Q: I am uncertain whether to cancel or borrow from a whole life policy (with a $100,000 benefit) that is a little over 10 years old, in order to pay off credit card debt. The policy's cash value is $13,000 and the credit card debt is $10,000. I would reinvest the difference in stocks and bonds.
The bigger picture is that I want to buy a term policy for $1,000,000 because a different existing $400,000 term policy has recently run over its term and is incurring premiums that are too high.
On top of that, I found out that I am paying too much for another group policy through my employer (for $300,000). I want to get rid of that as soon as possible; unfortunately, I am unable to until the end of the year. An additional $100,000 coverage is paid for by my employer.
I have read so many different and often opposing opinions about whole life policies in the past few days that I am thoroughly confused and don't know whether I would be wiser to keep than to cancel it.
The reason for the total coverage of $1,000,000 (20-year term) I'm seeking is that my wife is disabled and cannot work. I want to know she is secure enough that, in case of my death, she can live off the interest. I am 46, my wife is 49.
A: In my opinion, permanent life insurance policies, such as whole life and universal life, are best suited for permanent life insurance needs. These needs primarily surface for individuals with large, taxable estates or individuals with a special needs family member whom the insured cares for. Permanent insurance plans outside of these needs are commonly sold as investments, not the most cost-effective life insurance strategy.
In addressing the specific case, the choice to borrow or cancel the existing whole life policy should be made from two key considerations:
1. Ensuring the main life insurance need is addressed
2. Determining the most cost-effective way to reduce the debt
First, the key life insurance needs should be addressed. Most people need term life insurance to provide for their survivors in the event of a premature death. The need generally lessens over time until it is eliminated as financial obligations, such as college funding, retirement funding and debt repayment, are fulfilled. In most cases, there is little or no need for life insurance beyond retirement. Therefore, the term insurance is likely more appropriate than permanent life insurance, such as the whole life policy.
There is one circumstance in the present case that may create a need for permanent life insurance-- your spouse may need ongoing funds past retirement given the she is disabled. You may need some permanent life insurance if your retirement and other assets would not support your wife if you passed post-retirement age. In this case, a guaranteed universal life policy will likely be much less expensive than the current whole life contract.
Second, it's advisable to determine the true cost of borrowing from the life insurance policy. I spoke with my fee-only insurance consultant, and we discussed that many agents imply that borrowing from a life insurance policy is a free loan. The reality is this is not a free loan and will jeopardize the coverage if not paid back in most scenarios. It's best to request an in-force illustration showing the loan you wish to take along with the payments the insured plans on making. This will allow you to see how the loan will affect the overall policy performance. In most cases, the loan would likely not be paid back and would cause the policy to lapse over time, eliminating the coverage and possibly creating a taxable event.
Overall, the idea of replacing the whole life policy with term insurance and using the proceeds to pay off credit card debt is sound. It is suggested that you understand the cost basis of the whole life policy to determine if any taxes will be due. Also, you will want to see if there are any surrender charges that may exist. You should not cancel the existing whole life policy until the replacement term coverage is in force.