For the past year I’ve been going back and forth on whether or not I should I cash out my life insurance policy. Long story short, my mom took out a $50,000 policy on me when I was born. She paid into it as I grew up and has since given me the policy.
Like any sensible accountant, I ran the numbers on keeping my life insurance policy vs. cashing it out and the sensible move (in my case) is to cash it out.
I wanted to share the reasoning behind my rationale in this week’s post. To do that, I broke out the risks and the benefits for comparison.
Benefits of Cashing Out My Life Insurance Policy:
Based on the calculations from the post’s cover photo, I end up with an asset 75% larger than the policy by age 65.
My alternative approach is to cash out the policy and invest the premiums on my own. I’m assuming a relatively low rate of return at 5% plus an annual 2% dividend. I did not make adjustments to factor in inflation in an effort to compare apples to apples with the policy.
The tax consequences of cashing in a life insurance can be summed up as this: If we make any additional money on our premiums, then that amount will be taxed. In my case, the premiums that have been paid into the plan exceed that of the cash value. The end result is that there is no, “profit,” and I will receive the entire amount tax free.
The fact that the full value at 65 does not amount to $50,000 is troublesome. This value can easily be reduced further to created an alternative asset as large as 2x or 3x in value. For the sake of being conservative, I left this at 50k. If anyone knows a better way to approach valuing a 50k policy at 65 and throughout retirement, let me know.
One things to keep in mind is that, for now, I do not have any children. Not having kids is definitely not a “benefit,” per se, just a different life circumstance, but for these purposes it falls into my pros column when deciding on whether to cashing out or not. If kids come into the scene at a later date, and there is a need for income for many years ahead to cover expenses, then the discussion for life insurance can be reopened.
Risks of Cashing Out My Life Insurance Policy:
To offset the lack of a 50k policy, I have an 80k term life insurance policy with my current employer. Even if I switch jobs, I would expect at least a baseline life insurance policy to be included in my benefits. If it isn’t down the road, I can always pay into a term life insurance policy if needed.
At this point, I felt comfortable making the decision, but I wanted to take things a step further.
So, I went ahead and walked through my analysis with two different life insurance agents on two different calls with the company.
The general response from the agents was that I was under covered on my current policy. They brought this up despite my first comment suggesting I would close the account.
They suggested I should be be paying at least 3x MORE to expand my coverage.
Again, I felt this was a bit odd that each agent had this as their first response despite my telling them I wanted to close the policy.
The younger agent mentioned I wouldn’t see any significant return until 20 years into the policy. I told them that the current policy I was talking about is 27 years old and does not have any significant returns. They said I should be at that turning point “soon”. I wasn’t even sure what “significant return” they are talking about here since the death benefit & cash value is guaranteed, and the dividends are relatively unchanged year to year.
I noticed each agent kept stressing the tax free component. When I started asking about the actual return, they said it was “very high” but later said it was also, “very conservatively invested, because [the insurance company] does not want to lose you money.” They only mentioned a 4% “guaranteed” rate, but no numbers outside of that.
When I suggested investing the money instead, the older agent said two things:
- I should take a loan against the policy at 7% to invest instead of closing out the account. She did not say can, she said should.
- Life Insurance will cost me much more in the future if I terminate the policy because I’ll never have this low rate again. We can lose a great deal by chasing good rates.
A funny comment here: the older woman said, “If you had 2k that you could invest aggressively, then absolutely do that, but for a monthly payment of just a few cups of Starbucks, it definitely makes sense to stick to this policy.”
This is exactly what I was trying to do, but there was a disconnect since my approach included closing out the policy and no longer paying her organization the annual premium.
I went into the opportunity cost and discussed using the annual premium along with the cash value ($3,400 + premiums) to invest instead of paying for additional insurance.
They kept insisting I could and should do both. I tried to explain my goal was to maximize my net worth at the end of the day and that paying for insurance didn’t make sense given the factors I mentioned above.
I explained that I wanted a higher return on an asset that would build into the future. She responded with another statement about the, “guaranteed rate,” being very high and the full rate of return often being in the double digits.
If you’re unfamiliar with how these returns work, then the short answer is you pay $100 to have insurance coverage for the year. The cost of that insurance coverage (as in this case) is often in the 20% range, so the $100 is now $80. Add in that 10% return and you’re back up to $88.
I consider the “guaranteed return,” portion to be a recoupment of costs. As it should be too, since you are buying a great amount of coverage that might be essential given the circumstances.
At this point each agent started bringing up general phrases such as, “at your age, most people have this type of coverage,” and, “I think this is the right thing to do.”
That was the end of the call.
I hung up and remembered a line from Warren Buffett, “Don’t ask the barber if you need a haircut.”
I didn’t find it surprising that the life insurance agents would not agree with my idea to cancel a policy. I found it interesting they were telling me I should invest into the market with a 7% loan. This was my first experience receiving investment advice from an insurance agent and I feel like it won’t be my last.
Again, the benefit I have is not having children that would need a supply of income. In the case of my demise, my assets would be more than enough to cover my liabilities and expenses. Given my risk tolerance and time horizon, the logical next step is to close the account and invest.
In summary, I’m prioritizing my net worth instead of opting for additional insurance coverage. Key word, of course, is “additional”.
Would you do the same thing in my position? Any additional thoughts I should consider? Is there anything here I left out?
Barring any major oversights on my end, I’m planning on cashing out the policy in the next few weeks.