I don't actually post about whole life insurance (WL) all that much, but the comments on WL posts number in the thousands and go on for years and years after the post is written. Most of the posts address whether or not you should buy a whole life policy (or its cousins, Universal Life and Variable Life). I generally recommend against them, and the insurance salesmen who love to post comments longer than the post itself not only recommend them, but feed their children and pay their mortgage from the commissions (50-110% of the first year's premium) on the sales. They're not happy when WCI readers actually have responses to the myths they're using to sell them. Today, however, I'm going to address a different question that I get in my email box far more often—how to cancel a whole life insurance policy.
Should I Keep or Cancel My Whole Life Policy?
Long-time readers will recall I was once the proud owner of a whole life insurance policy from Northwestern Mutual (NML). It was sold to me as a medical student by a very dear friend who happened to be interning with NML that summer. He subsequently went into another line of work. The policy was not only inappropriate for me, but it was just a terrible policy. What I really needed was a $1 Million, 30-year, level-term policy. What I got was a convertible $280,000 term policy whose rates would go up every 5 years until long after I would be financially independent coupled with a $20,000 whole life policy.
This tiny whole life policy was something like $21 a month. The annual policy fee was relatively huge compared to the premiums, not to mention the premiums were being paid on a monthly basis (even a poor medical student could have come up with $240 all at once if he had known it would improve returns). The policy had a terrible return. After 7 years, I cashed it in for something like $1,100. I had paid in something like $21 * 12 * 7 = $1,764. That's a loss of 38%, or something like -12% per year. It didn't quite track the minimum guaranteed returns in the original illustration, but my returns were pretty darn close to the minimum and a long way away from the projected illustration. The in-force illustration I obtained (just for fun) prior to surrendering it indicated I was still many years away from breaking even.
For a few hundred dollars of ill-gotten profit, NML is partially responsible (along with a mortgage lender, a realtor, and a mutual fund salesman) for unleashing The White Coat Investor on the world. I wonder how much they would love to pay now to get me to take down the whole life posts on this blog given that over 12 million people have visited the site in its first decade and some of the most popular posts are about whole life insurance.
The question we will be addressing today, however, is not whether you should buy a policy. It is what you should do with the one you already have. There are a number of points to consider.
Do You Want or Need a Permanent Life Insurance Policy?
Although 75% of those who purchase whole life policies eventually surrender them, there are a select few who want them and even a tiny percentage who actually need them. If you are one of these people, you should keep your policy.
Examples of people who need permanent life insurance include:
- Someone who will never actually become financially independent (working until death) and will always have someone depending on their income financially
- Someone with an estate tax problem
- Someone with a liquidity problem
- Someone with some legitimate business issues that are best solved with these policies
Even if you don't need a policy, you might want one. Perhaps you can't stand the volatility of higher-returning investments like stocks or real estate. Or perhaps the 3-4% returns you reasonably expect on the policy are adequate for your needs. Or perhaps you're into the whole Bank on Yourself/Infinite Banking thing. If any of this describes you, then you may want to keep your policy, assuming it is actually correctly designed to do what you want it to do. You might be able to improve it by paying annually, changing dividends to offset premiums instead of paid-up additions, or even by purchasing additional paid-up additions, but you probably shouldn't get rid of it.
Keep Your Whole Life Insurance Policy If You've Had It for a Long Time
Whole life has low returns when held for decades. It has terrible returns if only held for a few years. That means that, after a while, the returns GOING FORWARD may not actually be too bad. The terrible returns are heavily front-loaded, and generally follow the period for which commissions are paid to the salesman. If you're past those years, you probably want to keep the policy, even if you don't like it. I think 15-20 years is about the turning point, but one could argue this occurs by year 10, or even sooner. It varies by policy and how much you hate it.
Certainly, you can't argue it is a good idea to keep it just because you've had it for a year or two or five. If you don't want to pay the premiums anymore, then change dividends to offset premiums. If you just want to maximize the return, then purchase paid-up additions up to the modified endowment contract (MEC) limit and make sure you're paying annually. If you don't want to hire someone to evaluate the policy, this post may help you to evaluate your own whole life policy.
If You're Going to Cancel Whole Life Insurance, Do It Now
Whole life insurance works out best when you hold it until death. Once you have decided you are going to cancel a whole life insurance policy, there is no point in waiting a few more years until it breaks even or gives you a certain return you will feel good about. You may want to wait until just before your next premium is due if it means the cash value will be a little higher, but you certainly don't want to pay more premiums on a policy you will drop at some point between now and your death.
Consider the Alternative
Remember that you cannot just consider the policy on its own merits. You also need to compare it to what you would do with the money if you were not using it for life insurance premiums. If you're going to be using the money to max out a 401(k), or even better, get a match in a 401(k), then it is a no-brainer to get rid of it. Likewise, if the alternative is something like maxing out an HSA or a personal or spousal Backdoor Roth IRA. If you, however, are comparing it to a taxable account, especially invested in low-risk assets, or to just spending the money, then it will compare a little more favorably. I often see agents selling whole life policies to doctors that still have 6-8% student loans. That's financial malpractice in my opinion. Heck, paying off your mortgage, even one with a relatively low-interest rate, may provide a better return than whole life, and it's guaranteed.
Get Term Life Insurance in Place First
Does your whole life policy belong in the trash? Probably.
It should go without saying that you should never cancel a permanent life insurance policy unless you already have sufficient term life insurance in place to meet your needs and wants. It usually only takes a couple of weeks to buy a term policy, but don't leave yourself exposed even for that long. Besides, you might be surprised by something found during underwriting.
Don't Worry About Tiny Policies
When you start talking about getting rid of a policy, the first thing to consider is any possible tax penalties or tax benefits of doing so. For a teeny, tiny policy like the one I had, that just doesn't matter much. My loss was only a few hundred dollars, and the tax benefit on that would be far outweighed by the hassle factor and the actual costs to claim that. If you have a tiny whole life policy, just cancel it.
You may have had one of these purchased for you by your parents, who dutifully paid a few bucks a month on it for two or three decades before presenting all $2,000 of cash value in it to you (and asking you to take over the payments). Be sure to thank them for their thoughtfulness, then cash it out and use the money to fund a Backdoor Roth IRA. You might not want to mention that you did that during Thanksgiving dinner, by the way.
Evaluate Your Options Carefully on a Large Policy
However, if you have paid tens of thousands of dollars in whole life premiums, you probably want to spend a little more time deciding what you wish to do with this policy. If your policy has a large gain, you've probably had it long enough that you should keep it. But if not, you can avoid taxation of that gain (typically taxed at your regular marginal tax rate) by exchanging it into a better cash value life insurance policy, a very low-cost variable annuity (VA), or even long-term care insurance.
The best of those options, in my view, used to be the VA, since buying another cash value life insurance policy most likely entails another fat commission, and most doctors reading this site ought to eventually be able to self-insure any long-term care needs. However, it is not so easy anymore to find a low-cost VA, so even that isn't a great option for a policy with a gain. Unfortunately, you can't even use losses from tax-loss harvesting to offset the gains since gains in a life insurance policy are not considered capital gains.
Preserving Your Loss
A much more likely scenario for someone who has only been paying premiums for a few years and now realizes they bought a “pig in a poke”, is that you are way underwater on your “investment” at this point. Perhaps you've been paying premiums of $20,000 per year for five years, and now have a cash value of $75,000. You could just surrender the policy, take your $75K to invest elsewhere, and consider the $25K a “stupid tax”. Or, you could have Uncle Sam share your pain a little bit.
Another Option If You Want to Get Rid of Your Whole Life Insurance
Yet another option is to just exchange that whole policy into a modified endowment contract. This can eliminate any need for you to make additional payments into the policy, a big reason why people want to dump their policies. Then you simply leave it alone until your death and have it be part of the inheritance you leave your heirs or your favorite charity. Note that if you go down this path, you can't use the cash value for a better use nor can you borrow against the policy later in life.
There are lots of options when you want to cancel your whole life insurance policy. Spend time evaluating them or you may make another mistake almost as big as the one that got you into this mess. But quit beating yourself up about your decision to buy it; many of us have done that.
What do you think? Have you had this dilemma? Did you cancel your whole life insurance policy or keep it? Comment below!
I got stuck with a whole life policy from a good friend of my dad’s before I discovered your site about two years ago. It’s a 400K policy, and I’ve paid about $4700 premiums for two years. The cash value right now is $3600. I already max out my 401K, backdoor Roth, HSA, etc, so I would be investing this money into a taxable account. Would the VA route be best, or am I doing fine just keeping this policy since I don’t have any tax-deferred accounts to re-invest into? I’m not looking forward to canceling given the agent’s my dad’s friend :).
Nice friend. Do you want a permanent life insurance policy? If not, I’d get rid of it. If you do, then keep it. The VA route would help you preserve a loss of $5800, which would save you a couple thousand on your taxes.
yes but it would change gains into being taxed at income rates, have slightly higher expenses then the same investments outside a VA (assuming a low cost one), eliminates the step up basis at death, and eliminates the potential for tax loss harvesting. Why not just invest in taxable?
