Balancing cash flow and insurance costs
Q. My father has a whole life policy for which he pays $5,000 a year. His cash flow is tight and he doesn’t need the insurance, but he says he wants to give me an inheritance. What should he do?
— Loving son
A. Life insurance is an important part of every financial plan, but it’s not uncommon for someone’s need for life insurance to change over the years.
In the event of death, a life insurance policy is a safety net that helps ensure a loved one’sfuture financial obligations are met, covering items such as funeral costs, outstanding debt, estate taxes, and potentially everyday living expenses, said Michael Green, a certified financial planner with Wechter Feldman Wealth Management in Parsippany.
Green said for older individuals, many use life insurance is to pay for funeral or burial expenses, noting that in 2014, the average cost for a traditional funeral was about $6,600.
“The sudden burden of paying over $6,000 for the funeral of a family member may be more than a family can handle,” Green said. “The benefit paid from a life insurance policy can help to reimburse or offset the cost of the funeral and burial borne by the decedent’s heirs.”
On occasion, people will purchase life insurance policies as an investment, Green said. Some types of life insurance allow the policy holder to build a cash value inside the policy and invest that cash in various mutual funds.
He said the idea is for the life insurance to grow in value over time and eventually be cashed out, but Green notes that there are other types of investments that may yield a greater return than permanent insurance policies.
Another strategy for which people use insurance is to leave an inheritance for their heirs, he said. This appears to be your father’s situation right now.
“Leaving an inheritance or legacy for your children is a generous gesture if one can afford to do it,” Green said. “However, sacrificing your standard of living or spending down your savings to accomplish this goal is not a prudent course to follow.”
Green said if the insurance benefit is intended to cover certain expenses, it may be worth speaking with a certified financial planner to create a plan to keep the policy in place.
“For example, you may consider contributing some of your own money towards the premium on the policy, if you can afford to do so,” he said. “Depending on the benefit amount associated with the policy, it may be worth it for you to keep it in force.”
There are quite a few options for your dad, and each comes with its own advantages and disadvantages.
First, said Taylor Thomas, a certified financial planner with Round Table Wealth Management in Westfield, your father can pay the current premiums — which will continue to cause stress on his cash flow — but will leave the death benefit, or inheritance, unchanged.
Second, your father can surrender the policy and receive the cash value (if any), Thomas said.
“Surrendering the policy will eliminate the death benefit, could subject the policy owner to surrender charges and/or cause the owner to recognize income if there is a gain in the policy,” he said. “However, this option may provide him with additional cash now via cash surrender value and he will no longer be required to make the annual premium payments.”
Third, he could keep the policy’s death benefit the same and use the dividends to reduce the annual premiums.
Thomas said your father can request that the agent or insurance carrier run an inforce illustration to show what the new premium might be reduced to if dividends are applied to cover a portion of the annual premium.
“An inforce illustration is a picture of the insurance policy as it stands now,” he said. “It will show the exact results of what has happened from the initial policy inception to today with future projections based on current assumptions.”
Thomas notes that this option is non-guaranteed and subject to change based on the actual dividends the policy receives. It will reduce the growth rate of the cash value as the dividends will no longer be added to the cash value or used to buy additional insurance.
The fourth option is to decrease the death benefit on the policy.
“The insurance agent or carrier can show you options (via an inforce illustration) to reduce the policy’s death benefit which will also reduce the annual premium,” Thomas said. “This option reduces the death benefit, but allows your father to pay a reduce annual premium.”
Another option is to request the policy be converted to a reduced, paid-up death benefit amount. Again, the agent should be able to provide you with an illustration showing how much death benefit could be provided if no additional premium payments are made, Thomas said.
“This option will provide a lower death benefit than the current, but no premium payments are required which would address your father’s current cash flow issue,” he said.
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Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.