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Universal life insurance. Loan VS. withdrawal

Tim Lumbao

Expert
29
I got a client who have 53k cash value and 220kdeathbenefit on his UL insurance. He is single and doesn’t have a family except a brother who is single too. Base on his finances he doesn’t need a life insurance for 220k, but he wants to pay his debt around 30k. He wants to use his cash value to do it. What are the pros, coms and tax consequences for withdrawing or loaning?. Can we loan it, then let it lapse by itself so we don’t have to pay taxes? What’s the best move? Thanks
 
I got a client who have 53k cash value and 220kdeathbenefit on his UL insurance. He is single and doesn’t have a family except a brother who is single too. Base on his finances he doesn’t need a life insurance for 220k, but he wants to pay his debt around 30k. He wants to use his cash value to do it. What are the pros, coms and tax consequences for withdrawing or loaning?. Can we loan it, then let it lapse by itself so we don’t have to pay taxes? What’s the best move? Thanks

Im sorry for saying this up front, but why are you out there selling this product if you dont know the answers to those questions?

You are creating a HUGE potential liability for yourself in doing so. Especially if you are not telling the client about some of the tax issues on the front end.

It also creates unnecessary liability for the client because they are not being fully informed about the product they bought. Not fair to them.

You are dealing with large amounts of money. You better know the details before you sell the policy... or you are going to have a career ending situation at some point due to litigation.

I get that an IMO might have suggested it. But they are not looking out for your best interest. Only you can do that. Be sure to be fully informed, especially about taxation, with the products you sell.

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Life insurance is not something you just accumulate in for a few years and cash out. That is literally the exact opposite of its purpose when focusing on CV.

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If it lapses, he will be taxed on the entire amount over basis. It will be considered earned income.

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A withdrawal will just take the money out like it was never there. It cant be put back and he will never have that equity in the policy again.

A Loan can be paid back to get the policy back to where it was before.

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He likely has 2 different loan options, but he might not have them at this point in the policy. Many have a wash loan option and a participating loan option. One washes out to a zero rate. Other gets charged a floating rate but still participates in index gains.

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If this is his only insurance he would be a fool to let it lapse most likely. Is this person still young? They are single now, but will they be for the rest of their life? Will they not ever take on more debt in their life? I would not be so quick to discount the need for DB, despite being single.

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Why did he buy the policy? If it was for tax advantaged growth, why on earth would he let it lapse??
 
Can we loan it, then let it lapse by itself so we don’t have to pay taxes?

Deal with it straight up, do not loan then lapse as that can have the same or even worse tax consequences because the loan will compound & will count in the taxation math.

You need more info:

1. What is the current cost basis in the policy?
2. What is the current taxable gain if surrendered?
3. Is there currently a loan balance on the policy?
4. Is he still in the surrender charge period?
5. Is the policy considered modified endowment contract (MEC).....IE-- premiums were paid too quick into policy & exceeded the IRS levels for best status of life insurance beneficial tax treatment

Once you know this info, it can be figured out how to best proceed.

If the policy is a non-MEC & out of Surrender charge, it is possible the best solution will be to take a withdrawal of the cost basis tax free to lag his debts. Then, the taxable gain still in the policy could be left in the policy & then 1035 exchanged tax free to either a single premium life policy or a non qualified annuity.
 
Im sorry for saying this up front, but why are you out there selling this product if you dont know the answers to those questions?

You are creating a HUGE potential liability for yourself in doing so. Especially if you are not telling the client about some of the tax issues on the front end.

It also creates unnecessary liability for the client because they are not being fully informed about the product they bought. Not fair to them.

You are dealing with large amounts of money. You better know the details before you sell the policy... or you are going to have a career ending situation at some point due to litigation.

I get that an IMO might have suggested it. But they are not looking out for your best interest. Only you can do that. Be sure to be fully informed, especially about taxation, with the products you sell.

---

Life insurance is not something you just accumulate in for a few years and cash out. That is literally the exact opposite of its purpose when focusing on CV.

---

If it lapses, he will be taxed on the entire amount over basis. It will be considered earned income.

---

A withdrawal will just take the money out like it was never there. It cant be put back and he will never have that equity in the policy again.

A Loan can be paid back to get the policy back to where it was before.

