Three Life Insurance “Half-Truths”

Advisors, you have clients that believe the statements below to be fact. The purpose of our August edition is to clear these up so that your clients’ life insurance expectations can be met. We’ll take them one at a time:

1. My policy is “Paid-Up.”
2. I own a “Whole Life” policy.
3. I can reduce my policy’s face amount to any amount, at any time.

1. My Policy is “Paid-Up.” This is probably the most misused phrase in life insurance.

True – When someone owns a Whole Life policy and either:

1. The original policy contract requires premiums only to a specified age or duration (for example, Whole Life Paid Up at Age 65). Once the last premium is paid, the policy is then contractually “paid-up.” Best practice is to request, in writing, a statement from the insurance company documenting that the policy is in fact “paid-up.” My father George Groome always says, “Create accountability in an otherwise unaccountable world.” In other words, don’t just trust this will happen automatically.

   or

2. Premiums were originally designed to be paid for a longer duration, but for one reason or another, the policy owner no longer wants to make premium payments. For eligible Whole Life policies, you can ask for a Reduced Paid-Up (RPU) quote. In this case, the death benefit decreases so no further cash premiums are required. If the policy is eligible for dividends, it’s possible for the death benefit to increase over time as dividends are paid. RPU must be elected with the insurance company, usually by completing the appropriate policy change form.

False – When a policy owner suspends premiums based on performance-based assumptions rather than contractual guarantees. This applies to all policy types: Universal Life, Variable Universal Life, Index Universal Life, and Whole Life. The most confusing case is when a Whole Life policyholder stops paying prior to the original plan, using an illustration that assumes dividends will cover future premiums. This does not mean the policy is paid-up. Premiums can reappear for a number of reasons, the most common being the insurer decreasing the dividend crediting rate. We hear this one the most — “I was told my policy is paid-up.” We hate to be the bearer of bad news, but often it’s not contractually paid-up.

2. I Own a “Whole Life” Policy. This is a half-truth because while many people do own traditional Whole Life insurance, the term gets thrown around loosely.

True – When the policyholder really owns an all-base, Whole Life policy.

False – When the policyholder says “Whole Life” but actually owns Universal Life, Variable Universal Life, Index Universal Life, or a blended Whole Life and Term policy. They usually know they have some form of permanent life insurance, but not the exact type. Each policy type has distinct characteristics, so it’s important to know exactly what the client owns.

3. I Can Reduce My Policy’s Face Amount to Any Amount, at Any Time.  I have a dear friend from Canada who is so polite, he often says: “Pardon sorry?” — almost as if it were one word. Most would think a policy face reduction is always possible and an easy feat. To that, I say, “Pardon sorry?”

True – When the policy allows for face reductions, the reduction doesn’t violate insurer administrative rules such as minimum policy size, and the reduction doesn’t violate IRS guidelines that qualify the contract as life insurance.

Noteworthy, some term policies allow for face reductions — but not all. This topic comes up mostly when working with Buy-Sell arrangements when the need for life insurance may decrease over time (i.e. debt is reduced). Always ask the question with term insurance: Does this policy allow for face amount reductions in the future?

False – When the policy doesn’t allow face reductions, or when a reduction would cause the contract to fail to qualify as life insurance under IRS rules.

Caution: Reductions in the policy face amount may have other implications such as triggering partial surrender charges, causing tax issues such as a Modified Endowment Contract (MEC), or reducing a benefit pool for a chronic illness rider.

Closing Thoughts

Life insurance is full of industry jargon and “half-truths” that can leave clients and even the most astute advisors with the wrong expectations. You and your clients need insurance advisors who prevent surprise premium notices, unintended tax triggers, and unnecessary benefit reductions – not advisors who explain them after the fact.  Our job is to ask the right questions, confirm details in writing, and make sure clients understand exactly what their policy can — and can’t — do.

If you have a client situation that feels fuzzy on the facts, bring it to the table. we will work alongside you as the advisor for a clear answer you can stand behind.

Any examples included are hypothetical and for illustrative purposes only, individual results will vary. The material is for informational purposes only and is not intended to provide specific advice or recommendations for any individual nor does it take into account the particular investment objectives, financial situation, or needs of individual investors.  Colton Groome Insurance Advisors does not provide tax or legal advice.  The material is not intended to provide and should not be relied on for tax or legal advice. Any information contained herein is of a general nature based on the information that has been provided to us. You should seek specific advice from your tax or legal professional before pursuing any idea contemplated.