There wouldn’t be gains. You don’t keep the VA forever, just long enough to get either the tax loss or the tax-free gains. Then invest in taxable.
Can you do that to kids policies too? I opened 3 kids policies but realized this is a big scam. I made it paid off so stopped paying any premiums. I have not cashed out those. Can I transfer them to VA and let it grow to cost basis and then get money out of VA too?
Sure.
Hey Himanshu yes definitely can do the 1035 exchange into a VA and have them grow to cost basis, then get the money out of the VA. Not sure if worth it though, depends on how much loss you have lost. For myself, I was sold whole life on my 2 kids and for my oldest kid who was 5 years into his policy, I had cash value of 2.2k and the cost basis was 4.6k, while my youngest kid who was 2 years into her policy was cash value of 1k with cost basis of 2.6k. with only $4k of loss added up from both of them, such a small amount I just paid the “stupid tax” and moved on. also, all VA’s will have a minimum to open and the Fidelity VA which I recommend has a minimum cash value of $10k to open with them.
Hi Rikki,
Wanted to ask your advice! I posted this in the forum, but figured you might be able to provide some insight as well. My SO has a NWM policy, which we are interested in getting out of, with the following
Net accumulated value: $32000
Less Cost basis: $49000
Taxable gain if surrendered: $0
Current monthly premium $1035.
Would you still recommend doing a 1035 exchange into the Fidelity VA, given our situation?
Thanks!
What is your guaranteed and projected return going forward and how does that stack up versus your other uses for money for you?
Hey Newdoc, sorry you got screwed. Yes, I would do the 1035 exchange given there is a $17,000 loss there that you can make up tax free. first you want to make sure you have appropriate term life insurance in place, which I assume you do as NWM usually places you in “Term 80 convertible.” As an aside this term insurance sucks and you should shop again on term4sale.com given this NWM term policy is overpriced given the term is to 80yrs old, and also has that convertible to whole life feature. If somehow you didn’t get sold this crappy term type NWM policy, well then definitely get term from term4sale.com, and then do the 1035.
Formally Jim is correct where one can look at the guaranteed and projected return of your policy cash value and see if what you’re paying now in premiums might be increasing the cash value even more, as in whole life the early huge losses in the first few years are water under the bridge and returns going forward may not be so bad. However, I know NWM policies and likely you are still throwing good money after bad, and that your money would go better instead of paying whole life premiums investing in taxable for retirement, especially during this bear market. also, if you do the 1035 exchange during this bear market, the equity “subaccount” you invest in the Fidelity VA (that is the total stock market index fund within the Fidelity VA) will bounce back quickly to your cost basis.
I have a WL policy that’s just over two years old, so no gains to consider when transferring to a VA. The transfer would be simply for the tax savings if the subsequent loss is deductible like said here. Is making the transfer something I can do myself? I feel that if I ask my NWM financial adviser to make the transfer that there would be more grief from them than I’d like.
Unfortunately, the IRS tightened the rules and you cannot claim the loss any more. However, you can transfer your WLI to a variable annuity and let it grow tax free. For example, let’s say you have a cash-value insurance policy with a surrender value of $7,000, but your cost basis is $20,000. As I mentioned, you can no longer claim a $13,000 loss. However, you can transfer the $7,000 to a low cost, variable annuity via a ‘1035 exchange’. You then let that investment grow. You can let it grow back to you $20K, and then cancel the variable annuity. You would owe $0 taxes.
I used Vanguard for a 1035 exchange, but any low cost provider should work. Fidelity has better hand-holding and likely equally good, low cost options if interested in 1035 exchange. You can read more about Fidelity’s variable annuities and exchanges here – https://www.fidelity.com/annuities/annuity-exchange
I have no relationship with Fidelity and only recommend as I have found their customer service much better than Vanguard. Other low cost providers are likely options, too.
If held only for 2 years, it’s likely that the surrender value is 0(mine was). In such a case I don’t think (I may be wrong) that a 1035 exchange can be done?
That’s right, you have to have at least $1 in cash value to exchange (and the minimum for most VAs is far more than that.) But most whole life policies have some cash value at 2 years. That’s a pretty crummy one that has nothing.
Thanks a lot for your guidance on this!
From the Fidelity website on annuities– “Bear in mind that withdrawals of taxable amounts from an annuity are subject to ordinary income tax, and, if taken before age 59½, may be subject to a 10% IRS penalty. Annuities also come with annual charges not found in mutual funds, which will affect your returns.”
You said it’d be tax free, however– is there a distinction in the amount withdrawn that I’m missing?
The reason for the exchange is to allow it to grow up to basis, THEN surrender it. If you pay $10,000 for an investment and sell it for $10,000, there is no gain and thus no taxes to be paid.
I am in a real financial mess. I was sold 2.7 m northwestern mutual while life policy as the best investment vehicle 2 years ago and I was paying $60 k premium annually untill due to unforeseen circumstances I had to change my job and my salary has dropped to 1/2. I can’t afford to pay the premium any more. Now I am finding out the ugly side of whole life policies and my so called financial advisors who are basically salesmen for insurance company. I feel just an idiot After reading WCI.
My questions:
what is the best lowest cost Variable annuity with reasonable fund option to k vest. I don’t trust any financial advisor anymore. I looked at Vanguard and I was thinking of doing the exchange to Total stock market index fund VA.
So for all the policies including my wife and 3 kids.
My cost basis was about $96000 and cash value of 30000
??????????☹️☹️☹️☹️☹️
Sorry to make you feel like an idiot. Obviously not the intent, but it is often a side effect of those whole life articles. If it makes you feel any better, I bought a policy too, thankfully like 1/1000 the size of yours though, so it didn’t cost me too much.
Yes, I like the Vanguard one. Some have looked at Jefferson National, but I understand that you pay a small annual fee AND a comparable ER there, which I didn’t think used to be the case but I could have been mistaken.
So I did the 1035 exchange last year, and the money has been slowly growing back in the VA account. I’m wondering, however– is there any reason the money needs to be kept inside the VA, rather than just selling out of those those funds and investing into lower ER options in my Roth, for example?
I do not have personal experience with this.
That said, my understanding is that money needs to be kept inside the VA only until it has grown enough to replace the money that you lost. The reason that you want to keep it in the VA until that time is that the growth to replace your lost premiums will be income tax free.
Until that time, perhaps someone else can comment on how you could optimize your investments within the VA?
Thank you, Donna. Per my understanding, I would only be taxed on gains within the VA— so if I’m still working back towards my cost basis, there arent any capital gains to tax if I were to withdraw.
The money would also be growing tax-free within a Roth, again as gains arent taxed as long as they’re not withdrawn prior to retirement. So the money would not be taxed within either account, but could have a lower ER in roth funds.
I could see that perhaps the issue is if I sell out of the annuity that perhaps that money be taxed this year for income tax, but what’s within the annuity is already post-tax money… so maybe the fear is having that double-taxed? I dont know.
Yes, grows back to basis tax free in the VA with some additional costs. It would grow tax-free in a Roth IRA without those costs. The idea is that you would ALSO be doing a Roth IRA in addition to this VA back to basis thing. If you had to choose between the two for some reason, choose the the Roth IRA.
Sorry if I’m missing something apparently obvious, but I guess I don’t understand why you couldnt just consolidate the VA money into your Roth— both of mine are at Vanguard, so should be the same funds/market exposure. Both are growing tax-free. I’m wondering why the VA would need to be kept open if I could get the same market exposure within my Roth at lower costs?
You can’t roll a VA into a Roth IRA. You are only allowed to contribute $6K/year into a Roth IRA.
You’ll definitely get grief. Probably easier to go to Vanguard and “pull” the money into a VA there and then you can probably avoid talking to the NML guy. Realize that Noraz123 is right- you can’t just immediately sell the VA anymore and write off the loss. The exchange strategy is only to allow that VA to grow back to basis tax-free, which isn’t nearly as valuable. So if the loss isn’t huge, might want to put term in place, take your money, and walk away.
Thanks for your help, much appreciated! My cash value is $7019 and the money put into premiums is about $14850. So the question Ill have to figure out is the annuity would take to grow back to basis vs opportunity cost
*I mean how long the annuity would take to grow it back to basis
I would think the VA is your best option. What would be the opportunity cost? You can invest the money with a minimal fee (0.50%) and it will grow tax free back to your basis.
Well, I’m dumping my whole life policy– thanks for the advice everyone. I’ve finalizing paperwork on the 1035 with Vanguard. Does anyone have advice on which funds to invest my ~$7300 cash value into? I’m considering their Moderate allocation and their Total Stock Market Index thus far. I am willing to take risk with this money, since it was essentially sunk cost anyway.
Probably a decade for your money to double at 7.2% return per year (rule of 72).
