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Question for the Money Doctors

Question submitted on Dec 10, 2016.

Question

After retiring, in 1987 my parents sold their large house and purchased a condo. They had $50,000 left to invest. Their advisor told them to buy a $50,000 life insurance policy which they could borrow against if needed. They borrowed $40,000 of their money and then my father passed away in 2002. My mother called the company to get the balance and was told that she was the insured on the policy and there were no funds left. Finally they said if she or her children terminate the policy, she will be taxed on $347,000+. We are so confused by this and she needs the $10,000 which the company still has.

Answer

It seems far fetched that you could pay a $50,000 premium, borrow $40,000, and perhaps owe taxes on $347,000, but that is entirely possible.  While neither of us has knowledge of the sales process, when one borrows money from a life insurance policy, it is possible to trigger significant taxable income if the policy accumulates substantial interest over the years.

It would be prudent to request a copy of the policy to see the guarantees that the policy has.  

You will want to review the rider section to see if there is an overloan protection rider.  This may shield your mother's policy from lapsing.  However, it may also preclude any access to what ever the remaining cash in the policy is.

Over the years, the remaining cash value may have been eroded by the interest on the loan.  

You will want to request an "in force" ledger to see how the policy behaves over time, and if it will lapse.  There may come a point that a significant premium payment is due or the policy will lapse.  A lapsed policy may trigger significant tax.  This can be a real headache to handle, so it is best to work with a CPA who has expertise in these matters from a financial and tax perspective so you can assess what the best solutions may be.  Visit www.findacpapfs.org to find a specialist near you.


For additional information visit http://www.360financialliteracy.org/

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