How much should my Mom pay into her UL policy?

[Nick Desoutter]

My parents bought a $250,000 second-to-die UL policy to fund my sister's Special Needs Trust. It is Option A--the cash value is not included in the policy proceeds.

My father has passed away, and my Mom is 80. She stresses out each year when she receives a letter from the insurer telling her that her cash value will be depleted in a few years (currently about 2 1/2 years) and she will need to pay more than she is currently paying to keep the policy in force. She is afraid something will go wrong and the policy will lapse. This year, the insurer sent her an illustration that showed, based on current assumptions, that she could increase her quarterly payments and support the policy until she is 92 without the cash value being depleted. Her initial urge was to do that, but I'm trying to talk her out of it.

My reason is that, according to that illustration, the cash value (currently about $15.5K) rises to over $26K in her mid-80s. If she dies at that time, we are essentially giving the insurer $26K--the cash value that they keep because this is Option A. (And if she dies at some other time before 92, we are giving them some other amount.)

My advice to her is to let the cash value fall to $0 and then "pay as you go"--pay the amount necessary to keep the policy in force each year. My question is: am I right? Is this the best thing to do?

The only reason I can see not to do this is that the minimum interest rate on the cash value is 4%--a good rate. So, if the cash value gets to around $25K as in the illustration, she will be receiving $1,000 in interest--a pretty good discount on the cost of insurance. Still, this doesn't seem to compensate for the risk of her dying and us losing a big chunk of change.

Some info on my Mom's health: she could lose weight and she does not exercise because of back problems. She has high blood pressure controlled with medication. Otherwise, we are not aware that she is suffering any terminal illness right now. Her mental state is excellent.

One other thing: I called the insurer and it is not an option to switch from Option A to Option B (though the opposite would be allowed).

Thanks for any thoughts on this situation.

 

[DHK]

See if you can open a bank account in the name of the Special Needs trust. Fund the bank account the higher amount but pay only slightly more than minimum payment to keep the policy afloat.

In this way, you should be able to keep any amounts remaining in the bank account AND pay the minimums on the policy to keep it 'on life support'. If a larger amount may be needed, it may be in the checking account.

Keep in mind that UL is an annually renewable term, so it will increase as she ages. 4% is practically meaningless against the increasing costs of insurance.

Remember: This is about funding the trust for the person who has special needs, so I wouldn't necessarily be quibbling over a couple hundred dollars extra a month in order to secure that death benefit for the trust and the trust's ultimate beneficiary.

Just my thoughts. This is not legal advice.

 

[scagnt83]

If the guaranteed illustration says it will last to a certain age, it is guaranteed to do so.

Save the policy if she can afford to do it. No way she will find a better rate. And no way sticking the Cash Value in a bank account is going to give the same benefit as the Death Benefit of the life policy.

You are not giving the company the Cash Value. I understand how it might seem that way. But the Cash Value actually helps to make up the current Death Benefit.

There is sometimes a Death Benefit Option called "increasing by Cash Value". But this carries a much higher expense... and would have cost around 50%-100% more in Premiums to choose this option.

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Ask the carrier for an "inforce illustration" showing the Premium required to last until whatever age your mom is comfortable with. Perhaps age 95.

As long as she can afford the Premium, this is by far the best choice for a special needs situation. Puting the Cash Value in a bank account would be taking a HUGE loss on benefits for your sister.

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DO NOT LET THIS FALL TO $0 CASH VALUE.

It will lapse if that happens. You cant just let it run to zero. It is too late at that point.

And allowing the Cash Value to dwindle down only forces your mom to pay higher premiums in the future to save the policy!

The more cash that is in there, means the less your mom will have to pay in Premiums. Every year she lets the Cash Value fall, she is increasing her future Premium.

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4% is an exceptional guaranteed rate for a UL policy. You cant find that rate in the current market today. Most non-guaranteed rates are only around 4.5% or lower.

But that is not the exact return on the Cash Value. The expenses of the policy, such as Cost of Insurance & Admin Expenses, will reduce the actual return you would see on the Cash Value. And since the CV is reducing year by year, that means the expenses are now higher than what the policy is generating in interest.

The point of a policy designed like this, especially when in a Trust, is not to maximize the Cash Value or even use the Cash Value. It is to generate the most Death Benefit possible. DB "rate of return" is the primary goal, not the CV.

Again, the Cash Value is essentially just part of the Death Benefit. This is not just profits that the insurance carrier keeps. It is required by IRS code that a permanent policy have a Cash Value component. It is just the way this very complex insurance product is designed by law.

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Keep the goal in mind when dealing with this situation.... your sisters wellbeing.