I would recommend you go with 100% equity (ie, more aggressive) for tax reasons. You should look at your entire portfolio to meet your risk tolerance, and so if you aren’t comfortable with all of this 1035 money in stock, I’d offset it in your brokerage or retirement accounts with less risky investments.
Remember, your goal with the annuity is to grow it back to its original basis and then cancel, as you won’t pay any tax on those gains. So go with the funds that have higher average returns (ie, all equity) to grow it back to the original basis as quickly as possible.
Congrats on the 1035, by the way. I learned so much about finances, financial advisors, and taxes going through the same process of unwinding a cash-value life insurance policy. While it is never fun to lose money, if you are like me, you are well positioned to more than make up for it with better investment decisions going forward.
Thanks for the advice and encouragement, Noraz! What reasons are you referring to when you say “tax reasons”, in regards to going 100% stocks?
Also I agree that this has been a good learning experience, both in finances and also in the value of doing my due diligence and not just trusting that people like my NWM agent have my best interest in mind.
I think he’s just saying to get it back to basis ASAP. Not sure I buy his argument, but I suppose the sooner you can get back to basis and surrender the VA, the sooner you can reduce your investing costs. Obviously, you need to be able to tolerate potential losses- never have an asset allocation more aggressive than you can handle in a nasty bear, but it’s best to look at the whole portfolio as one account.
Since gains in the 1035’ed VA are tax free, up to total contribution to the WLI, it would instead make more tax sense to use tax inefficient vehicles (i.e. bonds) in the VA, everything else being equal.
Stocks, and especially stock index funds like VTSMX, are already rather tax efficient by themselves.
To be more clear: if you want to hold stocks and bonds, it is better (tax wise) to have the bonds in the 1035’ed VA and hold the stocks in a taxable account, than vice versa.
I like that counterargument too. Ideally, you want something with a high expected return but still tax-inefficient, like REITs.
Absolutely! Except, for the sake of precision, REIT do not have “high expected return”, but only “higher expected dividend payout”.
Along the same lines one could suggest high-yield bonds, but I’m not sure VA can be found with a focus on them.
What returns do you expect from REITs? I expect returns similar to other stocks (in the long run.) I consider those high.
Yes, my point was that the sooner you get back to your basis, the sooner you can cancel it and have the funds in your regular brokerage accounts (more investment choices, lower expense ratios, etc.).
However, as all of you point out, if your portfolio is going to have tax inefficient investments, better to have them in the variable annuity. Not wanting to start any heated argument within the blogosphere, I’ll leave to the readers to decide if bonds go in taxable or tax sheltered accounts or not (hint: https://thefinancebuff.com/tax-efficiency-relative-or-absolute.html and https://www.whitecoatinvestor.com/rethinking-bonds-in-taxable/).
If you are going to invest in REITs, a variable annuity sounds like a good place to invest.
It means expansion has to be financed by debt, which is more costly.
Also, higher distributions mean less risk.
It all points to REITs having a lower expected return than stocks in general.
Yes, they have to distribute by law. That’s why their expected return is lower than stocks as a whole, for the reasons listed in my previous post.
What happened in the past does not really matter as expected (i.e. future) returns are concerned. Otherwise, now we’d be expecting 10% from stock investments and we ain’t.
I don’t know what future returns will be, but your theories about why REIT returns should be lower than the overall market don’t hold up when applied to all known data on REIT returns.
Well, since REITs have to distribute earnings, I expect lower total return than stocks.
They’ve had to distribute earnings forever, that’s not new. Have you looked at the historical data? For instance, the Vanguard REIT index fund opened in 2001. Returns since? 10.16%. Very stock-like.
“Well, since REITs have to distribute earnings, I expect lower total return than stocks.”
Is it possible Steffano is saying the nominal returns (i.ie, stock price appreciation vs. total returns that include dividends/distributions) are lower since earnings are more frequently distributed (vs. kept by company and reinvested in growth )?
It’s an interesting theory, but there’s no evidence it will be true in the future. It certainly wasn’t true in the past.
The fund opened in 1996. In the last 10 years returned 6.6% vs 9.1% of total US stock market.
We can consider the period from 2001, as you suggest, which has been one of historically low stock returns (total S&P 500 return since jan 2001 has been less than 1% annual !!) and instead RE values far outpacing inflation (i.e. unusually good performance). That is only a 17-year span and I can find several 17-years periods where bonds outperformed stocks. It would not be correct to infer that bonds have a higher expected return, though.
Rather than blindly looking at the past, it is a more sound method to analyze how returns are generated.
REITs can only finance their expansion by debt, since they have to distribute almost all earnings. That kind of financing is more costly and therefore tends to lower returns.
From a n even more general point of view, larger distributions lower a positions risk. REITs therefore have lower risk than “normal” stocks and consequently their return is not surprising that their return tends to be lower.
Sorry, I was looking at the admiral shares.
You’re nuts if you think the total return on the S&P 500 since 2001 is less than 1% annualized. It’s 6.29%. Try it:
http://www.moneychimp.com/features/market_cagr.htm
Now, if you want to argue that REIT returns in the future will be lower, okay, I don’t have a problem with that. But you need an argument that wasn’t true in the past to do so. You’re now pulling out another one…that again was true in the past.
In fact, REIT returns outpaced stock returns during 82% of the available 30-year periods.
https://www.reit.com/news/blog/market-commentary/comparing-average-reit-returns-and-stocks-over-long-periods
Again, no promises that REIT returns will be comparable to the overall market going forward, but it doesn’t seem crazy to me to expect that given that it has been true for the entire history of that legal structure. Certainly I don’t think it’s wrong to argue that REITs have relatively high expected returns when compared to other asset classes.
The fund actually opened in 1996.
However, let’s take the period of your choice. Since jan 2001 total S&P 500 return has been less than 1% annual. What should we conclude ?
The truth is that a single 17-year period is not meaningful. In that period RE values have outpaced inflation, which is not normal. And we can easily find several 17-year periods where bonds outperformed stocks, which does not mean bonds have higher expected return.
Rather than blindly look at the past, it is a more sound method to analyze how profits are generated.
REIT have to finance expansion through dept, since they distribute basically all earnings, and that’s a more expensive method than by retaining earnings. Therefore their profitability, and ultimately stock performance, is expected to be lower.
Form an even more general point of view, since they have higher distributions their risk is lower and an expected lower return is not at all surprising.
What a timely article. I have a Northwestern Mutual Life Whole Life 65 policy that my dad setup for me a while ago that has a decent cash value around $50k (Death benefit $150k). I don’t pay premiums as the dividends are used to reduce premiums. I was just thinking about moving that to a Vanguard deferred variable annuity. Based on this article was also thinking about moving a Comp Life and a Variable Life Northwestern Mutual Life policies to a deferred variable annuity. I would then use part of the premiums I was paying to increase the amount of term insurance I have.
I would appreciate your thoughts on that.
My thoughts are pretty much in the article. Older policies generally have better returns, so you may want to keep it. If you need more term, then buy more term before you do anything. I’d get rid of a NML VL pretty quickly, as you can make a decent case for a really good VL (think Vanguard and DFA funds), but that isn’t one of them. Complife is just a combination of of whole life and term. Chances of you wanting both products from the same company seem low to me.
Great and Timely, off goes my wife’s 7 yr old Northwest 250K policy thats underwater. Thanks to my inlaws friend who did a ‘favor’ and got a ‘good’ policy for my college going wife.
I don’t think the debate about deducting losses in a variable annuity is whether they are deductible at your marginal tax rate or at the lower capital gains rate. Because the gains are taxed as ordinary income, it doesn’t make sense to deduct losses as capital losses. The debate is whether the losses must be a miscellaneous itemized deduction subject to the 2% floor. If you treat it similarly to a non-deductible IRA, then it’s a miscellaneous itemized deduction subject to the 2% floor. Anyway as you mentioned you can sidestep the issue by growing it tax free in a VA until the value is back at your basis.
An interesting question. Why would it have to be a miscellaneous itemized deduction instead of putting it onto Schedule D if you bought it as an investment and then lost money on it?
For the same reason you don’t claim as capital gains when you make money. If you Google “annuity loss” you will find plenty of discussions, such as this one:
http://www.taxalmanac.org/index.php/Discussion:Annuity_Loss
The IRS stated clearly losses in a Traditional IRA with non-deductible contributions would be a miscellaneous deduction (Publication 590, p. 48).
Although I would think you could deduct it as an “other” gain/loss on form 4797 (feeding into line 14 on the 1040), pub 575 page 22 basically says you’re right. The deduction is subject to the 2% floor on Schedule A. For many people, that will eliminate or at least significantly reduce the value of that deduction. Probably better to exchange it to a “good VA” and wait for the value to equal the payments, then surrender. I also learned that surrender fees aren’t deductible today, which also sucks.
