Author Topic: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?  (Read 4570 times)

AppleDapples

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Hi All,

I have a very confusing situation involving a life insurance policy and any advice is GREATLY appreciated.

My father set up a 'last to die' $125K life insurance policy that covered both him and my mother - with me as the sole beneficiary.  He opened the policy in 1994 and it has a fixed premium of $70/month.  He passed away last year and had written me a letter advising that upon his death I should take over the payments on the premium and consider it an investment until my mother passes.  I'm 28 years old and my mother is 66. In his mind, the amount that I personally paid into it would be much less than the eventual payout.

To make things complicated, my mother borrowed against the accumulated cash value of the policy (without him knowing because she does that kind of stuff) and that loan against the policy has been accruing interest at 8%.  So now the loan against the policy is slightly over $10,000 and the current death benefit is $115K. 

The policy is now in my name, and I am the "owner". The question at hand is three fold: I could close the policy and take and reinvest the remaining accrued cash value ($6000 before taxes). I could continue paying the premium ($70/month) and allow the loan to keep eating away at the final death benefit (my crude estimate says that in 20 years the policy will be worth less than $80K), or I could pay off the loan amount of $10,000 and pay the monthly premium and allow the policy to pay out the full $125K upon my mother's death.  (There's also some weird thing where I can start using the accrued cash value to pay the premium).  The money that I would use to pay off the loan is basically my entire savings but I do have a full time job at the moment.

I talked to my accountant about it and he didn't really have much to say except that with life insurance policies there is no way to really evaluate the investment because of the major variable that you don't know how long you'll be paying into it and who knows if i'll even live longer than my mom anyway. I'm looking at this life insurance policy as an investment rather than in the traditional sense. She earns no wages and lives off of social security (also she's a hoarder and her house is a freaking disaster). I've been financially independent from my parents since I was about 12.  I have no credit card debt and no car loans.  I do have $15K in student loans that i've been paying consistently and i just opened a 401K at my job last month.  I've basically been tormenting myself this past year trying to figure out what the smart and responsible thing to do is. 

These types of policies are complicated and not very transparent. I've been studying it and trying to understand the details. I know that each year the premium and interest earned by the policy go into the accumulated cash value. There is also a mysterious "cost of insurance" that goes up every year but that seems to be balanced by the interest that is being earned.  My gut instinct is to pay the loan and the premium, rebuild my savings and allow the policy to deliver as my father intended when it set it up in 1994.

Thank you so much for any insight you may have.
   
« Last Edit: October 02, 2013, 03:52:47 PM by HeyAli »

lackofstache

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #1 on: October 02, 2013, 11:45:29 AM »
It sounds like you want to keep it. If you're going to keep it, you may want to see if you can pay back part of the loan w/ the $6K in cash value. It's usually called a partial cash surrender. You may not be able to take the full amount w/o closing the policy.  If you have to pay $4K + $840/yr for 34 years, you'd have spent ~$29K for the ~$100K.

Usually permanent insurance isn't an ideal investment, but since you're already 20 years into it before you start paying, it's not a bad deal, really. I would figure out if there's a way you can stop your mother from taking another loan w/o you knowing (as she already has). If you can't be sure she won't do more damage to the policy, it may be best to let it go.

One aspect of this you didn't ask about, but one that I would keep in mind is this:  The cash value goes away (back to the insurance company) upon death. If you're looking at the death benefit as the gain on your investment, there is absolutely no reason not to use the cash value before your mother passes, if you don't, it's gone. This is usually a missed part of the sale of life insurance. People see building cash value plus death benefit on paper, but in reality, if the cash value isn't cashed the policy is only good for the death benefit.

AppleDapples

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #2 on: October 02, 2013, 11:58:43 AM »
Thanks for the comment. 

I did have to ownwership of the policy changed to my name. That way I have to approve any loans or cancellations.

