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Surrendering Life Insurance Policy - Tax Question

764 Views | 5 Replies | Last: 4 yr ago by gigemhilo
jellycheese
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11:20a, 4/3/20
AG
My wife's grandmother prepaid a life insurance policy for my wife for $50k when she was a kid. Gma is long gone and we're wanting to surrender the policy for the current cash value of about $10k. When talking with the rep for the company, she said we will owe taxes of almost $4,000 on that money.

Can someone explain why the rate is so high? Would this change anyone's mind about moving to a 20 year term policy for around $1mil at $25/month?
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Stive
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In reply to jellycheese • 11:45a, 4/3/20
AG
jellycheese said:
My wife's grandmother prepaid a life insurance policy for my wife for $50k when she was a kid. Gma is long gone and we're wanting to surrender the policy for the current cash value of about $10k. When talking with the rep for the company, she said we will owe taxes of almost $4,000 on that money.

Can someone explain why the rate is so high? Would this change anyone's mind about moving to a 20 year term policy for around $1mil at $25/month?
Guessing you misunderstood and that you'll owe taxes ON $4,000, not taxes OF $4,000. My guess is she paid in 6k over the lifetime of the policy, and the cash value is now 10k. The growth on the cash value is taxed at your income tax rate if the policy is surrendered.

(disclaimer....that is just my opinion based on the information you shared in your OP. If additional information is provided, it might change my answer)


And no, that information shared wouldn't change my mind if my assumption is correct.
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jellycheese
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11:57a, 4/3/20
AG
That sounds way better than my original understanding. Pretty sure she said to set aside the $4k for taxes but I may very well have misunderstood.

That said, she didn't sound like an expert and could have been mistaken herself. Thanks for the response.
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Old RV Ag
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In reply to jellycheese • 12:32p, 4/3/20
AG
jellycheese said:
My wife's grandmother prepaid a life insurance policy for my wife for $50k when she was a kid. Gma is long gone and we're wanting to surrender the policy for the current cash value of about $10k. When talking with the rep for the company, she said we will owe taxes of almost $4,000 on that money.

Can someone explain why the rate is so high? Would this change anyone's mind about moving to a 20 year term policy for around $1mil at $25/month?
Before you cash it out, you should look at annual cash value increase versus premium paid. Cash value insurance makes most sense on kids as premiums are low. Based on your wife's age, you may be hitting the sweet spot where cash value increase are more than premiums and will grow to 3-10x premiums. I took a policy out on one of my sons (as he was in a category where he might not be able to get insurance as an adult) and he's kept it - he's mid 40's and gets close to 10x cash value increase each year versus premium. Paid up insurance is also 6x original value insurance value.

Your term insurance looks good and likely should be decided independtly of whether you cash out the other policy or not.
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Stive
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In reply to jellycheese • 12:32p, 4/3/20
AG
If she really meant that number and was trying to guess your tax bracket that's pretty bold but whatever.

One unfortunate possibility is if there has been cash value used in the past by grandma or along the way to pay for premiums, it's possible that the 4k number is accurate.

As a hypothetical: she contributed 10k to the policy over the years, it grew to 26k but she (or you guys) used 16k throughout the years for other reasons (cash needs, pay the policy premiums, etc). If that's the case, the growth would be 16k and you'd owe taxes on that 16 but you'd only be cashing out 10k (the amount that's left over).

I've seen that before and it can be REALLY bad for a client. But once again, if the numbers in the OP are accurate I'm betting it's owing taxes on the 4K.
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CS78
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8:05a, 4/4/20
Not an insurance guy but add the 1 mil at $25 a month either way.
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gigemhilo
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In reply to Stive • 8:22a, 4/4/20
AG
Stive said:
If she really meant that number and was trying to guess your tax bracket that's pretty bold but whatever.

One unfortunate possibility is if there has been cash value used in the past by grandma or along the way to pay for premiums, it's possible that the 4k number is accurate.

As a hypothetical: she contributed 10k to the policy over the years, it grew to 26k but she (or you guys) used 16k throughout the years for other reasons (cash needs, pay the policy premiums, etc). If that's the case, the growth would be 16k and you'd owe taxes on that 16 but you'd only be cashing out 10k (the amount that's left over).

I've seen that before and it can be REALLY bad for a client. But once again, if the numbers in the OP are accurate I'm betting it's owing taxes on the 4K.
A 40% tax bracket is pretty high... MAYBE if they lived in New Jersey or something...
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