We encourage our clients to provide us copies of their life insurance policy statements for analysis. During the financial planning process, we perform a life insurance needs analysis, and determine if the client has too little coverage, too much coverage, or just the right amount of life insurance coverage – or if they need life insurance at all. If you don’t have anyone dependent on your income, it’s likely you don’t need life insurance. However, if we determine there is a need, we normally suggest clients fill it with “term life insurance”. Term life insurance is an inexpensive way to ensure that your dependents don't require a lifestyle change upon your death - and is typically in place for a "term" of some years: until your net worth provides enough to maintain their standard of living - or until they're no longer dependent on you.
When a client comes to us with an existing life insurance policy in place, we must determine if that policy should be kept, replaced or cancelled. There are many factors to consider, such as length of term remaining in a term policy, the cost of insurance, the expected growth in cash value of any permanent life insurance, and of course the current insurability of the client.
Occasionally a client will come to us with a universal life (variable or fixed) insurance policy sold to them as a mix of insurance and investment. The life insurance agent often sells the policy by projecting that if $xx of premium is paid every month until you reach age 65, the policy’s cash value should then pay for the cost of insurance for the rest of your life, and you can have “tax-free living benefits” as well as a death benefit to be paid to your beneficiaries. In fact, they say, you can even spend some of the death benefit while still living. What’s not to like?
Well, there are a few reasons why these rosy projections that mix investing with insurance don’t end up with the desired outcome.
- You have a life event that prevents you from paying your monthly premium for a few years. Maybe it’s that you’re unemployed, or just had another child and your expenses are higher. “No problem! says the agent – the “cash value” of the policy can pay the premiums for you for awhile.
- The investments inside don’t end up earning what the agent projected they would.
- You have life event that requires you to “borrow - tax-free!” from the cash value while “paying yourself back with interest.” This either raises the required premiums to keep the policy from breaking, or reduces the amount of cash value each year, as the cash value pays back the loan.
- Because universal life is often “flexible premium” life insurance, the agent often starts the policy with a very low premium while you're young (because you can) rather than the premium required for the policy not to break as you age. They may have expected you to increase premiums over the years, but have not reached out to follow up.
So what should you do if you’re not sure the policy will perform as the agent sold it way back when? It is truly tragic – and sometimes devastating – that so many permanent life insurance policies end up “breaking” just as the client reaches the age where death becomes increasingly likely.
Important to note here is that typically the agent who sold you the policy hasn’t touched base with you in years, because they get paid at the initiation of the policy, and there is no incentive for them to check in and review the policy performance, your life changes, or any other details. In short, life insurance agents are not typically holistic financial planners with a fiduciary duty.
However, you have four options when your Universal Life Insurance cash value begins decreasing every year as the cost of insurance rises with your age.
1. Let the policy continue as-is, until it “breaks” (is canceled for non-payment of premium).
- This is the “default” option for most people, but only because they don’t know what else to do.
- If you’re now uninsurable for some reason (health-related typically), this may be the best way to keep the death benefit in place until your retirement – or at least for a few more years.
2. Cancel the premiums you’re currently paying for the policy, and let it break sooner than it would in option 1.
- If you only need the life insurance in place for a short-period of time, and can’t stand to think of cancelling the policy and then getting hit by a bus tomorrow, this will at least save you the monthly premium that you can re-route to either a term life insurance policy, to pay down debt, or to invest for the future.
- If you’re now uninsurable for some reason (health-related typically), this could be a good way to keep the death benefit in place until your retirement – if the cost of insurance doesn’t eat up the entire cash value before then.
3. Pay higher monthly premiums to keep the insurance in place.
- The cost of insurance rises each year as you age, so it’s important to review the insurance cost table in the original policy document to determine if you can afford to do this. It would be terrible to pay more into a policy that ends up breaking/cancelling late in life.
- If you are now uninsurable and need life insurance in place, this may be your only option – at least until you no longer have a life insurance need.
4. Cash it out for the net surrender value.
- The “Net Surrender Value” equals the cash/account value, less any commission already paid to the agent yet not recouped by the life insurance company via the policy’s internal expenses over the years the policy has been in place.
- This is a good option if you do not need life insurance any longer. There is no reason to pay for unnecessary insurance when you can invest the surrender value to grow your net worth.
- If you still need life insurance, this may be a good source of funds to pay for a 10- or 20-year term policy to cover your insurable need.
As you can see, life insurance can be a complicated beast. Luckily, there are many flexible options when it comes to how to proceed. Most succinctly, our team recommends keeping insurance separate from investments. We are happy to help determine your life insurance need based on your family’s financial goals – and to assist you in ensuring you’ve got the right policy(s) in place given your situation.