I was under the impression that the accumulated cash value is really only useful if you want to borrow it against the final death benefit (which my mother did) or if you cancel the policy you can receive that amount which is basically what my father paid into it over the years.  Otherwise it just sits there and gains interest to cover the mysterious "cost of insurance" I mentioned. And yes, upon death it goes away as you said.

unpolloloco

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #3 on: October 02, 2013, 12:21:06 PM »
Sounds like you should ignore any emotional ideas and run a few scenarios:
-80k benefit on death for $840/year.  That sounds pretty great actually.  Unlikely she'll live another 80 years, so it's probably a good investment.
-Payoff 10k and pay $840/year for 125k benefit in x years.  Not a bad deal really, but not worth sacrificing any security over either (you probably won't beat the return in the market, but it's not that significant of a cost either compared to what you could do elsewhere - and you tie up liquidity for an unknown amount of time with this option.
-Payoff 6k now - compared to the other options, this seems like it should be used as a last resort.

rubybeth

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #4 on: October 02, 2013, 12:33:57 PM »
I think my MIL has a policy like this; it's now in DH's name for pretty eerily similar reasons to your scenario above. I feel for you. I hate "whole life" policies like this, but we're keeping it because I think it's only $70/year for some burial funds when she dies. *shrug*

Question: can you take the $6k cash value out and invest it elsewhere right now? What would that do to the death benefit?

I wouldn't spend a dime paying off the loan for her. I'd just let the death benefit be what it will be with the loan never paid, and if you can, milk it for any additional funds that you can also invest now (like putting up to $5,500 in your IRA this year).

MrsPete

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #5 on: October 02, 2013, 12:48:47 PM »
This is complicated. 

First, you're the only child?  You stand to get the entire life insurance policy? 

Second, sorry to be blunt, but how's her health?  66 isn't really all that old.  Lots of women live well into their 80s.  You're looking at paying $840/year, and you can't "do the math" and see how many years you'll be paying that cost. 

Related topic:  Is your ability to pay this $840/year likely to remain stable?  The real mistake would be paying it for ten years, then stopping. 

I'm concerned about the hoarding behavior and her choices to take out loans.  You're one day going to end up being the executor of her estate.  I don't think that would mean they could touch your life insurance benefit, but I'd want to know that for certain. 

Absolutely do not pay off her loan. 
Absolutely do not mingle your money with hers. 

My general feeling:  Without emotion, if you think your mom is likely to live 20 years or less, keep paying the life insurance.  That means you'd be paying in $16,800, and the return would be worthwhile.  On the other hand, if you feel she'll live more than 20 years, don't enter into the deal and drop the insurance. 

But it is a big guess. 

AppleDapples

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #6 on: October 02, 2013, 01:25:38 PM »

@rubybeth - If i took the $6K cash value out, it would be a loan against the $125K charged at 8%. So it wouldn't make much sense to try and invest that somewhere else.   If I just closed the policy all together I would get that $6K but i'd actually have to pay taxes on the full sum (the $10K loan and the $6K remaining value is reported to the IRS as distribution even though I only get $6K).

I am an only child and the sole beneficiary and am now listed as the owner of the policy.

@MrsPete - She is in good health.  She hasn't had any major medical issues but is a rather irresponsible adult in many ways. She has no health insurance, drives without car insurance, doesn't pay her bills on time - that sort of thing.  We don't have the best relationship but I am an only child and no one in our family speaks with her so if she were to get ill, i'd probably be the only person willing to take care of her.  So, there's that.

Numbers Man

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #7 on: October 02, 2013, 02:06:19 PM »
I would keep the policy alive unless you can find a better deal for term life.

Kipp

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #8 on: October 02, 2013, 02:19:22 PM »

@rubybeth - If i took the $6K cash value out, it would be a loan against the $125K charged at 8%. So it wouldn't make much sense to try and invest that somewhere else.   If I just closed the policy all together I would get that $6K but i'd actually have to pay taxes on the full sum (the $10K loan and the $6K remaining value is reported to the IRS as distribution even though I only get $6K).


Only the interest on a whole life policy should be taxable as all contributions are with after tax dollars.  If they are saying the total value is $16,000 (including the 10k loan) for 20 years of $840 contributions, you currently have a negative $800 return.  There should be no taxable interest in this scenario.

