Loan Rescue Strategies for Old Whole Life Policies
Whole Life insurance has long been regarded as a great vehicle for cash accumulation. Owners of these policies enjoy dividends and compounding interest that ascend in value as their cumulative premium payments add up. It’s even possible for these interest and dividend payouts to cover the cost of the policyholder’s premium payments over time. Add to the mix a tax-deferred status to boot, and you can see why Whole Life policies are such a popular investment vehicle.
Borrowing from these policies is a great non-taxable way to get cash to fund your business or personal needs, however borrowing in this manner does not come without its risks. It’s not uncommon for old Whole Life policies with loans to become huge tax liabilities – just the opposite of the original intention. This article goes over the various problems that may arise with borrowed-from policies, and a few strategies for solving them.
1. Interest on these loans must be paid, or else it accrues in the policy and adds to the principal of the loan. Sometimes the accrued interest is so severe that the situation is beyond repair, and the policy may need to be surrendered before it matures, implying a tax liability even if the entire policy is now a debt because the cost of the loan principal plus the interest exceeds the remaining liquidity in the policy.
2. If the dividend rate of the policy declines over time, the premium payments may no longer be paid for, which, if unmonitored, will result in a loan being created against the policy to cover the premium expenses.
3. The most drastic situation of all happens when the policy owner does not pay the loan payments or policy premiums, allowing the policy to lapse and the entire loan amount, plus interest, to be considered taxable income by the IRS at the policyholder’s ordinary-income rate.
If you encounter a Whole Life policy with a big loan on it, the first thing to do is find out as much information about the policy and the loan as possible. Here are some other immediate steps you can take:
1. See if there are any excess dividends that can be used to pay down the loan.
2. If the policy dividends are being used to buy additional insurance, switch the policy to a cash option to further reduce the loan burden.
3. Check the loan rate of the policy and the loan terms! We have seen loans on many older policies with compounding interest rates as high as six to eight percent. In today’s next-to-zero interest environment, the policy will implode quickly.
1. If the policyholder is still healthy and values their coverage, many universal life carriers and index universal life carriers will take the loan over via a tax-free 1035 exchange. These policies have two advantages: a lower cost of insurance, and a lower interest rate. Repayment of the loan can be made all at once or over a number of years so that the policyholder saves thousands of dollars in interest and avoids a serious tax consequence.
2. If the policyholder cannot get new coverage due to health or age related matters, they should consider refinancing the loan. There are banks who now assume the loan position of the policy at a prime interest rate without conducting credit checks. The bank will place a lien on the contract however, as collateral.
3. Last but not least, the policyholder can sometimes sell the policy via a life settlement if the value is there to an investment firm.
Ultimately, the best strategy is to have a plan at the outset because planning will eliminate the problems discussed here. If you or someone you know already has a loan on their policy, it’s critical that they regularly review their policy and discuss all options, especially if the loan becomes a challenge to pay back. MSPG is here to help you and anyone you know navigate the challenges of Whole Life insurance policies with loans.
To contact us, please call us at (631) 647-4694, or visit our website and leave us a message using the following link: http://www.mainstreetplanninggroup.com/contact-us/