About 5 years ago I purchased a 3 mil whole life policy from NML. I was a young naive new partner in a private practice making money finally. I had the whole NML sales pitch on how good it was as an investment. Thankfully I was skeptical and obtained a second opinion from James Hunt of evaluatelifeinsurace.org. He was able to help me design the policy to maximize cash value and limit commission. This policy costs me 50K a year, but my cash value this year of 250K equals the premium outlay finally. I am 90% on canceling and putting the money to work elsewhere. Thank you for the ideas of what to do. WCI you may want to ask James Hunt to guest post to help everyone considering whole life from making serious mistakes. I am lucky that it has only taken 5 years for my premium outlay to equal cash value.
Clearly, a well-designed policy is better than a poorly designed one. 5 years to a 0% return is actually quite good for whole life. I presume also that your returns going forward will be better than the typical whole life policy. What is it that is making you want to get rid of it now? You just never really needed/wanted it in the first place?
I originally bought it for the insurance, then picked up a term policy for peanuts. Now I feel over-insured!?! The returns going forward will be 5-6%/yr. To date non-guarnteed dividends been very near the projected . So it’s probably a decent piece of my overall portfolio. Dang it WCI, I may need to keep this!
Be sure you’re looking at returns going forward, not just dividends. There is a difference. But the low returns of whole life are heavily front-loaded. Overall, expect something in the 3-4% neighborhood, perhaps 5% if you get lucky and have the policy designed well. But those include the low returns of the first five years, which are water under the bridge for you.
How do you calculate return on a WL policy? I would have just assumed dividend = return…
This is an error many people make. Remember, you’ve been getting dividends for the last five years, but you now have exactly what you put into the policy. So your return is zero, despite getting 5, 6, perhaps even 7% dividends. The reason is that the dividend is only applied to the cash value, not to the entire premium paid. Some of the premium goes to buy insurance, some to pay the commission, some for insurance company profit etc.
To figure out your return going forward, you need an “in-force illustration.” This will take your current cash value, and illustrate for you what will happen to it at the guaranteed scale, as well as at a projected scale. Then you can take a date, say 30 years into the future, and the guaranteed value, and then use the excel rate function to figure out your return on both scales. A good guess would be using something in the middle of those two numbers. If that return looks acceptable to you, then keep the policy. If not, surrender it and use that money in another investment.
In these cases where the whole-life policy has been designed properly, (ie. has been over-funded, contributions no longer required since dividends cover the premiums etc…), can’t Radguy just assume that the cash-value of his policy is part of his “bond/fixed income” component of his portfolio, and therefore can increase his equity component (take more risk) in his overall portfolio?
John
Sure, except it is particularly hard to rebalance whole life as an asset class. Other downsides of whole life as an asset class are listed here:
https://www.whitecoatinvestor.com/whole-life-insurance-is-not-an-attractive-asset-class/
It’s official, my whole life policy has been CANCELLED! It took 5y for my premiums to nearly equal the cash value. DO NOT MAKE the same mistake I did. RUN from anyone peddling whole life, as the majority prey on Docs. Save your money and invest it! You’ll be much better off. Buy the cheapest term insurance from a A rated company. I hope my experience helps all residents and fellows from making this financial blunder in the future.
5 years isn’t too bad as these things go. I wasn’t anywhere near breaking even after 7 with mine.
I know this is an old post but I’m praying you still read it!! Whole life 65 policy through mass mutual from a ” friend”. I have now had it 5 yrs w 50,000 in but only worth 32,000… Very new at learning this was a mistake. Just cut losses or convert ?? I don’t have 401k or Roth
I just posted on this. You can read the analysis of my situation which is similar to yours.
You have to take into account the opportunity cost. What else could your money be doing? And decide if the death benefit really is a benefit to you.
Sometimes the answers are obvious but we just need someone to tell us it’s ok.
Shelli, you know in your heart it’s a turd and a waste of money. It’s ok to dump it and move on.
Northwestern Mutual “Adjustable Complife” insurance policy. It is a combination of whole life and term life. It “pays” an annual dividend around 7%, which goes to increase cash value and death benefit.
Current death benefit is $200,000.
Current cash value is $36,446.
Annual premium is $3,780 ($314 per month)
As of this writing I have paid into this thing for 125 months (10.4 years) for a total premium outlay of $39,312.
Leaving aside the cringe-worthy opportunity cost of missed growth of these funds over this period, in strictly cash outlay I am down a net $2,866 on this deal.
But, I did have the benefit of the life insurance component over this time, which works out to about $23 a month, which isn’t the greatest deal but somewhere near the ballpark of reasonable for a term policy.
I expect NWM is nicking me on some kind of other fees and expenses I can’t see, so the cost is surely higher than this and most likely takes it outside the bounds of reasonable.
Absurdity: to terminate the monthly payments and still maintain the death benefit would reduce cash value by $185 per month!
The NWM death benefit component is not really significant any more. I am 50 years old with a wife and two toddlers. I am financially independent with current assets and other life insurance totaling some 75x annual expenses. In short, even without the NWM death benefit, the financial security of my family is fully insured/self-insured in the event of my untimely demise.
If I cash out the NWM policy and put the $36k cash value in broad-based Vanguard mutual funds as a lump sum, and continue monthly contributions in the same amount as the NWM premium ($314 per month). In 10 years, at 5%, I calculate the sum will be $109,196.
If at that point I stop the monthly contributions and just let it ride at 5% for another 25 years (at which time I will be 85 years old and likely not long for this earth), the sum will be $369,776. Much better than the death benefit of $200k.
The death benefit and cash value of the NWM policy would also increase during that time, but not nearly that much and at much higher cost.
In addition, the mutual fund investment money obviously comes with liquidity during my lifetime. But if I don’t touch it before I die then it will just go to my heirs the same way the NWM death benefit would have, and then they could let it ride for continued growth.
This Adjustable Complife product is a murky bog, and my past choices were perhaps not good. The idea of continuing to donate money to NWM annoys and embarrasses me. But what’s done is done. I want to avoid perpetuating/compounding a high opportunity cost. The decision seems easy and obvious. I don’t need this turd and I want it gone.
In masochistic fashion I ran an opportunity cost calculation for that 10 year period. That stream of payments, at a meager 5% return, would be worth $50k today compared to the $36k cash value, a $14,000 difference in growth.
But it’s not like I got nothing. I mean, the death benefit was always there had my family needed it. But a similar term policy for the same period would have cost me about $2,500, so the opportunity cost associated the NWM death benefit was $11,500 over those 10 years, which is like $92 a month. That’s some expensive life insurance.
And that’s figuring at 5%. Shares in the Vanguard Total Stock Market Index Fund have more than doubled in value from 10 years ago to today. I’m not masochistic enough to calculate the value of the lost opportunity at that rate.
One factor to keep in mind is that, going forward, a 5% return will be anything but meagre. The last 10 years of the total stock market shouldn’t be taken as a baseline for estimates. In fact, any decade is more likely to be different from the preceeding one than it is going to be similar.
If it makes you feel any better, a huge percentage of readers of this blog have made the same mistake, including yours truly.
In case others reading this aren’t aware, the dividend rate is NOT the rate of return on these things. That’s the rate at which the cash value grows, but all of the premium doesn’t go to cash value.
GOFU
I am curious as to how you did your calculations for taking out your cash value as a lump sum then investing it in MF, did you use the rate of return calculator with daily compounding interest with continued payments that were equal to your monthly premium payments?
WCI
You mentioned that the rate of return is not the dividend and that we need an in force illustration to look at the guaranteed rate of return in a point in time in the future to determine ROR. which calculator can you use to determine this since I have my in force currently and trying to decide what to do.
I am currently in year 5.5 of a large Whole life policy and yearly premiums close to $20,000 and I’m hoping to get a better understanding of how GOFU came up with his calculations and how I can look at my current policy. Planning on dumping soon
https://www.whitecoatinvestor.com/how-to-evaluate-your-own-whole-life-policy/
Just look at the values now and in 10 or 20 years and run a RATE calculation on it using your favorite spreadsheet. If you’re okay with the guaranteed and projected rate, then keep it.
I’m about 3 years into a $2M MassMutual policy. I bought it as a resident after we had someone come give us the chat about the “personal banking tool of the rich and famous”. I had not really paid much attention to it because I was making enough money that it didn’t squeeze me too badly, but now I am on deployment to Afghanistan and the cost is becoming clear. I recently discovered this site and wish I had known about it sooner. Feeling really dumb about things now!
Much of the discussions above exceeds the very little knowledge I have, but at least now I know what needs to happen. I plan to hold onto it until I get back to the US because now is probably the few times when it would be nice (for the beneficiaries) to have a stout policy – though hopefully it will be a non-issue (fingers crossed no rocket attacks).
Wow! A $2M WL policy as a military doc. I bet that’s tough on the budget.
Any update on an iTunes Release for your book? I have a gift card I’d love to use towards it!
