Thursday, August 07, 2014

Messy Client Trick

Have you reviewed you own life insurance coverage lately? Do you know who owns it? Who's the beneficiary? Who can tap the cash value?

Here's a story about the dangers of assuming:

One of our agency's clients - we'll call him Steve - called the other day looking to withdraw some cash from his life insurance policy. The good news is that there's plenty of it available. The bad news is: it's not available to him.


Turns out, the policy is owned by his father's (former) company; Dad bought coverage on Steve, paid for it, and named himself and Steve's wife as the primary beneficiaries.

There are, in fact, several messes in play here:

First, since Dad owns the policy, only he can access the cash values. And, only he can change the beneficiary. And why would he want to do that? Because, as it stands now, if (when?) Steve dies, the insurance company is going to cut one check, payable to both Dad and Wife, and they can try to figure it out from there.

So, no worries, we transfer the ownership from Dad to Steve. No harm, no foul, and Steve can then tap the cash and make his wife the sole beneficiary.

Wait - did I say "no harm, no foul?"


Here's the harm and the foul:

Dad owned and paid the premiums on the policy for 20+ years. When he signs over ownership to his son, all that sweet, sweet cash value money is taxable.

Whoa there, Henry: I learned in Insurance 101 that only the gain (or profit) in the cash value is taxable. What gives?

Ah, padawan, that is only a part of the story: you are quite correct, if you're talking about Dad cashing in the policy. But he's not: he's transferring ownership to Steve, and thus the entire cash value (equity, if you will) is taxable to Steve.

Now, is this a big deal? Maybe not: we're talking $15,000 here, not $150,00. But still, this needs to be considered.

Now, I had started to propose this alternative:

Why not have Dad withdraw $10,000 from the policy and gift that to Steve, leaving just the remaining $5,000? That way, he's cut his tax liability by two thirds.

NB: I am NOT an accountant (nor do I play one on TV, nor did I stay in a Holiday Inn Express last night).

Anyway, most of this mess might have been avoided had Steve asked some questions after his father retired and ostensibly left him the policy, and addressed these issues then.

So, have you checked your policy lately?
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