AppleDapples

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #9 on: October 02, 2013, 02:32:47 PM »

Here are the actual numbers if that helps make sense of it:

Value Accumulation as of 2012: $16,291.6 1
Amounts Added to Account
From Premium: $671.25  (I dont know why this is actually less than what was paid)
From Interest: $954.70
Amounts Deducted from Account
Cost of Insurance $495.11

Value Accumulation as of 2013: 17,422.45
Current outstanding loan balance:  $10,411.26
Surrender Charge $60
Net Cash Surrender Value $6,951.19
This years net interest rate: 5.80%
Next years projected net interest rate: 5.83%
Next years projected cost of insurance: $567.32

Kipp

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #10 on: October 02, 2013, 02:38:13 PM »
They probably base their prices on paying an entire year instead of monthly.  That may be why there is some difference in the premium compared to the monthly total of $840.  If you are interested in keeping to policy, see if they will allow you to switch to the annual premium which should be the amount they gave you there.

AppleDapples

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #11 on: October 02, 2013, 03:16:07 PM »

@Kipp - Yes, i believe that is correct.


MMM says that markets earn historically 7-8% annually after inflation. If I pay the $10K loan and stop the 8% compounding interest, i'm sort of earning that 8% rather than losing it.  So in that sense, could you say it's kind of like investing that $10K? Or is that totally wrong?  Given, i wouldn't see a return for 20-30 years (which sort of makes it like a 401k).  It does sound crude but i can't imagine her living past 96.  So, if i pay the $10K loan now and $840 for 30 years that is a total of  $35,200 and i'd be getting the full benefit of $125K.  In the same 30 year scenario, if i don't pay the loan, the death benefit would be down to $20,235 because of the compounding 8% interest on the loan and I would have paid $27K in premiums meaning i'm $7K in the hole after 30 years.

Another thing to keep in mind is that if i paid this loan off it goes back into the "accumulated cash value". So, in theory if I had some kind of emergency and had to have some cash, I could cancel the policy at a later date and get the surrender value.  Or borrow it again at the same 8%.  Or I could be completely misunderstanding the whole situation but i think that's how it works.

This is making my brain turn to mush. A Money Mustache Mush Mind.

Catbert

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #12 on: October 02, 2013, 03:45:33 PM »
Who actually "owns" the policy now, you or your mother?  If it's her (and I'd guess that it is even if you're paying the premium) there's probably nothing to keep her from borrowing more money  out the policy.  If that's the case I'd pass on paying the premiums and let it lapse.

AppleDapples

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #13 on: October 02, 2013, 03:47:35 PM »
@Maryw - I am the owner of the policy.

Bruinguy

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Re: Messy, Confusing Life Insurance Policy on my Mother - Reader Case Study?
« Reply #14 on: October 02, 2013, 04:00:27 PM »
MMM says that markets earn historically 7-8% annually after inflation. If I pay the $10K loan and stop the 8% compounding interest, i'm sort of earning that 8% rather than losing it.  So in that sense, could you say it's kind of like investing that $10K? Or is that totally wrong?  Given, i wouldn't see a return for 20-30 years (which sort of makes it like a 401k).  It does sound crude but i can't imagine her living past 96.  So, if i pay the $10K loan now and $840 for 30 years that is a total of  $35,200 and i'd be getting the full benefit of $125K.  In the same 30 year scenario, if i don't pay the loan, the death benefit would be down to $20,235 because of the compounding 8% interest on the loan and I would have paid $27K in premiums meaning i'm $7K in the hole after 30 years.

This is how I was thinking about it.  You also should consider the return that you could have received on the annual payments as well, so there is some compound interest to consider too.  I see your opportunity cost as paying $10,000 + 840 in year 1 and then 840 in each subsequent year in order to have the right to receive $125,000 somewhere down the line. 

If my quick calculation is correct, you would receive a 10-11% return on your investment, assuming that payout occured in year 20.  If payout was in year 25, I calculate an 8% return.  In year 15, it would be 16%.

If you commit to keeping the policy, then you have just taken out a $10,000 loan.  I think you approach paying that off the same way you would if you had $10,000 of credit card debt.