I’m sorry, I keep getting sidetracked! I also lost a bit of motivation when I saw how poorly it sells on B&N (1 a week as opposed to 300 a week on Amazon) as I expect a similar result on Itunes.
Any thoughts on what to do with high cash value whole life policies in Irrevocable trusts
I’ve written about trusts here:
https://www.whitecoatinvestor.com/you-dont-have-to-buy-life-insurance-with-your-irrevocable-trust/
I think life insurance is a little better in an irrevocable trust than outside of one, but the same principles apply. What’s the purpose of the trust and the insurance (i.e. why was it bought in the first place?) Has something changed? If not, why change it? Was it sold to you without you understanding what it really was? An irrevocable life insurance trust has some important uses for estate planning and I presume that’s why you (or someone you care about) own one.
I think I was naive and I puchased a VUL about 6 month ago. The high fees on the policy bothered me alot and now the more I read and learn about the VUL the more I hate it. I feel as if I trapped there for the next few years. Is there a good time to drop it and switch to regulat term insurance and leave the whole thing behind? I know you said use the VA. Also how can you avoid the surrender fee?
thank you for the very informative article.
That sounds like an expensive lesson to me. First, make sure it really is a bad VUL. Most are, but I’ve seen a few that weren’t the worst thing in the world. The truth is that after surrender fees, you probably don’t any cash value right now, whether you take it out of the VUL as cash or whether you move it to a VA. If you’d like to preserve the loss, you need at least $1 of cash value. That might mean making a few more payments, I don’t know.
The only way to get out of the surrender fee is to somehow get the guy who sold this thing to you to pay it. Good luck with that.
Holding on to it “for a few more years” is usually the wrong thing to do. You either hold it until death, or you get out of it ASAP.
Hard to give more specific information without knowing more about your situation- like how much you’ve paid so far, whether you’re paying monthly or annually, what the cash value is today, how bad the fees and investments are etc.
I’m new to the blog and to managing my finances in general. I got hooked up with a Northwest Mutual financial advisor through a friend and now am not so sure I did the right thing. He assures me the whole life policy he has built for me is the greatest thing and I’ll thank him in 20 years. After doing some reading and asking some of my partners I’m not so sure.
I am 31, single and in my first year of practice. I met with this guy to secure disability insurance and left with a Whole Life with Adjustable Term Protection and a Term 80 policy with increasing premiums. The whole life about $5100/year with a 400,000 death benefit. The Term 80 policy is about $35/month with a 1.1 million death benefit. After doing some independent reading I am realizing there is no reason I need $1.5 million in death benefit because I have no dependents and I’m feeling quite dumb about it. I do get some life insurance through my job which should be more than enough for me at this point.
The only reason I think keeping a term insurance policy for myself would be to avoid going through medical underwriting again in the future if/when I do need it. It’s relatively cheap but is a Term 80 with increasing premiums even necessary? I was told I can convert to a level term but my premiums will be much more and in the short term this is my cheaper option.
In terms of the whole life policy, I’ve only had the policy about 2 months so I’m out about $900 which may be a small price to pay compared to what i have been reading. My advisor assures me he built this policy in a way that it will benefit me greatly and it’s not comparable to other whole life policies out there. The way I understood his explanation of how the policy is built is that NWM will apply a higher percentage of the premium to the cash value of the policy than most other companies resulting in higher dividends over time. He gave me a dividend scale interest rate form that shows what the rates have been for NWM dating back to 1872 (did they really exist back then?) and it shows the rates have been well above the guarenteed rate. For the last 10 years it has varied from 5.5-8.2
I don’t know if my explanation makes me sound dumber than I already feel but I’ll take any suggestions. One of my senior partners has told me to cancel it ASAP and invest the money in a S&P 500 instead. What do you think?
Wow! You’ve learned in two months what took me 7 years. Congratulations. I wouldn’t feel dumb at all. Let’s see about your financial advisor:
1) You go in to buy one thing (you need) and come out with something else (you don’t need).
2) He sold you life insurance you have no need for.
3) He sold you “Term 80” life insurance. Not only do you not need life insurance now, but you almost certainly won’t need it between ages 60 and 80. So this wouldn’t be the right insurance product if you did have a need for term insurance.
I wouldn’t pay $35 a month for a decade or more in order to avoid underwriting, especially for a policy I wouldn’t buy then anyway.
I’m also surprised you got such good financial advice from your partner. That’s pretty cool.
Another example of a NWM “advisor” hosing yet another doctor. I hate to say such derogatory things about a single company, but this seems to be the modus operandi for these guys. Did you even get the disability insurance while you were there? Might want to reshop that too:
https://www.whitecoatinvestor.com/why-not-northwestern-mutual-physician-disability-insurance-friday-qa-series/
HMS, I faced similar things from NWM: Whole life. After responding no, Term 80. After responding no, level term that is a few hundred more than other carriers. Their term, in their eyes, offers more potential options in the future. The term 80’s rates are crazy after 15 years, which are when you would need coverage if you don’t currently have kids.
What you need to factor is part of your genetics and habits. If you think underwriting in the future will be a problem when you meet Mr/Mrs Right and have kids, then lock in now with a cheap carrier. If you think you will have enough of a nest egg to pay for future kids’ colleges when you breed or adopt, invest in Monster Energy or medical marijuana penny stocks (fine, SP500 index funds) and wait it out.
Between WCI and Bogleheads, whole life is like a bad penny: it always turns up. For WCI readers, NWM/NML is often implicated. I don’t know if other carriers have the same “push” toward the docs.
Thanks for the help. I am canceling my WL policy today before my next premiums are due. I maxed out my 403b but didn’t realize I also have the a 457 I can max as well. Certainly something I should have done before purchasing WL. I had a lot of trouble with medical underwriting while trying to obtain disability insurance so I’m hesitant to cancel my term policy. I was declined by Principal and MetLife and was finally about to get disability with NWM with a disability waiver. Given that I think it is in my best interest to have some kind of Term Life so I don’t have to go through that again. I can convert my Term 80 to a Level 20 so I’ll look into that.
That’s too bad (assuming it’s any kind of a reasonable 457). That’s probably a good move to convert your term insurance if underwriting was such a big deal for you. Be very sure 20 years is adequate for you to become financially independent. Also, don’t be afraid to shop around for other term. NML isn’t exactly cheap for term. You might be better off with another company, even if you have to go through underwriting again. Just don’t cancel what you have until your new policy is in place.
Any advice on what to do for life insurance if term isn’t an option? I’m in my last year of residency, about to start a family, and while healthy am a type 1 diabetic. My life insurance broker said almost no companies would offer me term life, so took the best whole life option I could find (about $4,500 a year from NML for $300,000 benefit). I know the numbers sound awful, but unless I was lied to, it was about the only option as a diabetic I could get. I know the $4,500 would be better if I just invested it in the long term, but that wouldn’t help my wife much if I died in a car accident tomorrow.
Well, let’s start with the big assumption in this case- that term insurance isn’t available to you at a reasonable price but whole life is. I am exceedingly skeptical of that and would get a second opinion. There is no doubt that you would pay more for a term life policy than a non-diabetic would. But, it’s not like you don’t have to do underwriting for a whole life policy. Also, be sure to take advantage of any GROUP life insurance that may be available through your work, your professional association, and even your credit union. Many of them will give you up to $300K in life insurance without any underwriting. Add a few of those up and they represent a significant amount of life insurance.
All that said, if it is true that term isn’t a good option but whole life is, then sure, that would be a pretty good reason to accept the downsides of whole life. But I’m pretty skeptical.
Is your insurance broker an affiliate of NML? One NML who I worked with said that Banner is the way to go if you have a health problem. Term. I think Joe Capone wrote that Banner has a more lenient underwriting group than many others.
I’m told by an agent that term life is certainly available for diabetics (let me know if you need a referral). However, it is a lot more expensive as you would expect. A healthy 35 year old might pay as little as $459 per year for a 30 year term policy. With diabetes, that could increase to as much as $2,744-3,485, or about 6-7 times as much. This is pretty similar to what life insurance costs for those of us with a bad habit like rock climbing.
I’m still looking in to whether the difference in the cost of whole life insurance for a diabetic is quite as severe, which is the real question. I’ve also sent you an email.
Is there an easy way to compare term to whole life, or is it apples to oranges? Is the ~3,000/yr term insurance ($1 mm benefit I’m assuming) better or worse than ~4,800/yr whole life ($300,000 death benefit, 1 year paid already)?
Although diabetic I’m otherwise healthy and 31 years old, and (I’m sure this is a common line agents use) if I took the term insurance, there’s a very good chance I’m alive 30 years from now and out of $100,000 of premiums, whereas at least I have something to show for my money with the whole life.
