Four retirees with an old policy: keep, shrink, convert or sell

Almost every retiree who owns a permanent life insurance policy eventually asks the same thing: is this still worth what it costs? The answer depends less on the policy than on what the owner needs the money for. Four options sit on the table: keep the policy as it is, shrink it, convert it into something else, or sell or cancel it. Four invented retirees show how the choice falls out when the need is different.

Everything here is hypothetical. The policy values, premiums and tax rates are round numbers chosen to make the arithmetic visible, not data from any insurer, and they are not predictions. Policy details differ enormously, which is why the first step in every case is the same: get the facts from the insurer before deciding anything.

First, the facts every owner should collect

Before choosing among the options, all four retirees ask the insurer for the same items. You can do the same with any policy you own.

1. An in-force illustration. It projects the policy forward from today under current assumptions and shows how long it lasts at the current premium. See how to request and read an in-force illustration for how to request and read one.
2. The current cash surrender value. This is the cash value minus any surrender charge and loan.
3. The loan balance and interest rate, if there are loans. A policy loan reduces both the cash and the death benefit.
4. The cost basis. Roughly, the premiums paid less any dividends or withdrawals taken out tax-free. The insurer may report this, and a tax professional can confirm it.
5. The guarantees. Older policies sometimes carry guaranteed interest rates, guaranteed premiums or a no-lapse guarantee that a new policy would not match. Losing a guarantee is a real cost.
6. The nonforfeiture options. If it is whole life, ask what reduced paid-up insurance or extended term would provide. See nonforfeiture options: reduced paid-up and extended term.

With those in hand, the keep, surrender or sell your policy? is a good place to compare. Now to the four.

Carl: the policy he should keep

Carl is 72. He owns a whole life policy with a $100,000 face amount that he bought in his 40s. He pays $3,000 a year, and the cash value is $62,000 with no loans. His adult daughter has a disability and will need financial support for life. Carl and his wife have set up a special needs trust, and the policy is meant to fund it.

What he asks. Is the policy still doing its job, and can he afford it?

The arithmetic.

• Premium: $3,000 a year, or $250 a month.
• Net amount at risk: face amount minus cash value = $100,000 - $62,000 = $38,000. That is the amount of pure insurance he is really buying this year, because the cash value is already his.
• Cost per $1,000 of net insurance: $3,000 / 38 = about $79 a year. Because the cash value keeps growing, the net insurance he buys shrinks over time, so the policy gets more efficient in one sense, even as he ages.

Options he tests.

• Pay the premium from dividends, if the policy is participating and the insurer pays dividends. Say the annual dividend is $1,100 (invented). Used to offset the premium, his out-of-pocket cost becomes $3,000 - $1,100 = $1,900. Dividends are not guaranteed, so he checks the policy's dividend options.
• Reduced paid-up. He could stop paying and take a smaller paid-up policy. He asks the insurer for the figure and compares it to the need.
• Surrender. He would receive about $62,000, less any tax on the gain. But the need that the policy serves, funding a trust for his daughter, would then have to be met another way. The special needs trust has a purpose that the cash would not automatically serve.

His decision. Keep it. The need is permanent, the policy is paid for from a stable income, and the death benefit is tax-free to the beneficiary in general. He sets up the premium on automatic payment, names the trust as beneficiary with the help of an attorney, and asks for an in-force illustration every year or two.

The lesson. Keeping is a real decision, not inertia. It works best when someone depends on the money, the premium fits the budget, and the policy has guarantees worth having.

Joan: shrinking a policy that costs too much

Joan is 76 and owns a $250,000 universal life policy. The premium was set at $9,000 a year years ago, and the insurer has raised the cost of insurance. Her income is $48,000. Her husband died last year, her children are grown, and nobody depends on her income.

The arithmetic.

