Heed your life insurance policy’s expiration date
Pittsburgh Post-Gazette
By the time most people hit the age of 100, they will have outlived many they know and love. There’s also a good chance they also will have outlived their life insurance policy.
A provision that exists in many permanent life insurance policies is an expiration date. It often goes into effect at age 100 — sometimes at age 95 or 90. When that happens, the insurance company will pay out the cash value to the owner.
While some people are blessed to live long enough to spend their own life insurance money, the dilemma they face is the cash value could be lower than the death benefit. To make matters worse, the policy owner also could end up with a tax bill.
“After years of paying premiums for a policy you expect to remain in place until your death, you may lose the benefit of passing wealth to your heirs tax-free,” said Shormari Hearn, an adviser at Palisades Hudson Financial Group in Fort Lauderdale, Fla.
While the issue is more critical for people in or near their 90s, anyone with permanent life insurance should examine the life insurance policy to see when it will either “mature” or “expire.”
Pittsburgh financial adviser Robert Fragasso has seen clients come to him with life insurance contracts that expire as early as age 90.
“It all depends on how the contract is written,” said the CEO of Fragasso Financial Advisors Inc. “Most people are not aware of it. They either didn’t read the contract, or if they did, it was decades ago. They may have either forgotten about it, or they never expected to live that long.”
Permanent life insurance policies are intended to stay in force for
the lifetime of the insured, unlike term life insurance policies, which are less expensive and are purchased for a specific time period, such as 5-, 15- or 30-year “terms.” Term policies only pay a death benefit if the insured person dies while the term of the policy is in effect.
Data compiled by Limra, a Windsor, Conn.-based insurance industry trade organization that represents more than 850 insurance and financial services companies, shows permanent life insurance policies are by far more popular than term life policies. In 2016, 61 percent of insurance policies sold were permanent; 39 percent were term life policies.
The dollar amount of the policies sold was not available.
“Consumers often don’t know what they own,” said Catherine Theroux, director of public relations at Limra. “They don’t understand if it’s term or permanent, and they certainly don’t know if it’s a whole life policy or universal.”
Heading off the problem
The insurance industry, which makes a profit by charging premiums for coverage high enough to cover claims, has seen the issue of maturing policies coming for a while.
According to the U.S. Census Bureau’s 2016 American Community Survey, there were 70,233 residents in the Pittsburgh metropolitan area age 85 or older, which represents 3 percent of the population. In Allegheny County alone, there were 36,497 residents 85 and older.
A report by the Center for Disease Control, which tracked mortality among 100-somethings starting in 2000, shows that while centenarians are uncommon, the number of Americans above the age of 100 had increased more than 43 percent from 2000 to 2014.
In the mid- to late 2000s, the insurance industry responded by raising the maturity age of permanent life insurance policies in new contracts to age 120.
An unknown number of older contracts with the 100year-old age limit remain in some consumers’ hands.
According to news reports, some insurers have offered policy owners the opportunity to extend the age of maturity in their older policies with varying financial terms.
Permanent life insurance generally comes in whole, universal and variable universal life products. All three bundle an investment component with insurance.
When a whole life policy matures, the cash value will equal the death benefit plus accumulated interest, if any. The cash value of a whole life policy is usually guaranteed toequal the death benefit. For example, a whole life policy with a $25,000 death benefit will typically have a cash valueof $25,000 at maturity.
However, people who own a universal life or variable universal life policy may get a rude shock.
With a universal life insurance policy, the cash value is typically not as high as the death benefit. The amount is usually a lot less. Depending on the custom terms, the frequency and the amount of paid premiums and the agreed upon cash value, it is possible the cash value of a $25,000 life insurance policy could be worth only $800 at maturity. Some universal policies reach maturity and pay nothing at all.
“Universal policies unlink investment and insurance components of a policy in order to offer lower premiums,” Mr. Hearn said. “If investment results are poor, the cash value at maturity may be considerably less than the promised death benefit.”
When a permanent life insurance policy matures, it causes two problems.
First, the policy owner’s beneficiaries will no longer receive a death benefit. Second, a portion of the payout — often a significant amount — will be taxed as ordinary income. The payout’s cash basis, which is the total amount of premiums paid over the years, is not taxed.
If the insured were to die while the policy is in force, beneficiaries pay no taxes on the death benefit.
For consumers, the first step in fixing the problem, Mr. Hearn said, is to find out the maturity age of the policy. Age 100 is the default. For people who bought their policy within the past 15 years or so, it’s probably 120.
Potential fixes
The easiest fix is to ask the insurer for a “maturity extension rider” to extend the policy’s maturity age to 120. There may be a small fee, and not all insurers offer such riders.
Generally, the death benefit of a policy with an extension rider is the cash value of the policy at the original maturity date plus accumulated interest, without any additional premiums.
“If the insurer grants the rider, you may be able to avoid a taxable event, and your beneficiaries will receive the policy’s benefits upon death as originally planned,” Mr. Hearn said.
But there are no guarantees.
“The IRS may rule that you still owe tax at the policy’s original maturity date even if you forgo the lumpsum payout. Insurers are fighting the IRS on this, but it remains a gray area,” Mr. Hearn said.
People with universal life policies may find it more difficult to secure the rider than those with whole life insurance. But even if you have a whole life policy, the insurer may not cooperate.
“If your insurer won’t extend the policy, you may be ableto buy a replacement policy with the now-standard age 120 maturity,” Mr. Hearn said. “For a relatively healthy individual in his or her 60s, swapping may be feasible but may not be for those whoare older or sicker.”