I don’t think you’re quite getting it. It would be easier if we were comparing apples to oranges. Let’s use some round numbers to do so:
If you decided to meet your needs (let’s say they’re $1M in insurance) with whole life, that might cost you something like $16K per year. If you decide to go term, you might pay $3K per year. So yes, after 30 years if you’re still alive, you’ve “wasted” $100K in term insurance premiums. Congratulations. I hope I waste all my premiums too. If you instead decide to buy the whole life, after 30 years you’ll have a policy that will probably have a $1.5M death benefit and perhaps a cash value of something like $750K. So, what would you have to earn on that $16K-3K = $13K per year in order to have $750K in 30 years? About 3.94%, or a little over the expected rate of inflation. Beating that doesn’t seem particularly difficult to me, but if it does to you, then whole life might be an option for you.
Hi,
I naively bought a VUL policy a few years after finishing training, and I let it percolate along for several years without really understanding the fees. This is a tough lesson, but at this point I’m interested in some advice about how best to move forward.
I think that I am less inclined to transfer this to another VUL policy, and am more inclined to surrender the policy and invest the money in taxable index funds. But I would be interested in some expert advice in case I’m missing something.
I have a Riversource VUL policy with a cash surrender value of $575K. This is comprised of approximately $430,000 in premiums and about $145K in cash value. I am in year 12 of the policy, so there are no surrender charges, and the M/E fee is 0.45%. The COI is $2,28 per year, and the expense ratio of the funds in the subaccounts generally runs around 1%, (although they do offer one index fund – Columbia S&P 500 index with an expense ratio of 0.4%). The fixed account provides a rate of guaranteed return of 4%. The death benefit is 1.5M.
My understanding is that if I cash out / surrender the policy, I would be responsible for tax (as ordinary income) on the 145K cash value.
When I sketch out some basic calculations, it seems that even at this stage of the game I would do about the same cashing out this policy, buying term life insurance, and investing my money in low-cost index funds.
1. Surrender entire policy and pay tax (31%) on 145K. This would leave me with 100K to invest. After 15 years, at 6% return, this would grow to $239,656. And if I then paid 15% capital gains tax at year 15, I’d be left with $203,708.
2. Keep the 145K in the VUL, with expenses around 1% (0.45% M/E plus ER of funds), with estimated 5% return rate. At 15 years this would be 300K, and if I surrendered the policy and paid 31% income tax it would leave me with 207K, which is about the same as above. And this calculation ignores the cost of insurance. And it doesn’t involve making a low interest loan to myself, which is how they sell you VUL.
3. Or I could surrender up to the cost basis, then transfer the remaining in a 1035 exchange to Vanguard variable annuity.
I am not so inclined to keep the RS VUL in place – to use it as they suggest, in order to obtain my money I would then have to loan money to myself, pay interest on that, which would decrease my death benefit, and might cause the policy to lapse if the cash value is depleted. And my COI would likely increase over time. It would also require me to maintain this VUL for life, which is something I don’t think I want to do.
But I want to make sure I’m not missing something which is why I am seeking expert advice.
Another possibility woudl be to transfer all of the money to the fixed account (4% guaranteed return, no M/E fee, no other fees except COI), then over an extended period (1-2 years?) invest it in Vanguard index funds (as a dollar cost averaging strategy). I could even decrease the COI somewhat by restructuring it. And while the money is in the fixed account I would count that as a substitute for the ‘bond’ portion of my global asset allocation strategy (when I consider my other investments, 401K, other taxable accounts etc.).
Thanks – part of why I’d like to get out of this is that it’s way too complicated. Any insights appreciated.
This is probably worth seeking advice from a real expert. In your case, I would definitely get an opinion from someone like http://www.evaluatelifeinsurance.org/ (no financial relationship.) But I’ll make a few brief comments.
First, it’s unclear to me exactly what you have. Are you saying you have paid a total of $430K in premiums and now can only walk away with $145K in cash value? Or are you saying you have paid $430K and can walk away with $575K, of which $145K is taxable? Obviously, you want to be really sure about this. But either way, you have either a large gain you don’t want to pay taxes on, or you have a massive loss you want to be able to harvest. If a gain, why not roll the cash value over to a very low cost VA at Vanguard or Jefferson National? If a loss, why not roll it over there prior to surrender so at least you can claim the loss on your taxes? It seems just cashing it out wouldn’t be wise to me. But I agree you’re in a terrible VUL and probably need to get out of it, even if it is just to go to a good VUL.
I’m also unclear about one option you seem to be considering. Are they letting you take out your basis tax free and just leave the $145K in gains in the policy? Seems odd, but if so, perhaps you ought to just take out that basis and then roll the rest over to a VA and use it for your REITs or TIPS allocation. I think this is your option 3, and it seems like the best choice to me. But again, this is enough money that it is worth getting some professional advice.
Hi, Yes – I communicated with evaluatelifeinsurance.org and James Hunt made the suggestion of cashing out up to the cost basis and transferring the profit to the Vanguard variable annuity. And I confirmed with my Ameriprise rep that I have a gain of 145K (not a loss) and that the taxable portion would be the gain (not the premiums). That makes sense to me considering that the premiums are post-tax income I invested. I’ll probably ask this question to my CPA before proceeding.
Can you explain why you specify REITs or TIPS allocation in the VA?
Thanks.
This, of course, assumes your asset allocation calls for those two asset classes. They are particularly tax-inefficient- the REITS because of their high expected return of which most is fully taxable and the TIPS due to the phantom tax issue. If you don’t want those two asset classes in your asset allocation, then put something else in the VA.
Do you recommend dumping equity index universal life insurance as well as whole life? Or EIUL slightly better than whole life?
It’s different. Better in some ways (possibility of higher return, though far less than investing directly) worse in others (especially the guarantees).
I own neither and don’t plan to buy either. Occasionally run into a doc who understands his policy and is reasonably happy with it. But most feel duped once they realize how it really works. It’s very rare to run into a doc who loves what his policy has done for him. There was a commenter recently who claimed to be both a doc and happy with his IUL policy but refused to send me a de-identified copy of his illustration. I’m skeptical that he was anything other than an insurance agent, but obviously can’t prove anything.
First, thank you for your very informative website.
Second, hopefully you can add a comment to this old post. I have now become smart enough to dump my NWM life policy. I understand that a 1035 exchange to an annuity is beneficial for tax purposes, but I am still “dumb” and don’t understand this: “You may then either let the VA grow until the cash value equals the basis, and then surrender the VA with no tax cost, or you may immediately cash out of the VA and book the loss.” I would greatly appreciate an explanation or link to explain further.
Again, thanks for your site.
First, what is the cash value of your policy compared to the premiums paid? If much less, then you have the ability to make some gains and not pay tax on them. You do this by exchanging to an annuity. If your basis is $10K, and your cash value is $2K, then you leave the money growing in the annuity until it equals $10K, then you pull it out and don’t owe any taxes on those gains.
Second, if your cash value in the whole life policy is more than the premiums paid, if you just surrender you’ll owe taxes on the gains. Exchanging to an annuity keeps you from having to pay those until you pull the money out in retirement. But if you’ve had the WL policy long enough to actually have gains, you may wish to just keep it, as most of the poor return years are now water under the bridge. Look at an in-force illustration to see what your returns going forward are likely to be.
Thankn you for your response, it took me a while just to understand what the figures are. It is a NWM policy about eight years old. My cash value is about $15,000, with premiums paid of about $20,000. I understand that a 1035 exchange would be best for tax purposes, but 1) I am not financially savvy at all (that is how I got in this mess), so doing whatever needs to be done to transfer to annuity would take a lot of learning time for me and 2) I don’t want to wait several years for the annuity to grow to $20,000, I would prefer to take the money now in a lump sum and open a Roth IRA. How can I figure out how much in taxes (if any) I will save by opening an annuity?
Thank you again for this great website!
Well, it’s a $5K loss. So at your marginal tax rate of say 25%, we’re talking about $1,250 (over 2 years). However, if it is really future capital gains taxes you are avoiding, that’s only 15% (depending on your income, could be 0% or could be 23.8%.) At any rate, it’s certainly no more than $2K in saved taxes and possibly much less.
All these whole life advocates love to talk about how to get your policy to even within 5 or 7 (or even 3) years. But every time I run into someone with a policy, they’ve got one like yours that is still way underwater after 8 years. Your NML policy is just as bad as mine was. I still had a 33% loss after 7 years.
So I pulled the trigger and canceled. I paid to date $20,790 in premiums to date (actually more because I paid monthly, but I am not including the monthly surcharge) for my seven year old policy. Here are the numbers per the surrender letter :
Total cash value: $17,259
Cost basis: $24,720
Estimate of total taxable gain: $0
Total loans: $0
Net cash value $17,259
Like you suggest, I am looking at a loss. But given these numbers, I don’t think I will pay any taxes, and I don’t think a 1035 exchange will save me anything. Am I wrong?
Thank you again for your insightful guidance.
Define anything. The tax loss you passed up was worth something. Maybe not worth your hassle, I don’t know. No, you won’t have to pay taxes on surrendering your policy for a loss. But that loss has value if you had exchanged to an annuity prior to surrender.
