With many Americans struggling to meet their retirement income needs, it is unfortunate that valuable assets may not be properly utilized in retirement planning.
Assets like home equity and life insurance are often neglected in the planning process despite being some of the most valuable resources that retirees have in retirement. While neglecting home equity won't cause the value to lapse, life insurance could, leaving thousands or hundreds of thousands of dollars on the table due to improper planning.
The total amount of life insurance that lapses due to nonpayment of premiums or is surrendered or cancelled by older policy owners is extraordinary. A 2012 joint study, U.S. Individual Life Persistency Update, between LIMRA and the Society of Actuaries showed that the overall annual policy lapse rate was 4.5%.
This level of lapsing is large when considering that according to a 2016 report by the American Council of Life Insurers, individual life insurance protection in the United States totaled $12.3 trillion at the end of 2015. What makes this even more troubling is that seniors don't seem to understand their options.
UNKNOWN OPTIONS
A survey by the Insurance Studies Institute reported that more than half of seniors did not know they had the option to sell their policy and 90% of those who let a policy lapse would have considered it had they known it was an option.
If retirees have life insurance policies, the first step is to determine if they still need it. Reasons include needing to provide income protection for surviving family members, guaranteeing a legacy, or as a source of funding for estate taxes.
However, if the retiree realizes that they no longer need the insurance coverage or they can no longer afford to continue the policy, they should look at a variety of other options. One option is to surrender the policy for the cash value. Another is to continue paying required premiums while taking withdrawals or loans from the cash value to support retirement income needs.
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This could be the right strategy if there are sufficient funds to pay premiums — if not and the policy later lapses there can be significant income tax consequences. In other cases, where there is no appreciable cash value (for example in a term policy) the policy owner may think the only option is to let the policy lapse.
An option that many fail to consider is selling the policy ?in the secondary market, which may provide more than the cash value in a permanent policy, or with term insurance can provide value when the owner was unaware the policy had value.
According to Jamie Mendelsohn, executive vice president of the Ashar Group, "When retirees and financial advisors are thinking about letting a policy lapse, surrendering it for cash value, or just tapping into cash value to meet retirement income needs, you can benefit from engaging a professional who can provide an accurate value if the policy were sold in the life settlement market."
MISCONCEPTIONS
According to Mendelsohn, a big misconception is that the cash value is the best you can get for your policy. In some instances, you can get five to 10 times the cash surrender value from a life settlement. Additionally, convertible term policies can also be sold in the secondary market. Mendelsohn continued, "policies begin to be attractive in the secondary market when an individual has a life expectancy of 15 years or less."
Kunal Sachdeva, a PhD candidate from Columbia Business School, says in a study, "Many policies have little to no surrender value. Analyzing policies with an account value, settlements have generated on average seven times more value than simply surrendering them to their insurance companies."
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Retirees also should consider a 1035 exchange of the policy to another life insurance or annuity contract, instead of surrendering a policy that is no longer needed. This can help protect the basis in the original policy and avoid income tax treatment of potential gains.
Too many retirees let policies lapse or surrender them for cash value instead of considering selling on the secondary market or using a 1035 exchange to get a new better suited product. Advisers should learn more about these options for clients.
Jamie Hopkins is a professor of tax at the American College's Retirement Income Certified-Professional program. Follow him on Twitter @RetirementRisks.