---

He likely has 2 different loan options, but he might not have them at this point in the policy. Many have a wash loan option and a participating loan option. One washes out to a zero rate. Other gets charged a floating rate but still participates in index gains.

----

If this is his only insurance he would be a fool to let it lapse most likely. Is this person still young? They are single now, but will they be for the rest of their life? Will they not ever take on more debt in their life? I would not be so quick to discount the need for DB, despite being single.

---

Why did he buy the policy? If it was for tax advantaged growth, why on earth would he let it lapse??
This person is 63yold just recently retired and doesn’t have anyone than his brother who doesn’t need anymore money and no children based on what he told me. I’m not selling him anything as, we are just trying to find what’s the best option for his cash value vs debt.
 
Deal with it straight up, do not loan then lapse as that can have the same or even worse tax consequences because the loan will compound & will count in the taxation math.

You need more info:

1. What is the current cost basis in the policy?
2. What is the current taxable gain if surrendered?
3. Is there currently a loan balance on the policy?
4. Is he still in the surrender charge period?
5. Is the policy considered modified endowment contract (MEC).....IE-- premiums were paid too quick into policy & exceeded the IRS levels for best status of life insurance beneficial tax treatment

Once you know this info, it can be figured out how to best proceed.

If the policy is a non-MEC & out of Surrender charge, it is possible the best solution will be to take a withdrawal of the cost basis tax free to lag his debts. Then, the taxable gain still in the policy could be left in the policy & then 1035 exchanged tax free to either a single premium life policy or a non qualified annuity.
1. What is the current cost basis in the policy? I don’t know. Dumb it down for me please
2. What is the current taxable gain if surrendered? 12%
3. Is there currently a loan balance on the policy? None
4. Is he still in the surrender charge period? no
5. Is the policy considered modified endowment contract (MEC).....IE-- premiums were paid too quick into policy & exceeded the IRS levels for best status of life insurance beneficial tax treatment: No
 
1. What is the current cost basis in the policy? I don’t know. Dumb it down for me please
2. What is the current taxable gain if surrendered? 12%
3. Is there currently a loan balance on the policy? None
4. Is he still in the surrender charge period? no
5. Is the policy considered modified endowment contract (MEC).....IE-- premiums were paid too quick into policy & exceeded the IRS levels for best status of life insurance beneficial tax treatment: No

You have to call the carrier or look on the carrier systems to get the policy tax information about the cost basis & the taxable gain.

Those are the 2 items required to figure out tax ramifications.

Cost basis is his investment into the policy (IE- in most cases the total of all his premiums paid)

The taxable gain is not 12%. That will be the total cash value minus the cost basis.

Basically, has he made it lost money in total

If not a MEC, he gets to pull out his cost basis first as a tax free return of premium-cost basis
 
This person is 63yold just recently retired and doesn’t have anyone than his brother who doesn’t need anymore money and no children based on what he told me. I’m not selling him anything as, we are just trying to find what’s the best option for his cash value vs debt.

Still, why did he buy the policy in the first place?

If it was for tax advantaged growth, why would he want to surrender the whole thing?
 
You have to call the carrier or look on the carrier systems to get the policy tax information about the cost basis & the taxable gain.

Those are the 2 items required to figure out tax ramifications.

Cost basis is his investment into the policy (IE- in most cases the total of all his premiums paid)

The taxable gain is not 12%. That will be the total cash value minus the cost basis.

Basically, has he made it lost money in total

If not a MEC, he gets to pull out his cost basis first as a tax free return of premium-cost basis
This is a great information for the cost basis. Thanks
 
You have to call the carrier or look on the carrier systems to get the policy tax information about the cost basis & the taxable gain.

Those are the 2 items required to figure out tax ramifications.

Cost basis is his investment into the policy (IE- in most cases the total of all his premiums paid)

The taxable gain is not 12%. That will be the total cash value minus the cost basis.

Basically, has he made it lost money in total

If not a MEC, he gets to pull out his cost basis first as a tax free return of premium-cost basis
Now that I did some numbers he is going to get taxed for 15k of his cash value. Around 10% federal bases on what the carrier told us, but do we get state tax too? The carrier did not tell us. We live in VA.
 
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