Thanks for your comments. Yes after seven years paying into the policy I was still way underwater. And actually I did not cancel the policy, but I only stopped paying the policy premiums and kept the policy in force while I figured out what to do. I did transfer the policy to a Vanguard annuity.
For the benefit of anyone else in my shoes, here are my suggested steps to complete 1035 exchange from a NWM policy to a Vanguard annuity. The whole process will take about three weeks. I note that I completed and sent the Vanguard application first and then a week later found out from Vanguard that I needed a “Request for 1035 Exchange” form from NWM, the process may be easier/faster if you just get the “Request for 1035 Exchange” from from NWM first and then send it and the Vanguard application to Vanguard all at once.
1. Based upon my experience, NWM agents know very little about how to do a 1035 exchange so maybe it is best to deal with corporate NWM (800 388 8123 is their corporate number). Tell them that you are doing a 1035 exchange, and you want a letter stating the current cash value, cost basis, estimate of taxable gain, total loans and net cash value. This information is on a form letter they send when you tell them you may cancel the policy. You want this information to know the value of the policy and the current cost basis to ensure that the proper funds and information is relayed to Vanguard. But don’t cancel the policy, because the policy still must be in force to do a 1035 exchange.
2. You need to speak with the NWM “1035 Exchange Unit” and request a NWM “Request for 1035 Exchange” form. They can mail, fax or email this to you, but for some reason they send the emails out in batches so the emailed version took a few days to receive. I simple had them fax it to me. FYI my NWM agent told me that no paperwork was needed from NWM to transfer to an annuity, this is incorrect.
3. If you don’t want to pay the policy premiums anymore, you can make that request that they suspend the premium payments for a month or so (my agent did this for me, I don’t know if the corporate reps have that ability as well). You can also have the policy premiums paid from the cash value of the policy, but of course this will erode your cash value.
4. Complete the NWM “Request for 1035 Exchange” form and send it to Vanguard. The NWM “Request for 1035 Exchange” goes to Vanguard, who then completes it and then returns it to NWM.
5. Complete the paperwork in the Vanguard annuity online kit available here:
http://www.vanguard.com/vvap/Pdf/vprosppa.pdf You do not need to know the exact amounts of the polices for the application, an estimate will suffice. But it is easier if you have the letter I mentioned in step 1.
6. You will need to complete a Vanguard “1035 Exchange Assignment Form” for each policy you want to transfer; it is part of the online kit. NWM does not require signature guarantee indicated on this form (or at least it did not for me).
7. The Vanguard application requests the complete NWM policy, but the Vanguard agent I spoke to said actually it is easier on their end if you do not provide the whole policy and check the policy lost boxes in the application. But I did include the letter from NWM described in step 1 and my last policy statement letter from NWM. This helps Vanguard know the amounts of the annuity.
8. I called the Vanguard annuity department before submitting the application, they were very helpful in addressing some minor questions I had. Once you are set, mail/FedEx the application to Vanguard. Emailed/electronic applications are not accepted from what I can tell.
9. Vanguard should call you in a few days to let you know they received your application. Confirm that they have everything needed and that Vanguard will send the NWM “Request for 1035 Exchange” exchange form to NWM.
10. In a few more days reach out to NWM, confirm that they received the NWM “Request for 1035 Exchange” from from Vanguard, and if so, when it will cut the check.
Hope this helps, and thank you White Coat for your advice and guidance!
So I followed these steps above and I am at a bit of a crossroad.
My value as current after 3 years stands as this:
I have put in $31200. My cash value is : $22558.89 and my surrender value is $1656 with an annual premium amount of $7200 in order to continue maintaining the policy and not borrowing against the value I have which is not much $1656.
I filled out all the VA documents and she called me regarding questions about which market- I told her put it into a Money market account. She said ok in order to do any VA account I need a $5000 balance so combined with the $1656 I would need to put in the additional amount to get to $5000 to open up the VA account.
Should I move forward with this and then withdraw the money out of the VA and then be able to claim the remaining amount of loss and is the loss valued as what I put in the $31200 or the cash value amount of $22558?
Or should I just hold onto the policy and continue contributing to the policy bc it hurts to lose so much $ and once the amount I put in and what the policy is worth balances out? That is how I was convinced to buy the policy by x amount of time your cash and surrender will even out blah blah.
Any help would be appreciated.
That’s a pretty big loss. I think I’d put in some money in an attempt to claim it even though it feels like throwing good money after bad.
Is the surrender value something I have to get from the company (of course it’s NWM)… It’s not a value I’ve been able to find in any of my documents. Thanks!
It should be on all your statements.
Hello and thanks for the info on the site.
Briefly here’s my situation: Cashed out a “bad” VUL (NW mutual) 3 years ago and invested proceeds ($96k) and began making $8500 annual premium payments on a “good” Indexed UL (Pacific Life) on the advice of a newly minted financial planner (a friend’s son). Policy currently has a $1.25M death benefit which I don’t need because I have 12 years left on a $1.5M level term life policy. (Thankfully, I’m on course to be retired and financially independent before then). So the premium paid to date is approx. $121.5k, accumulated value is $103k and surrender fee is $14k, leaving me with $89k to move into the VA you suggested.
How is the basis calculated?
Will my $89k instantly lose value as with a VUL? If so, how much?
When time comes to cash out the VA, is there an associated surrender fee?
Thanks for your input. Gotta dump this thing…it’s giving me a stomach ache just writing about it.
It depends on the VA. The two generally used are Vanguard’s and Jefferson National’s. I don’t think either of them have surrender fees or pay commissions but double check that before exchanging. So the idea is invest in there for a couple of years until the value is equal to the $121.5K basis, then pull the money out tax-free and invest it in a taxable account. As I recall, Jefferson National has a flat $20 a month fee, and Vanguard has expenses ratios that are a little higher (0.57%) than most of its straight mutual funds, but still low compared to most mutual funds.
http://www.fa-mag.com/news/annuity-ingenuity-14691.html
https://investor.vanguard.com/annuity/variable
I believe I’m going to end up paying a stupidity tax of around 50K. It’s really painful but I’ve come to see that IULs are designed to lapse and I’m certain and paranoid that I would end up losing much more down the road. Definitely causing many sleepless nights. We’ve only been paying into them for a year. We were rubes and didn’t really understand what retirement would look like. The money that would have otherwise gone toward the premiums will now go to my wife’s 547 where it should have been going all along. Our surrender value is negative so it’s a pretty expensive and bitter lesson. Better to learn it now than when we’re retired. Thanks for the site.
Sorry to hear about your situation. I agree a 457 is generally a higher priority investment wise than cash value life insurance, whether IUL or any other type.
From my experience so far, I would assert:
1) If your premium is > 4% of your after tax income -> walk away
2) If your surrender value after one year is/will be less than 50% walk away
3) If it can’t be illustrated with the guaranteed minimums that your policy will be self sustaining after 10 years -> walk away
4) If your tax rate is walk away (see #1)
What was your fourth rule?
If your tax rate is less than 35% (see #1) -> walk away
Thanks so much for the informative post. This is very helpful as I am now going through the exact process to determine what to do with my wife’s policy. She’s paid about $50k to date, with about $30k in surrender value.
I am very much a novice with respect to whole life insurance and annuities, so please forgive my naivity. But if I were to do a 1035 exchange so that I could preserve the $50k basis, and then surrender the following year, are there irs penalties for being under 59.5 years old?
I think the penalty is assessed only on any gains, if you don’t have any, no penalty. That’s for a non-qualified annuity (one purchased with after-tax dollars.)
Hi Jim, thanks for setting up this blog and for the advice you give here and in your book, it is invaluable to the “whales” out there who want to break free from the sharks who call themselves financial advisors.
Both my wife and I have $500K whole life policies with NWM and we’ve paid so for roughly $24k in premiums over 2 years. I just checked with them and the surrender value is like $1500 each… which makes them thieves rather than insurers. I’m not sure if it’s still the best at this point to do a 1035 exchange to Vanguard and to contribute the difference to $5000 in cash (Vanguard has a $5,000 minimum for opening the account). I’m thinking this way I would still preserve my cost basis. On the other hand I need cash right now as we’re planning to buy a house, so maybe it’s better to wait?!
Yet another depressing tale of how NML got to someone before I did. There are literally thousands of these out there.
Why not add $3500, put it in the VA, then surrender the VA and claim the $21K loss on your taxes (carrying it over for a few years.) Then you get your tax loss and you get your money too.
I currently have a Universal life insurance policy for myself, my wife, and our son(He’s 2). I pay $400/month for all 3. My sons is $25,000 and mine and my wifes are $250,000. The $400 pays the premiums, and the excess is put into a 3% earning savings account. I’m pretty frustrated after looking into the policy. I’m earning 3% and spening 7% on service fees. My agent states that the tax deferred aspect is worth the 7% but I don’t believe that for a second. It is a cash value policy. We are looking at about $1,600 in surrender fees if we exit the policy. I’ve only been paying on them for a year. We already max out our Roth IRAs and are 26.
