Q. My children are grown, and I'm divorced. I can't think of any reason to maintain a life insurance policy I purchased many years ago. The policy has a cash value of around $35,000, which is declining because I no longer pay premiums and I guess the cost of the insurance is increasing along with my age. I don't need the money right now, but I'm thinking about cashing it out before the value declines any further. Will I owe any taxes if I cash out my life insurance policy?
Recently a large CD matured, and I had the proceeds deposited into my checking account. An investment adviser from my bank called me, and when we met, he suggested I combine the cash from the CD and the insurance policy and buy an annuity. The money would grow tax-deferred.
He also talked about some guarantees and lifetime benefits I didn't completely understand, but they sounded interesting. He said there would be no fees to pay, but I remembered reading somewhere, maybe your column, to ask how much of my money would I get back if I changed my mind. He said all of it if I changed my mind within 30 days, but after 30 days a 12 percent surrender charge would apply in the first year. After seven years, the surrender charge would be zero. I asked for a prospectus, and he said I'd receive one when the annuity policy was issued, and I'd have the 30 days to review it and cancel if that is what I wanted. Some of the annuity features sounded pretty good, but a 12 percent charge sounds pretty steep. Are they always that high?
A. That's a pet peeve of mine. Why should the bank's investment advisers be privy to activity in your bank account? I'm always thrilled when the investment advisers at my bank call to offer free consultations when they see a decent-size deposit into my account.
Sorry, back to your questions.
Contact your current insurance company, and request an estimate of the amount subject to income tax owed if you were to surrender the policy. Any amount over your adjusted basis will be subject to ordinary income tax upon surrender. You can replace a life insurance policy with a new life insurance or annuity policy without tax consequences if you meet the requirements of Section 1035 of the Internal Revenue Code. The original policy's tax basis will be preserved, and recognition of gain will be deferred for income tax purposes if the transfer is done properly. If you are considering purchasing an annuity, it is probably better to use a 1035 exchange rather than surrender your life insurance policy and use the cash to make the purchase.
All annuities have expenses and charges, but a 12 percent surrender charge is pretty steep. A high surrender charge is typically an indication of a high commission being paid to the agent/broker. If you want to work with an agent/broker, I'm sure you can find one selling annuities with more reasonable surrender charges and lower expenses.
There are no-load and low-load annuities that don't have sales load or surrender charges. Ameritas Direct, Jefferson National, American Skandia, Ohio National and other insurance companies offer these types of annuities. Some companies sell both directly to the consumer and through brokers, so you need to make sure which type of annuity you are evaluating.
If you buy directly, in addition to having no surrender charge, your fees and expenses should be less, but you won't have the one-on-one advice of an agent/broker. Annuity contracts can be fairly complex, and if you want to buy directly, paying for a consultation with a fee-only adviser is recommended. The Securities and Exchange website has some good information concerning variable annuities: "Variable Annuities: What You Should Know" at www .sec .gov /investor /pubs /varannty .
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question.
