Using whole life insurance for tax-free income in retirement
Borrowing against a policy’s cash value can provide tax-free income. But there are still costs involved and other factors for retirees to consider.
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Borrowing against a policy’s cash value can provide tax-free income. But there are still costs involved and other factors for retirees to consider.
I am retired from my company, where I am the sole owner. Thirty years ago, the company bought a whole life insurance policy with the expectation of an annual tax-free dividend. However, it appears to be very difficult to now obtain such supplementary income because most financial institutions will not offer loans against a life insurance policy. When I ask the agent about this, he is not helpful and discourages any talk about cashing out the policy. I have not spoken to him in years, but he is probably the primary person currently benefiting from this life insurance policy. The current cash value is around $100,000 and a death benefit of $136,200. (I cashed out a portion of it a few years ago and paid a significant amount of tax.)
I don’t want to leave this insurance to my benefactors and would rather cash out (taxable) or gain some annual income from the policy. The whole life is not as it was originally sold, which at the time offered supplementary retirement income. I would appreciate any advice.
—Alan
Alan, I suspect there are a lot of whole life policies sold 30 years ago that have not performed as originally suggested. Times were different back then. I will elaborate on that further down. First, I want to clear up a couple of misconceptions expressed around bank lending and your agent benefiting more than you from the policy.
Your agent earned a commission when he first sold you the policy 30 years ago. Using today’s pricing as an example, a 35-year-old male purchasing a $100,000 whole life policy will have a premium payment of about $143 per month. The agent will earn about $2,401 in the first year, $86 per year for the next two years, and then $34 per year until the policy is no longer in force. At $34 per year in commissions, your agent is not benefiting in the way you may suspect.
What may surprise you is that if you transfer your policy to another agent to help you, the original selling agent continues to earn $34 every year, and your new agent earns nothing. To be fair, the new agent can go to the original agent and ask them to “please sign over the future commissions.” This doesn’t often happen, though.
When policy holders, like yourself, don’t feel they have received the help they need from an agent or insurance company call centre, they can sometimes take matters into their own hands and do as you are thinking: cash out by surrendering or cancelling the policy. This is referred to as a policy lapse, which is good for the insurance companies and existing policy holders. The insurance companies benefit because they don’t have to pay out the larger death benefit, and some of those savings are reflected in the dividend scale (or returns) on existing policies.
You may hear an agent talk about a company’s dividend scale as a rate of return and assume it refers to your policy’s growth rate, like with investments. However, that is not how it works. On Sun Life’s website, for example, the company says: “The dividend scale interest rate isn’t the return that a client can expect from their policy.” It goes on to say the growth rate is influenced by a number of different factors, including the number of premiums paid to the policy and the insured person’s age and risk characteristics.
Alan, when your policy was designed, interest rates were higher, and the business environment was different than it is today. I suspect if things remained exactly as they were 30 years ago when you purchased the policy, it would be performing close to what the agent suggested. Times changed and the policy has been affected. I could say the same thing about other investments and tax strategies. This is why it’s important to incorporate different and flexible strategies, including life insurance strategies, into your long-term plans.
I don’t understand why you’re finding it hard to borrow against the policy, because banks and other third-party lenders do lend against the cash value of an insurance policy. Just like with any other loan, you must qualify, and banks often like to see that you have an income. As a retired corporate business owner, do you have an income or only investments? Is it possible you’re having difficulty getting a loan because you’re not showing an income?
You can get tax-free income by borrowing against the policy using a third party for the loan. Although tax-free sounds good, tax is just one type of cost. Instead of thinking tax-free, think cost-free. You will realize that borrowing against a policy for income is not cost-free. Cumulative interest costs on the loan negatively impact the insurance death benefit, the most valuable part of a life insurance policy.
So if you do not want anyone or a charity to receive the death benefit, I can understand why you’re not sure what to do with the policy. My suggestion is to ask your agent to create a proper plan showing you how your policy fits into your future. As you are doing the planning work, see what happens if:
Knowing you have a tax-free death benefit as a backstop, would you have more freedom to spend more, borrow from your home equity or ease worries about long-term care costs, knowing the money will someday be replaced? Your answer will help you make planning decisions.
Alan, life insurance is an interesting financial product that provides some guarantees, tax advantages and options. But, before cancelling your policy, it’s worth talking to a planner to see what you can do with it, especially after paying all these years and getting it at low cost because the policy was purchased when you were young.
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If I’m not mistaken, Manulife bank will let you use the policy as collateral without a credit check or proof of income.
One thing to note, most insurance salespeople in the Life side are not financially educated. Don’t take advice from a “financial advisor”, as they call themselves, because most can’t see past the little calculation window in their could-be-done-by-a-spreadsheet software.
I purchased a similar policy in 1985 when I was 25. Policy value is $111K. Premiums are $35 monthly. Policy was supposed to go on premium offser after 13 years. I’m still paying.
Every time I speak with the broker about going to premium offset, he recommends against it. Seems to me I should now be able to make that choice. I will be 65 next year and will ha e paid Premiums for 40 year.
Any advice? Thank you.