• The premium is $9,000 / $48,000 = about 19% of her income (18.75%).
• Her in-force illustration shows the policy runs out of cash value at about age 84 at the current premium, unless she pays more.
• If she reduces the death benefit to $100,000, the insurer says the premium needed to carry the policy to age 100 drops to about $4,200 a year (an invented figure). That is $4,200 / $48,000 = about 8.75% of her income, and a saving of $9,000 - $4,200 = $4,800 a year.

Why reducing can work. In universal life, the monthly cost of insurance is charged on the difference between the death benefit and the cash value, and it rises with age. A smaller death benefit means a smaller charge. See why universal life policies lapse, and how to prevent it for why these policies can run out and the cost of insurance charge itself.

What she weighs.

• Surrender charges. If the policy is young enough to carry a surrender charge, a reduction may trigger one. At 76 she probably is past that, but she asks.
• What she wants to leave. She would like to leave something for her grandchildren, and $100,000 does that. She does not need $250,000.
• Alternatives. She could stop paying and take whatever the cash value buys, or surrender and invest the money. She sees that the cash value is small and the guarantee is the point: a policy that she can pay for the rest of her life, at a lower cost, with a death benefit she has chosen.
• Tax on a reduction. A reduction in the death benefit can produce a taxable distribution in some cases, particularly in the early years of a policy or if it has been structured as a modified endowment contract. She asks the insurer and a tax professional before making the change.

Her decision. Reduce to $100,000, confirm the new illustration shows the policy lasting to age 100, and review it every two years. The savings of about $4,800 a year, about $400 a month, goes back to her budget. This is the kind of step covered in keeping an old permanent policy affordable on a retirement income.

The lesson. Shrinking is often the middle path between keeping the whole expensive policy and losing it all. It works when the need for coverage is smaller than the face amount.

Maureen: converting an old policy into care coverage

Maureen is 71, single, with no dependents. She owns a whole life policy with a $75,000 face amount and $55,000 of cash value, and she has paid in net premiums (cost basis) of $38,000. She no longer needs a death benefit; what she worries about is paying for care if she needs it. Her savings are modest.

The idea. Instead of surrendering the policy, she asks whether it can be exchanged for a policy that has a long-term care benefit. Under section 1035 of the Internal Revenue Code, a life policy can be exchanged for a new life policy or annuity, including one with a qualified long-term care benefit, without immediate tax on the gain (see 1035 exchanges: swapping policies without tax).

The tax arithmetic, illustrative.

• Gain in the old policy: $55,000 - $38,000 = $17,000.
• If she surrenders and takes the cash, the $17,000 gain is generally taxed as ordinary income that year. At an illustrative 22% rate that is $17,000 x 0.22 = $3,740. She would receive $55,000 less tax.
• If she does a 1035 exchange, the full $55,000 moves to the new policy and no tax is due at the time of the exchange. The gain is carried into the new contract and is addressed later.

The exchange has to be done properly: the old insurer sends the value directly to the new insurer, and the owner does not take the cash in between. Her agent should confirm the process with both companies.

What she weighs.

• Underwriting. The new policy requires health screening. If her health has changed, she may be declined or offered less. She learns this before she cancels the old policy.
• What she gives up. The old policy's guarantees, its cash value and its history. A new policy has its own surrender charges, a new contestability period and new terms.
• What the new policy pays. A hybrid policy's long-term care benefit pool is typically a multiple of what is put in, paid out over a period at a monthly maximum. See hybrid life and long-term care policies. If $55,000 bought a care pool of, say, $150,000 over 36 months, that is $4,167 a month ($150,000 / 36 = $4,166.67). That would not cover a full $7,000-a-month care bill but would make a meaningful dent. These are invented figures.
• The alternative. Keep the old policy and add a long-term care rider or a smaller hybrid. Or self-fund care with the $55,000, which is flexible but may fall far short.

Her decision. She applies for the new policy while keeping the old one in force. Only when the new policy is issued and the free-look period is under way does she complete the exchange. If she were declined, she would be back to the old policy with nothing lost.

The lesson. Converting is a one-way move that deserves a parallel track: apply first, exchange second. turning an old cash value policy into long-term care coverage covers the exchange in detail.

