Five Options for Retirees Who No Longer Need Life Insurance

I wrote an article in February titled If You’re Retired, Do You Still Need Life Insurance? I was quickly inundated with hate mail from life insurance agents, but the feedback from everyone who isn’t paid a commission to sell life insurance was pretty positive.

The reality is that life insurance is meant to cover working capital, which is the present value of all future earnings, as well as liabilities. Both shrink over time.

There are reasons to keep life insurance in retirement, such as the desire to leave a fixed, guaranteed amount or as a way to cover estate taxes. This article is for those who consider they no longer need the coverage and no longer want to pay the premium.

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If you are retired and have a term policy, you need to work with your planner to confirm you don’t need the coverage. If that turns out to be the case, the question is: Do you drop the policy now or when the term expires? Most private policies come in terms between 10 and 30 years. Once that term expires, they renew at exponentially higher premium rates. Often, we work with clients to see which policies cover their needs at the most affordable cost and then drop the expensive excess.

Here are five options if you’re retired and have a permanent policy:

1. Surrender the policy

I see this option utilized most often when people need cash, not because this was their plan all along. If you surrender the policy, the insurance company will send you the cash value, less any outstanding loans.

There are two major drawbacks here: You lose the insurance coverage (I know, that’s the point) and you have to pay taxes on the difference between premiums paid and cash value received. That gain is taxed as income, not as a capital gain.

2. Use the cash value to pay the premium

This is typically an option for universal life insurance policies, not whole life. Whole life policies specify the premium term at issue.

If the pain point of the insurance is the cost and you still want some coverage, this may be your best bet. You can call your insurance company or your insurance agent to run an “in-force illustration” showing what would happen if the premiums were paid by cash value. In instances with large balances, the policy may stay in force for the rest of your life. In other situations, you may have to reduce the death benefit to keep the policy in force.

3. Take loans against the cash value

There’s an army of TikTok influencers peddling life insurance retirement plans (LIRPs). To be clear, these are typically universal life insurance policies and are in no way retirement plans. The basic premise is this: Fund a life insurance policy with as much money as is allowed to keep its tax-favorable status. In life insurance jargon, this is called max non-MEC (modified endowment contract). When you want to access the cash value, you can take tax-free loans.

Spoiler alert: This is much more complicated than it seems. You can access the funds tax-free in the form of loans, and we have done this for clients. The downside is that this is not a “set-and-forget” scenario or guaranteed income stream. You must evaluate how much you think you can pull out annually without the policy collapsing. In other words, what’s the maximum withdrawal before you actually run out of cash value and the policy goes away, possibly creating a taxable situation?

Remember, the cash value loans are tax-free because they are loans. It’s just like taking out a $1 million mortgage; that $1 million is not taxable because you must pay it back. In the LIRP scenario, loans are paid back at death, reducing the death benefit. This plan can work, but it requires an attentive agent who fully understands the nuances of your policy.

4. Sell the policy

You’ve seen these TV ads. If they seem a bit sketchy, they’re not. They’re one level below that. There is an entire life settlement industry that may be willing to buy your policy. You can sell the policy directly to an agency or through a broker who will attempt to solicit multiple bids for your policy.

When you buy a life insurance policy, you want to be as healthy as possible to minimize the cost of insurance. When you sell a policy, you want to be as unhealthy as possible, as this will increase the amount buyers are willing to pay. Depending on the sale price, you may or may not owe taxes on the sale.

5. Exchange it for an annuity

If you sell an investment property and follow all the necessary steps to exchange it for another rental property, you can defer the taxes on the gain via Section 1031 of the Internal Revenue Code. Insurance has its own like-kind exchange, called a 1035 exchange.

A 1035 exchange allows you to exchange life insurance for life insurance or life insurance for an annuity. An annuity can do a number of different things, but in its purest sense, it will provide guaranteed lifetime income. This is a set-and-forget scenario if you use a fixed annuity. The upside is that rates are much higher than they have been for the last 15 years. They have started to fall as the Fed cuts rates, but you can likely still snag a good deal. The downside is that a certain portion of your income may be taxable.

Before you try to figure out which option is best for you, you need to ensure that you don’t need the insurance. Most financial planning software will have an insurance needs analysis. You can try a free version of our software here.

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