Surrender whole life policy or pay its loan?

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Hello,

I have a whole life policy through Northwestern Mutual with base coverage of $125k and after paid up additions totals $301,762.00 in death benefit. However, I took a loan out a few years ago to pay for school in the amount of $40,000 which has accrued interest and now totals $41,605.13. The total cash value is $65,533.80 and net cash value is $23,928.67. The policy pays dividends in the amount of about $2,100 per year but that's not enough to pay the premium and the loan, so I've been paying the premium in the amount of $831.25 every year and using the dividends to pay the loan's interest.

Here's the question, my wife and I are paying down student loan debt and organizing our finances, do we surrender the whole life policy now and start paying for a term policy for the next 20 years and contributing more to retirement now OR keep the policy and try to pay down the loan and possibly surrender the cash after the loan is paid off or just keep it all together?

We anticipate being debt free in about 1.5 years (save for mortgage on our house and our rental property). We will also be paying a significant portion of our income to child care for the next 2-3 years.

Thanks

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1) You understand that if you surrender the policy or let it collapse that you will pay ordinary income taxes on any gains. Right?

2) You need to get any replacement insurance in place BEFORE you let the policy lapse.

That is apparently a pretty old policy. At this point, the dividends and cash value increase year to year should be pretty strong even with the loan interest. Whole life is typically a poor investment because of slow growth in the early years. You're already past that, and going forward your policy might actually be a good value. Get an inforce illustration from Northwestern to see for yourself. You may want to keep it, and add a separate term policy for your needs.

you need to decide if you want a permanent death benefit. If you do then typically you pay off the loan.

if not then its a little harder to decide but while its almost always a bad decision to purchase whole life, keeping it after many years is a different conversation because of sunk costs. Going forward the return likely would be around 4% a year currently but that's just a guess. You can request an inforce illustration to get a better idea of the current returns. So if you were going to invest this money conservatively then likely keep it. If you were going to invest it more aggressively then you need to understand that comes with more risks.

definitely get term in place BEFORE doing anything

The other question is: Is this even enough insurance?

stanolshefski said:   1) You understand that if you surrender the policy or let it collapse that you will pay ordinary income taxes on any gains. Right?

2) You need to get any replacement insurance in place BEFORE you let the policy lapse.

  I do understand the income tax issue. I am unclear on the calculation. Is the basis the aggregate of the policy premiums only or does the interest paid on the loan factor in? Also does the gain include the loan amount or is it only the remaining net cash value? We would get a term policy set up prior to the surrender.

RBirns said:   That is apparently a pretty old policy. At this point, the dividends and cash value increase year to year should be pretty strong even with the loan interest. Whole life is typically a poor investment because of slow growth in the early years. You're already past that, and going forward your policy might actually be a good value. Get an inforce illustration from Northwestern to see for yourself. You may want to keep it, and add a separate term policy for your needs.
  It is old. Over 28 years old. I'm going to obtain the inforce illustration and see if it ultimately outperforms any other other investment option we have.

stanolshefski said:   The other question is: Is this even enough insurance?
  It's not. We probably need to get a term policy to supplement and use this WL as more an investment vehicle.

Keep!

You can just ask the insurance company for the basis and taxable gain

Basis is premiums paid. Interest, loan amount, and any amount they give you back subtract premiums paid is typically the number you pay taxes on.

abdomega1 said:   
stanolshefski said:   1) You understand that if you surrender the policy or let it collapse that you will pay ordinary income taxes on any gains. Right?

2) You need to get any replacement insurance in place BEFORE you let the policy lapse.

  I do understand the income tax issue. I am unclear on the calculation. Is the basis the aggregate of the policy premiums only or does the interest paid on the loan factor in? Also does the gain include the loan amount or is it only the remaining net cash value? We would get a term policy set up prior to the surrender.

  
Your basis is premiums paid minus total dividends.  Loan interest does not affect basis.  Insurer can give you those numbers.

Basically, if the value of the cash value/death benefit increases over a year more than the cost, then keep it. Many WL policies increase guaranteed cash value on a yearly basis - see yearly statement. From your 1st paragraph you are getting back (as dividends) more than you are putting in.

Outstanding loans will be taken from the death benefit. You can pay down more than the loan interest which will then reduce the loan interest Q. What is the interest rate?

The interest rate is usually more than a HELOC, but substantially less than personal loan or credit card (except short term promotion rate). Depending on the interest rate, you may want to pay down more or keep the strategy that you now have in place. Use the WL loan feature to your advantage.

As for additional insurance, it depends on your age and your financial standing. It most probably will be best to get term and almost definitely not WL.

Not an expert at WLP but when I wanted to shop for term I used term4sale to get 2x the coverage I currently had with work overage and a side policy for 1/2 the cost from United of Omaha.   That site will give you options based on ratings, health ect...  You should be able to find some good 500k 20yr term rates there to get that in place since you have a kid(s).  I use my retirement account and SS death benefit for a minor as a backing or insurance to some effect as well.  Something you may want to consider if you only wanted a 10 year term policy and are an aggressive saver in retirement acounts.



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