Q: Should I Keep My Cash Value Policy If It Is Paid Up?
Dave never recommends keeping a cash value policy regardless of how long or short you have had it unless you are unable to qualify for a new competitively priced term life policy. However, you should never cancel an existing plan until you have received the new policy and reviewed it to make sure it meets your specific needs. Most people don’t realize there is still a cost to paid up policies in that you are paying a higher price for the cost of insurance and administrative fees than a term life policy and receiving a poor rate of return on money that could be used to pay down debt or be invested more wisely. There are still costs related to the insurance but the insurance company is drawing it from your cash value account so there still is a cost related to lost income.
The basic premise for cash value plans is that you will need life insurance your whole life so the plans overcharge you in the early years to pay the higher costs in the later years. Dave’s opinion is that if you buy term life insurance then you avoid this overpayment period and use the savings to attack debt and to build savings. With 15 or 20 year level term insurance you have time to eliminate your debt and grow your savings so you no longer need life insurance. You can visit our website, www.zanderins.com, and click on the “Term vs. Cash Value” link to learn more about this issue.
The cash value in your plan is available to you subject to the surrender penalties of the policy. These surrender charges decrease over each year you have had the plan and typically are gone after 10-15 years. Dave would typically recommend using the remaining cash value to intensify your debt reduction efforts, help establish your emergency fund and then take advantage of better investment options. Where ever you are in your “Baby Steps” is where you should focus this money. Whether your debt is mortgage related or other types of debt Dave’s baby steps will address the priority of what to do with your existing savings. You may not be able to take the annuity into account since there are penalties both IRS and insurance company related, which would not make it wise to move to other positions. It just doesn’t make sense to maintain a savings plan of any kind at a poor rate of return while paying out higher expenses for credit card and other debt and not addressing more important financial objectives.
When you attempt to cancel your Cash Value Plan most companies will try and imply that dropping the policy will have “serious” tax consequences. There is very rarely any tax due, and if there is, it is based on the amount you receive back that is in excess of the premium you paid. By adding up the number of years you have paid the premium times the annual cost you can quickly determine the extent of any tax that may be due. The tax liability is only on the gain over the amount of premium paid, not the entire cash value amount. However, you need to include any dividends received during the policy term in addition to the cash value. Even if a tax is due or surrender charges applied, Dave advises cancelling these plans and moving on to more effective strategies.