I wish your story were rare. Are you aware that healthy 26 year olds can buy $1 M in term insurance for under $25 a month?
What do you plan to do with your policy? Are you just going to walk away?
Sorry for such a basic question: Do all whole life-type policies have a surrender fee? No such fee was discussed when I was sold my whole life policy (Northwestern Mutual), and I always figured that I would just be able to stop paying the premium and collect the cash value of the policy if I wanted to discontinue the policy.
It’s usually “built-in”. Your cash surrender value is your cash surrender value.
I am wondering why one could not just consider a whole life plan as a gift to heirs. In other words, you know you will die so it is a guaranteed pay out. As long as you are maximally finding 401k, 457b, HSA plus a sizable after tax investment account then the way I think about it is it could be the bulk of my estate to leave to family and all the rest of the money I invest will be for me and retirement. In the meantime, should I die early, they will benefit right away. I realize I will get poorer return long term than if I invested in an index fund but whole life buys piece of mind in the meantime and is a safe bet right? Especially true if the market crashes at exactly the wrong time for me. What am I missing in my thinking?
Thanks.
There seems to be two items you point out – a safe means to gift to heirs and an insurance component to benefit them should you die early.
For the latter point, you mention, “In the meantime, should I die early, they will benefit right away.” Term life insurance would do this too, at a much reduced cost.
For the former point, you mention, “I realize I will get poorer return long term than if I invested in an index fund.”
This is correct, you will you get a *much* poorer return. Even indexed universal life policies have caps on the upside, and most usually don’t index to total returns, rather they are indexed to price appreciate (ie, they neglect returns from dividends).
You also mention, “but whole life buys piece of mind in the meantime and is a safe bet right?”
If you hold whole life policy for many years [20+ years], you will get your return, albeit low. However, should ever need these funds in the early years, you will likely take a significant loss in due to surrender charges. Definitely *not* a safe bet.
You’d be much better buying term life insurance, and investing the difference in a taxable account taking into account the proper risk adjustments (asset allocation – stocks, bonds, government securities). Moreover, your heirs will be quite thankful for the step up in basis upon your death.
So in summary – use cheaper term insurance to benefit your heirs in the case of an untimely death. Use taxable account investments properly accounting for your risk profile. It will be cheaper for you, benefit your heirs more, and give you cheaper access to funds should you have any life changing events. Win-win-win when comparing to whole/universal life insurance policies.
The only myth about whole life insurance around here is that the first year’s commission is 50-110% of the first year’s premium. A properly designed policy is no where near that amount. More like 20% of the paid commission, for one year.
I have run numbers plenty of times and I can tell you that commissions like that are far cheaper then the “low” management fees and index fees charged on your stock portfolio each and every year. A fee that is calculated not on the amount of contribution put in, like life insurance, but on the total balance of your account.
All this emphasis on percentages is deceiving it doesn’t tell us exactly how much money it is costing. It’s Wall Street’s dirty little secret. I can do math however, and when your account is finally up to the size you need it to be for retirement that is when they are really raking in the dough. Yes, even the so called cheap index funds.
“Properly designed” = mostly paid up additions. I agree the commission is lower on those. But the standard, off-the-shelf whole life commissions are that high. You know that and I know that. So it’s hardly deceiving. Especially when I get multiple emails a week from people being sold those policies. Docs aren’t being sold “properly designed” policies. They’re being sold policies designed to maximize the commission.
Uh…..the emphasis on percentages isn’t deceiving either. Take my TSP investments, for instance. The ER is 0.02% per year. Even with a $2 Million account, the total fee is $400 a year. In a Vanguard index fund at 5 basis points, that’s $1000 a year. If your portfolio averages 10 basis points, that $2K a year. My average is 0.15%, so that’s $3K a year on a $2 Million portfolio. I can pay for a lot of years of expense ratios for the price of a commission on a $50K a year whole life policy. And that comparison ignores the substantially higher ongoing costs of the insurance that cause the returns to be so low in the first place. If only the commission were the only significant expense!
Some advice wanted please: I am among the many physicians who’ve been duped into an indexed universal life insurance policy that I now realized I don’t need as a healthy single male with no dependents, intended primarily as an investment vehicle after maxing out ira/401k. $2M with Allianz (which I can’t even find a rating on). It was in the midst of intense oral boards preparations and I should have known better to wait but unfortunately my trust in the relationship and distracted state of mind got the better of me after a relatively painless experience purchasing disability insurance through the same people. Now that I’ve passed and finally have time to do some research, I’ve grown a rather large pit in my stomach reading about these policies and how I’ve been suckered.
The relatively good news is that I’m only 3 payments in, totaling $6600. Current cash value: $4282. Next premium autopay goes out tomorrow, and being Memorial Day today I’m not sure how successful my attempts will be to stop this payment.
Is the best option still to 1035 exchange this amount into a VA? Or pay a penalty, accept my loss of $2318, and cash out? How much should I expect my penalty to be by the way? Can’t trust these people to tell me anything true anymore…
First, Allianz is Aa3 rated by Moody’s, that’s “excellent” below “superior.”
Assuming you actually want out, the 1035 exchange to a VA would allow you to claim your loss on your taxes. Assuming 33%, you get your $4282 and the loss should be worth something like $800 for a $1600 loss. Not too bad. Lots of docs have paid a far higher “stupid tax.”
Thanks so much for this site. I, too, am trying to get out of the Whole Life that a CFP (yes, an independent *CFP* but affiliated with MassMutual)put me in as part of an investment retirement plan.
I was sold a Limited Payment Whole Life with premiums up to age 65 last June 2014. Since it was a way to “save and invest” rather than for the death benefits, I put away $4000/month (I already max out my SEP every year), but made the entire year’s premium of $46K (after discount for upfront year’s payment). At 65, the policy pays for itself and I do not have to make any more payments but have a current projected $1.6 million in cash value (assuming 7% dividend rate). The policy was designed so that I could decrease the premiums whenever I wanted based upon my financial situation. I never intended on continuing at $4000/mth, it was just my way of socking away a big chunk of money for asset protection that first year. (I’ve read through the section regarding the cons of WL and all of my reasons for accepting what the CFP put me in are on the list. [chagrin]) If projections are on-target, the cash value will equal to my total premiums somewhere in year 7.
But, I want out of the WL. Unfortunately, there’s no way to convert the policy to something like a 10-pay or high early earning WL, at least that’s what the CFP told me. So, this is what I thought I’d do in order to keep the $46K that I’d already put in and not sacrifice it with a cancellation of the policy, I’ll continue making minuscule payments on the order of $50/mth. At the worse, it would be for 20 years when I reach age 65, at which time my total additional payments will be $12,000. So, for an additional $600/year for the next 20 years, I’ll keep the policy to get back my $46K. I’m just looking to salvage my initial $45K investment. Of course, I can do whatever premium payment I want, so I could do $25/month or $10/month, but whichever amount I choose, I’d make an entire year’s payment upfront every year.
Hopefully, I’ll be lucky like Radguy and get to equal cash value as my total premiums in 5 years so that I can cash out completely, minus whatever fees I’m sure they’ll hit me with.
What do you think of this plan of reducing the total premiums to a small, bearable amount so that I don’t sacrifice the $45K? Since it’s only been 1 year, I’ll only have about $1000 in cash value, so doing a 1035 Exchange to Vanguard’s VA would just be too painful as I’d lose $44K.
Or, do you think there are other options I should consider?
Thanks for the help.
Addendum:
Just talked to the CFP to confirm that the $46K already invested will be intact when I drop the premiums down to $20/mth. Now, her answer is that she didn’t know how that would affect the $46K since $20/mth is such a drastic drop compared to $3000/mth (which was what I had intended to drop the premiums down to in year 2.) My question to her was, if I could always drop the premium payments to whatever amount I wanted as she stated to me a year ago, then why did it matter whether the new premium amount was $20 or $3000? She said she didn’t know and would need to get an in-force illustration for the $20/mth. I am even more irritated with this new development of “I don’t know” because now it’s a big drop in premiums, and, likely, whatever commission lost from the second year’s premium.
That news is not a surprise to me.
Well, if you exchange to the VA you get to have the government share in your loss, right? You can use those losses against $3K of regular income every year for a 15 years. Or use them to reduce capital gains taxes at some point. So that’s one nice thing.
Also, be sure to consider the time value of money. $46K in 5 years is not the same as $46K now.
But from what you’re saying, that you can pay $10 a month for 7 years and then get $46K, that sounds like a great deal to me. The return on that investment is phenomenal. I’m not sure it’s true, but if it is it’s really, really good. I mean, you’ve got $1000 now, you pay $120 a year for 7 years, so you’ve paid in less than $2K total and now it’s worth $46K? That’s a crazy good return. That’s why I’m skeptical.