Case File: Whole Life insurance dilemma

“I asked for the policy number to which it referred, and advised him that when the policy lapsed last year it created a taxable event, and that the balance due is being treated as taxable income (which would have also been the case if my client was still with us).”

That is, letting a policy with a substantial loan against it lapse is a sure-fire way to trigger a potentially hefty tax bill.

Flash forward to earlier this week, and I field a call from another agency client who had some questions about his life insurance policy. In this case, the policy was still in force, but also one he had bought from another agent long ago (and with a carrier we don’t represent). So I of course offered to help as best I could (because he is an agency client) but that my answers would of necessity have to be pretty generic.

The facts were these: the gentleman, now in his late 70′s, had purchased a whole life plan from XYZ Life while in his 30′s. Over the intervening years, the policy’s cash values had grown (substantially), and he had borrowed heavily against them, such that his original $200,000 death benefit is now reduced to about $20,000 (yikes). The problem is that the loan keeps growing, and if he doesn’t at least freeze it, the policy will lapse.

Okay, so what? If he no longer needs that policy, what’s the big deal with just letting it go?

Well, as mentioned above, that will trigger a pretty sizeable tax bill, one that he may well wish to avoid (being on a fixed income and all). So by paying the interest, in addition to the premiums, that should freeze the loan. The goal, I explained, was for him to die before the policy does. In that case, the loan, and potential tax bill, die with him.

Morbid, I know, but also honest.

He asked if he should pay all the interest, and I said that would be ideal, but even just paying some of it will help to forestall the inevitable.

To which he replied: “oh, I get it, paying some of the interest shows my good faith effort to the IRS.”

Um, no: the IRS (and the carrier) couldn’t care less about “good faith efforts,” it’s all about the Benjamins.

Pretty simple, that.

The lesson here? Consider all the long term implications, and ask questions, before stripping the cash out of a policy.