Bernard: selling a policy he cannot afford and does not need

Bernard is 79. He has COPD and his health is declining. He owns a $500,000 universal life policy on his own life that has cost him $14,000 a year, which he can no longer comfortably pay. The cash value is $9,000. His wife has died. He has two adult children who are financially secure and have said they do not need an inheritance.

His options, with the arithmetic.

What a sale involves. A buyer, usually an institutional investor working through a licensed provider, prices the policy mainly on the insured's life expectancy, the death benefit and the premiums required to keep the policy in force. People who are older or in poorer health tend to receive higher offers. The process includes release of medical records and independent life expectancy estimates, offers from one or more providers, contracts and disclosures required by state law, and a period in which the seller can rescind. See life settlements: selling your life insurance policy.

What he weighs.

• Offers vary. A broker who represents the seller can solicit several bids. The difference between the lowest and highest bid can be large. Ask each provider to explain how it arrived at its number, because life expectancy estimates and assumed returns differ.
• Fees and tax. Brokers are paid from the proceeds in many deals, and part of the gain may be taxable. If he paid $60,000 in total premiums (his basis) and sells for $85,000, the difference is $25,000. How much of that is ordinary income and how much is capital gain depends on the policy's cash value and basis, and a tax professional should work it out before he signs.
• Government benefits. Settlement proceeds can affect eligibility for needs-based programs such as Medicaid, and the disclosures a seller receives mention this. If he may need Medicaid for care, he asks an elder law attorney first.
• Loss of the death benefit. His children lose the $500,000 they would have inherited. They have said they do not need it. If they had, the answer would be different.
• Contact after the sale. The buyer may contact him about his health status at limited intervals.

His decision. He gets offers from more than one provider through a licensed broker, reads the disclosures, asks his tax adviser about the sale, and uses the proceeds to pay for in-home help. He compares the best offer with the alternative of keeping the policy at a cost of $14,000 a year for a benefit his family does not need.

The lesson. Selling can pay far more than surrender for an older, less healthy owner, but it is not simple. It is a financial transaction with licensing, tax and benefit consequences. The question to ask is whether anyone would be hurt if the death benefit disappeared.

A note on term policies

Not every old policy is permanent. A retiree holding a level term policy that is ending has a similar menu: let it expire, renew year by year at much higher prices, or convert part of it to permanent coverage before the conversion deadline. Many policies end conversion rights years before the term itself ends, so check the date. The converting term life to permanent: how the conversion option works guide explains the mechanics, and life insurance in retirement: keep, cut or cash out sets the choices in context.

A side-by-side summary

How to choose for yourself

1. Name the need first. Who depends on the death benefit, if anyone? If no one does, the question is about cost and cash. If someone does, keep the benefit and fix the price.
2. Get the numbers from the insurer in writing. Illustration, cash value, loans, basis and guarantees.
3. List the options that fit the need. Keep, reduce, exchange, sell or cancel are not all equal for each need.
4. Never cancel before the replacement is in force. If you are exchanging or buying something new, wait until it is issued.
5. Ask a tax professional about any surrender, exchange, reduction or sale, since gain and basis decide the result.
6. Tell your family what you decided and why, and update your beneficiary designations.

A fee-only financial planner, a tax professional or an elder law attorney can check the numbers for your specific policy. should you sell, surrender or keep a policy you may no longer need? is a decision guide for the case where you are not sure the policy is needed at all.

Key takeaways

• Start with the need: a permanent need such as a special needs trust points to keeping, while no remaining need points to shrinking, exchanging or selling.
• Get an in-force illustration, the cash surrender value, loans, basis and any guarantees from the insurer before choosing.
• Reducing the death benefit on a universal life policy can cut the premium sharply, in the example from $9,000 to about $4,200 a year.
• A 1035 exchange can move cash value to a care policy without immediate tax on the gain, but the new policy needs underwriting, so apply before giving up the old one.
• A life settlement can pay far more than surrender for an older owner in poor health, but compare several offers and check tax and benefit effects first.