If your mom is worried every time she sees the statement, then she obviously still sees a strong need for the Death Benefit. That is the main goal. And a bank account wont even come close to giving the same benefit as the life policy.

 

[scagnt83]

4% is practically meaningless against the increasing costs of insurance.

David, there is no way to know if that statement is accurate or not. And it is most certainly not accurate in a general sense.

Most every IUL or UL Ive sold would be guaranteed not to lapse at a 4% credited rate.

I have reviewed hundreds of in-force ULs from the 80s and 90s. Only a small portion of those were actually underfunded and in danger of lapsing. And many had been decreased to the 4%-5% range once the 2000s hit.

If the policy was properly funded, it could be perfectly fine at a 4% rate, regardless of the increases in COI. In this situation, the carrier has already shown what it will take to extend to age 92. Not much more would be required for age 95 or 100... it sounds like the policy is already at the guaranteed rate, so the carriers numbers would be guaranteed if so.

 

[scagnt83]

Remember: This is about funding the trust for the person who has special needs, so I wouldn't necessarily be quibbling over a couple hundred dollars extra a month in order to secure that death benefit for the trust and the trust's ultimate beneficiary.

This times 10!

 

[DHK]

It was late when I answered this, AND I was mentally comparing this to my father's own variable whole life situation - which is different enough, but I still made the mental comparison.

The 2nd to die is a $250,000 UL policy... with current cash values of $15k (more or less).

Here's the death benefit formula:
Net death benefit = cash values + net amount at risk - any outstanding loans.

Scagnt83 is right: The insurance company is NOT "keeping the cash values". It is being paid out with the death benefit. If anything, it's a lower 'net amount at risk'.

In other words: $250,000 = $15k + $235,000.

At least the costs of insurance are more favorable with the policy being a 2nd to die.

But don't look at the 4% crediting rate as an "investment" of any sort - but as a way to keep up with the increasing costs of insurance.

Guy Baker compares life insurance to "the box". Generally speaking, the more and the sooner you fund the box, the better the box will work for you.

 

[Nick Desoutter]

Many thanks to both of you for taking the time to think and write about this.

First, let me assure you that I have no intention of letting the policy lapse. I'm just trying to figure out whether it is a better idea to pre-fund the contract or, as DHK put it in his first response, "keep it on life support."

Here is something I think I have figured out from your responses: if my Mom does live to 91, then the total cost of insurance we would pay over the years would be less if we paid more into the cash value than if we kept the cash value very low. This is for two reasons: 1. the 4% interest we would be receiving on the cash value would offset part of the yearly cost of insurance; 2. the cost of insurance would be based on a smaller net amount at risk (as you said $250K - $15K =$235K). Is this correct?

However, if she doesn't live to 91 (say she dies at 85), then I still think we lose if the cash value is relatively high at the time or her death. I can see why, FROM THE INSURER'S POINT OF VIEW, the company is not just keeping that money as profit because it is using the cash value to pay part of the $250K death benefit. But, FROM OUR POINT OF VIEW, we gave the insurer more money than if we let the cash value get small, but we didn't get more money back. Either way, we only get $250K. Am I right on this point?

If I am right so far, then it seems to come down to taking a gamble on how long I think she might live. If I think she has a good chance of making it to her 90s, we should pay more into the policy. If I think it's more likely she'll die in her mid 80s, then I should keep the policy on life support. Correct?

 

[DHK]

That's correct as I can see it.

You have two choices (using the analogy from Guy Baker's "The Box" video):
- Fund the box @ 4%
- Pay the curve

The choice is up to you... and when you assume your mother may pass away. The longer she'll live, the better it would be to "fund the box" @ 4% rather than just paying the cost of insurance curve out of pocket.

 

[Nick Desoutter]

Yes, I watched the video and I was thinking of it in those terms, too. She's a little like the guy in the video who woke up and found he had cancer, except she woke up and found she was 80!

 

[mespinosa]

That's correct as I can see it.

You have two choices (using the analogy from Guy Baker's "The Box" video):
- Fund the box @ 4%
- Pay the curve

The choice is up to you... and when you assume your mother may pass away. The longer she'll live, the better it would be to "fund the box" @ 4% rather than just paying the cost of insurance curve out of pocket.

As your mom gets closer to 100, neither choice will work. Cost of Insurance will be like 250k per year, more than the death benefit itself. Do you think the casino will let you go with your winnings? If you had invested this same amount in the market, your mom would be sitting on millions now.

p.s. I am an Engineer and I did ask Mr.DHK about life insurance just like I ask my mechanic about my car as I don't have time to figure that level of things myself. My time is more valuable.