Panning for Gold in Those Unwanted Whole Life Policies

gfreeman@advis… |

We know you have seen it on your clients’ balance sheets: the often unsuitable and expensive whole life policy that got slipped in by our friends at Acme Mutual. There are good reasons for whole life, but that is not always the case. Even if they started out well, older whole life contracts may have suffered from declining dividends (constantly for the past 10 years or so), changes in client objectives, and unmanaged policy loans. We won’t dwell on those cases where the client should have owned term in the first place.

When these life policies appear on the balance sheet, don’t just set them aside as a legacy asset that you can’t do much about and move on to other things. You could also just cash them in, but let me share some things you can do with these contracts that might make better sense.


Need to have coverage but at a lower cost and only to a certain age, such as 65.

The obvious option is to switch to term if the client is insurable. The question is whether to hold onto the whole life with maybe premium loans or cash it out. In my experience, there is little reason to hold onto policies you no longer need, no matter how much you have paid into them. The cash value will be eroded by ongoing insurance charges or loan interest. A better solution will often be to unload the whole life.

Now things get interesting. Assuming we have an insurable client, your next big question should be, “what is the cost basis?”. If the policy has a gain, that gain will be taxed as ordinary income. But not necessarily. We work with a major carrier that has built a policy that is priced like term insurance but fits the definition of universal life insurance. That contract can take over the cash value of the old whole life contract without triggering ordinary income. Then, based on the amount of cash value exchanged, the future premiums can be substantially reduced. In effect, the client will be re-applying the excess premiums previously paid for whole life to a new term policy. That is a pretty good save.

More often, the cost basis search may result in finding that there is a loss on the whole life contract. Let’s say your client has a cost basis of $60,000, but the cash value is only $20,000. That $40,000 loss will not be deductible if the policy is surrendered. The client would then buy his or her new term policy with the $20,000 or other assets. Yes, the client will still be receiving $20,000 of tax free cash, but the loss of the $40,000 tax deduction is not insignificant.


Let me suggest another approach when there is a loss on the whole life contract.

You could exchange the $20,000 cash value for a deferred annuity. The annuity would be worth $20,000, but it would also have a cost basis of $60,000! The annuity could then grow from $20,000 to $60,000 without any tax liability on the $40,000 gain. If you are not so sure you like annuities, you can always change your mind in the future (I would wait at least a year). If you later decided you didn’t like that annuity, you could always cash it in. At that point, you could take the tax loss on the difference between the annuity value and your original $60,000 of basis. We don’t give tax advice, so you should always verify this frequently used approach with your accountant.


For clients over age 50, there may be a greater need for long term care funding.

Here again, that whole life contract may come in handy. Among the more popular ways to set aside funds for potential long term care needs is to purchase what is often called a hybrid contract. These contracts are typically funded with a single large premium. For example, a client might pay $100,000 into a contract that offers his or her money back in one of three ways. If the client ends up needing long term care, the contract might pay out, say $300,000 of long term care benefits. However, if the client doesn’t need long term care and passes away first, the contract might pay the beneficiaries around $150,000. Finally, if the client doesn’t need the long term care but just wants the money back, the policy will give a full refund of the $100,000 at any time. All of the benefits and pricing are based on a number of factors such as age, duration of benefits, and whether the policy pays out on an indemnity or reimbursement basis. You can see where this is going. We have frequently recommended exchanging old whole life cash values for hybrid long term care policies. If the cash value doesn’t cover the desired benefit, the client can add additional funds to fully fund the program. This works especially well when the cash value is greater than basis. In that event, the otherwise taxable gain in the whole life policy simply defers into the long term care hybrid. Note also that the long term care benefits and the death benefit are both tax free, even if they were funded with otherwise taxable funds.


Last but not least are those whole life policies that are intended to deliver a retirement income using policy loans or withdrawals in the future.

For most of the clients we have encountered, whole life policies are terribly inefficient and inflexible for this purpose. By contrast, many of the newer universal life and indexed life contracts can deliver much greater incomes, even as much as 100% more! Whenever the Acme Mutual agent tells you that even though there may not be a need for the coverage any more, the policy should be kept since it will pay a significant retirement income, take a pause. Have the agent give you an illustration of what should happen and then run quickly to a firm that can show you some alternatives. We think you will be pleasantly surprised at how much better your client might end up.

By paying attention to the whole life policies that your clients own, you can be of tremendous service. With the benefit of a policy review, you can help your client better manage their current coverage. You can also offer alternatives that could be significant and make a big difference in their financial situations.

Do you have any clients with whole life policies? AdvisorServe is here to make your review thorough and easy. We will give you the information you need to serve your clients well.