-term care. If you no longer have a death benefit need, you may want to consider a 1035 tax free exchange of the cash value into a Long-term care policy. This policy could then be used to pay for costs that Medicare doesn’t cover (adult day-care, in-home care, nursing home costs). The insured and owner of the life policy needs to be the same as the new insured and owner of the long-term care contract. You could use the cash value as a single premium pay, or large start to premiums due. There are also new hybrid products in the marketplace now that start with traditional life insurance, and death benefit to beneficiaries when you die and if you need the LTC component, the money available may exceed the death benefit providing tremendous leverage on your premium dollars.
Gifting a policy. When you change ownership of a policy to an individual, there may be tax consequences. If the cash present value is more than the current annual gift exclusion of ($16,000) you will have gift taxes to consider (which would be offset with your lifetime exclusion amount currently at$12.06 million). The death benefit of the policy is now out of your estate and the death proceeds are not taxable income to the beneficiary. The new owner is now responsible for paying the premium on the policy and would have access to the cash value in the contract. Of course, there are creative ways around paying the premium with additional gifts. There are different types of trusts that could be named as owner of your policy to remove it from your estate. Note that if you pass away within three years of changing the owner on the contract, the IRS will “claw back” the death benefit amount to be included in your estate.
Philanthropic Intentions? You can change the beneficiary of your life insurance policy to your favorite charity or two. Upon your passing, the non-profit organization will receive the proceeds of your death benefit tax free. You would continue to pay the premiums per terms of your contract yet would leverage the amount ultimately given to the organization. To receive tax benefits, you need to name the charity as both owner and beneficiary. The deductible benefit would be equal to the policy’s cash value, along with any premiums paid on the policy after the gift has been made.
Life insurance policies are contracts and as with any legal structure, there are underlying considerations to look at and understand before deciding. These ideas just scratched the surface with benefits, risks and limitations. Please work with your fiduciary financial professionals to determine which tools best serve you for protecting and prospering your unique version of true wealth.
Related: The Talk: Five Financial Conversation Tips For Aging Parents