Readers of Financial Highway will be aware that in November, several bloggers, including myself, launched a Bloggers for Charity initiative. The essence of this initiative was to auction off our blogs for one day to the person who bid to donate the largest amount to charity. That person would become a blogger for a day.
On Financial Highway, the highest bid was made by Glenn Cooke with a bid of $100. Glenn made his donation to the Wilmot Family Resources Center and his blog follows below.
Replacing an existing life insurance policy with a new one is fraught with dangers. You run a very real risk of ending up with worse or no life insurance if you’re not careful. In this article we’re going to look at some of the reasons you might replace an existing life insurance policy and provide some strategies on the process.
Why would you replace an existing life insurance policy? Certainly one of the immediate reasons is cost. Perhaps you have term insurance that is coming up for renewal. If you’ve decided you want to separate your insurance and investments (see the article at Michael James on Don’t mix life insurance and investments.). Or perhaps you purchased a universal life insurance policy that hasn’t performed as expected due to market downturns (see the article on Million Dollar Journey article on Is your life insurance policy about to implode?).
Guideline #1 – never cancel an existing policy until the new one is fully inforce.
You should never cancel an existing life insurance policy until your new policy is fully inforce and irrevocable. If your new insurance company finds a hidden surprise in your medical exam and declines you, all of a sudden that old policy is going to start looking mighty attractive. But that old policy won’t do you any good if it’s cancelled. Being declined for surprise reasons isn’t an exercise in academics – it does happen. The easiest way to plan for something like this is to simply keep your existing insurance until your new policy is in force.
Guideline #2 – consider stopping payment instead of cancelling.
If you stop payment at your bank on your existing insurance (basically bounce the payment), the insurance company will allow you to resurrect the policy for 30 days simply by paying the outstanding premium. At the end of the 30 days your policy will lapse completely. This effectively gives you 30 days of free insurance on the back of your old insurance company. If you die in that 30 days, your beneficiearies pay the outstanding premium and get the death benefit. Manage to stay upright for the month and it cost you nothing.
Guideline #3 – you will restart your 2 year exclusion clauses
Most life insurance policies have a 2 year exclusion clause for suicide or for misrepresentation (called ‘incontestibility’). Your new policy will restart this two year period, giving the insurance company a new 2 year window to deny a claim.
Term with Term
A common scenario is a term insurance policy that has reached the end of it’s term, or come up for renewal. The premiums on most term insurance policies today become exorbitant at the first renewal, making it attractive to take a new medical exam.
If you’re simply swapping a term policy with a new term policy, then it’s generally simply about price. Make sure your broker shops the market to find the lowest priced companies, be aware of the 3 guidelines above, and start saving some money.
Term with Permanent
If you have term insurance and later determine that you want permanent insurance and you’re healthy, then the obvious solution is to simply take a medical exam and purchase a new permanent life insurance policy.
However perhaps you’re a bit older than when you bought your term insurance and you want to skip the medical exam. Or perhaps your health has deteriorated as you’ve aged and it’s clear that you’ll be rated with a new policy. There’s a solution to this. Most term life insurance policies have a conversion clause that allows you to do a direct swap of your term policy for a permanent life insurance policy without being subject to a medical exam. Simply complete the form and the new policy is issued. This is a good example of why Guideline #1 above is so important. If you cancelled your existing insurance prior to finding out that you got declined on a new policy, you’ll have lost this conversion option.
Whole life to Term to 100
More on Life Insurance
If you’ve previously purchased a whole life policy with cash values, you may decide to cancel the whole life policy and purchase a term to 100 policy or universal life insurance policy – basically swapping out a permanent policy with cash values, for another less expensive policy with no cash values. Perhaps you intend to invest the after tax cash values in your RRSP.
In addition to the guidelines above, there are two important considerations here. The first is that your cash values may be subject to some taxation. You’ll need to contact your insurance company to find out if this is the case. Secondly, some whole life policies have mechanisms that allow you to automatically increase the amount of coverage (a typical term to 100 policy would not have this). Be aware that there are circumstances where you may decide you want more insurance in the future and be unable to purchase it.
Term to 100 premiums are on the rise so it’s getting less and less likely that a new Term to 100 policy will have lower premiums than a whole life policy you’ve owned for a few years. Still, depending on the cash values it may or may not make sense.
Whole Life to Term
If you’ve purchased a whole life policy for investment reasons and later decided that you prefer simple insurance coverage, you may consider cashing out your permanent policy for a less expensive term insurance policy and investing the resultant cash values in your RRSP’s.
Similar to the previous case, be aware that you may be required to pay some taxes on the cash value, and you may lose the ability to increase your insurance coverage without a medical exam. The analysis for this comparison is often called ‘buy term and invest the difference’ but if you are considering this make sure you are a) using a sane interest rate to compare the products, b) using the cheapest term product available not just whatever the rep is selling and c) ensure you purchase a term policy that has conversion, the ability to switch back to a permanent life insurance policy without a medical exam.
I would note that this particular swap is one that requires very careful consideration. Numbers aside, I have often heard regret from 50 year olds who cancelled their whole life policy when they were 30 and now wish they’d kept the policy.
Universal Life to another Universal life or Term to 100
A primary reason for switching a universal life insurance policy for another similiar policy or a term to 100 policy is the result of investments not performing as expected. A second reason might simply be for insurance costs purposes – either you can get a cheaper policy, or one that has better guarantees.
Unfortunately these switches are very dangerous and costly for consumers – be careful.
If you are switching to another universal life insurance policy, ensure that you have guaranteed level cost of insurance – accept nothing less. And let me be clear: level premiums does NOT mean that you have guaranteed level cost of insurance.
Universal life policies frequently have an investment portion of the policy. When you cancel the policy you will be collapsing these investments and perhaps investing them in your RRSP’s. Unfortunately while the U.S. lets consumers transfer these account values from one universal life insurance policy to another investment without incurring taxation (called a 1035 transfer), in Canada you’ll be dinged taxes on the investments. In addition, there may be excessive deferred sales charges – fees charged by the company when you withdraw ‘your’ funds. These deferred sales charges are a nasty surprise for many consumers so here’s a strategy for minimizing them.
Deferred sales charges typically decrease to 0 over 5 or 10 years. The strategy is basically to reduce the amount of insurance coverage inside the policy to the bare minimum (and thus reduce the insurance costs of the policy) and then wait out the deferred sales charges. Once the deferred sales charges are over, collapse the policy, pay the taxes and withdraw the funds. Note that the government has guidelines on the minimum amount of insurance you can have inside your policy, your existing company will be able to provide the exact number for you.
In all cases replacing insurance is complex and requires individual consideration. Follow the above strategies and always keep an eye out for any possibility that could leave you without coverage.
Glenn Cooke is a life insurance broker and president of InsureCan Inc.. He offers second opinions on life insurance and can be reached at (866) 662-5433.