A nearly $5,000 invoice from a life insurance company sits on my desk. But I haven’t paid it yet. Because I’m considering cancelling the policy. Which is a good thing to ponder.
Life insurance policies, often bought and then renewed on the basis of emotion, can become a fantastic waste of money.
But cancelling life insurance gets tricky.
Why Life Insurance Makes Sense
Let me start out by stipulating that life insurance makes total sense for lots of people.
My own story? I bought my policy, a cheap $1,000,000 of term life insurance, decades ago. My wife had stopped working to raise our two daughters. I continued working as a writer and CPA. Our little family depended on my income.
Buying that $1,000,000 of life insurance made good sense, therefore. Essentially, the life insurance replaced enough years of my earnings that my wife wouldn’t need to rush back into a career if I died.
I then basically forgot about the policy, keeping it in force for roughly the next 30 years.
In a few weeks, however, I turn 60. And reflecting that milestone, the premium jumps substantially this next year. I’m looking at close to a $5,000 annual payment. Ouch.
According, the rumination about cancelling life insurance.
I’ll tell you at the end of the blog post what I’ve decided to do. But let me share with you the factors I considered and which you may want to consider if you’re faced with a similar choice.
Do People Depend on My Earnings?
For example, here’s the first thing I considered: Do people still depend on my earnings?
In other words, if I die, does the absence of my earnings create a hardship for someone else. Like my kids. Or my surviving spouse. Or someone else I’m financially responsible for.
By the way, I don’t think we ask whether someone would live at higher spending level with a “extra” million dollars. That question would always be answered yes.
What I think we consider is whether anybody for whom you’re or I’m responsible truly depends on us working.
My conclusion? I don’t think anybody does.
My kids? All grown and taking care of themselves.
My spouse? Well, we’ve been common-sensed about saving for retirement. (It’s like a law that accountants must do this.) She’ll be fine with the IRA and 401(k) balances we’ve stashed away over the decades. She’s also a few months away from qualifying for retirement benefits.
Will Heirs or Estate Confront Liquidity Issues?
But I don’t think people depending on my or your earnings is the only factor we want to ponder.
For example, another issue? Will your or my estate confront liquidity issues.
In other words, will our passing either trigger expenses (like estate tax) or accelerate payments (like a loan guarantee) that burden heirs?
Consider for example the prospect of estate taxes…
Now most people don’t need to worry about federal estate taxes. In 2019, an estate faces federal estate taxes only when the estate’s value exceeds $11,400,000. Few folks need to worry about that.
But some states levy taxes at lower levels. Washington state, for example, hits estates just over $2 million with hefty estate taxes that run 10 percent to 20 percent.
Note: In Washington State, special provisions ease the estate tax burden in the case of some illiquid assets like farms and small businesses. But I think the provisions don’t really work in every situation.
And then the issue about whether someone’s passing accelerates expenses…
In recent years in my own situation, I was the primary guarantor of some commercial real estate lease obligations. Especially at the start of the lease terms, I was alert to the risk that my death might pressure my estate to quickly pay down that business debt.
In any case, we want to consider these issues. Liquidity concerns may impact your or my need for life insurance. Even if we’re financially independent.
By the way, in my own case, those contingent liabilities have shrunk over time. I don’t need to worry about them any more.
Are There Contractual Commitments Related to Cancelling Life Insurance?
A quick, final, related point: Do you or I have a contractual commitment to insure our lives?
For example, do you or do I need to maintain key man life insurance as part of a business partnership or some investment venture?
Maybe a related point: If a business owner’s untimely death would cause catastrophic problems, will life insurance mitigate a business risk the firm wants to avoid? And if that’s the case, should the business itself start buying key man life insurance?
In my case, I didn’t have any thing like this playing into my decision. But quite honestly? I’ve seen client situations where key man life insurance makes all the difference to a business, the surviving owners and the firm’s employees.
Tip: If a business depends on a principal, the firm would typically pay for the life insurance policy. Note that key man life insurance policy premiums don’t count as tax deductions.
My Own Decision about Cancelling Life Insurance
In case you’re interested? After thinking about these issues and conferring with my wife, I cancelled my life insurance.
Term life insurance isn’t usually a product older, financially independent folks need.
And continuing to insure against risks that don’t matter much makes zero sense.
One last note: No, I shouldn’t have purchased whole-life or cash-value insurance to “keep” insurance in the future. The point really is, I just don’t need life insurance anymore…
Good points with only the whole life needing comment. Life insurance is a risk-management tool, NOT an investment. Anytime there is an article about life insurance that starts with what a lousy investment whole life is, stop reading, the writer does not know anything. Whole life is a different way of paying for this risk management. From a quality company, in the long run it is cheaper and more flexible, and only once the insurance needs have passed can one consider it as an investment (again, not to buy as an investment, only whether to keep it). My children are adults, no one needs my income after me, it now provides a nice tax-free income, it leaves a legacy to my heirs. While the income is tax-free, if I was to surrender it I would have a taxable gain. For many policies, the cost of whole life will be cheaper than term after only 3-5 years. In any discussion about term vs whole life, we talk about pure term vs pure whole-life, not the variations the insurance companies have come up with to sell more policies (such as 15 year level term or universal life). In any discussion with buying or keeping insurance, one has to start with what risk is being insured and then to decide how to pay for that. I am a CPA and do not sell or benefit in any manner if my clients buy or don’t buy insurance. But I do see many insurance agents who know less than I do about insurance and push a product that benefits the agent.
It seems to me that the fundamental problem with something like whole life insurance and similar hybrid products is they become too complicated for both buyers and sellers to understand.
I also wonder if these products are largely out-of-date now that (1) the big financial services companies offer super-low-cost index funds and (2) other better tax-deferred investment options are available. (I’m currently working as executor for a family member who had cash-value life insurance as one of his investment options. Very sophisticated guy. So his choice surprised me for a minute. Then I realized it was really the only tax-deferred investing option available to him when he started investing fifty years ago.)
In any case, I would suggest that if someone does want to buy this product, they should look at the alternative which bundles a cheap term policy for the insurance (though only as long as someone needs insurance) and then a cheap index fund or collection of index funds that match the asset allocation of the investment component of the product.
Rather than paying $1,000 a year for term insurance from the AICPA and making a $9,000 contribution to my SEP-IRA for 30 years, I could have just paid $10,000 a year for a whole life policy.
Once one re-frames the choice this way–which requires something like Microsoft Excel so you can use the financial functions–someone can pretty easily determine which choice is better.
BTW, it would be pretty easy to use Excel and the AICPA’s schedule of insurance policy amounts by age to see what someone pays for $1,000,000 of term life insurance for 30 years and what amount they could then have leftover for saving into their IRA, 401(k), etc.
I would be surprised if the whole life insurance option compares favorably when someone makes this comparison.
My point is that insurance is a risk-management tool, period. Then we consider how to pay for it. If cash is not the concern (which it is for many), then the economics of whole-life are more favorable over term, and that the break-even for WL over term is less years than what one would think. I have never advocated buying it as an investment. I advocate that once the insurance need is no longer a factor, only then should one factor investment concerns.
The problem with buying term and investing the difference, which is basically what is mentioned, is that no one ever does it. Good in theory, but when we advise clients, we must advise for each one realistically. Doesn’t mean clients will follow it, especially when they are overwhelmed by uninformed, well-intentioned or self-interested, contrary information. (Think about paying for college: Lots of bad advice, I have seen only one method that works, and I can’t convince anyone to do it.)
Hmmm. I would say that if a hybrid product bundles insurance and investment, it’s no longer just insurance or just investment… but both. And then I’d want to verify that the vendor doing the bundle isn’t charging too much for the “convenience” of the bundle.
I will also say that whenever some client asks me to look closely at the economics of a real-life whole-life policy, wow, the numbers don’t look pretty. It sounds like your experiences differ from mine… but what I see are expensive investments and/or expensive insurance premiums.
BTW, the point about people not successfully buying term and investing the difference seems good. But seems like someone should also take note of fact that people regularly abandon their whole-life policies early on. Which I think destroys the investment returns or means that someone massively overpays for their insurance.
I cancelled my life insurance policy after I was financially independent. I just didn’t need it anymore. If I still had it today, and I died, the insurance policy would provide 15% of my net worth. Wouldn’t make a big difference. At some point the “term” that you need life insurance ends and you no longer need it. It is not the lottery for your kids, it is to protect them from catastrophic loss if I had died before I was financially independent. Love you points and will ad this article to my Fawcett’s Favorites next Monday.
Dr. Cory S. Fawcett
Prescription for Financial Success
Thanks Cory!