If you have an old life insurance policy, insurance sales people will sometimes try to talk you into a life insurance exchange. That is simply exchanging your old policy for a new policy. This can happen with term or whole life insurance. There are two possible reasons for the salesperson to suggest you do this. First, it might actually be in your interest to do it. Second, the salesperson makes juicy commissions when you do so. Before you take any action, make sure this move is in your best interests.
Under IRS Section Code 1035, you can transfer the cash value of your life insurance to another policy without paying any tax as long as you do it right (one condition is that the you can’t change the insured or the owner when you exchange the policy and you can’t take any money in the transaction).
Life insurance agents make a number of arguments when they try to talk you into doing this. Some of their arguments make sense, but you owe it to yourself to make sure they’re telling you the truth. Let’s take a look at the typical pitch and dissect the arguments:
1. Company Safety
I don’t need to explain how the strength of your financial institution can deteriorate quickly. So if you’re holding a policy where the issuer is teetering on collapse, you may indeed need to exchange your policy. If your agent makes this argument, make sure he’s telling the truth. (Read “Is My Annuity Safe.”) If after you do your own research, you confirm that your existing company is going down, you might go ahead with the exchange.
2. Lower Costs
I love the idea of owning inexpensive life insurance, but you have to be careful here. Let’s consider what term life insurance is and how costs are determined. In most cases, it’s hard to get cheaper term insurance as you get older because your mortality rates go up. But if you bought a policy from a shyster agent and a shyster insurance company and you’ve been paying too much for coverage, it might be possible to lower your costs with a new policy.
If that’s the case, it won’t be hard for an agent to replace the policy with lower rates. But if it was me, I wouldn’t work with an agent who sold me a lousy policy from the get-go. He or she should have known the company was overcharging.
Having said that, there are times when the insurance industry as a whole reduces rates. This happens when mortality rates go down across the board. But if that’s the case, the insurance company you are currently with might be able to give you lower rates. This is more likely to happen with term insurance rather than universal or whole life.
3. Higher Returns
Agents may try to convince you that you should exchange your whole policy into a universal life policy. They are convinced it’s the way to go. But both policies stink if you ask me. (Ever wonder how the Buffett family got so wealthy? It’s because they own insurance companies that sell this kind of insurance.) They’ll tell you that the universal policy will provide higher returns. To be honest, I can’t stand either type, so this one is going to be up to you. Whole or universal life is not one of the best investments. In fact, it’s one of the worst.
Having said that, I’ll just mention that universal might have higher returns than whole life because the investments are in the stock market. But whole life provides a fixed return and people who own those policies aren’t subject to stock market risk. In my experience, this is a moot point anyway. The costs are so high with both that very few people build up any cash value anyway.
If you own term insurance, your agent may suggest you dump it to buy a different policy that is convertible. In other words, if you don’t own a convertible policy, when the term is up, you’re done. The policy goes away. If you buy a convertible term policy, you can convert it into a whole life policy. That way, you can continue making premiums and thereby hold on to your insurance coverage. For my money, this can make sense once in a while, but rarely. If I need term insurance it’s because I realize that at a certain point, I won’t need the coverage anymore. That being the case, why do I need convertibility? And it can be expensive. Do you really want to get a second job just so you can pay your insurance premiums? I don’t.
I just bought some additional term insurance, and the broker I deal with tried to sell me on convertibility. He told me that it would be nice for my family to have more money when I die. Nobody can argue that. But using that argument, everyone should own whole life. I’m sure the agents agree with that, but I don’t. Insurance is a tool and nothing else. If you no longer need it, why pay for it? The money you spend on it is precious. There are other uses for that money. I’d rather spend on things I need than on convertible life insurance that I don’t need. When I get older I’ll look into senior term life insurance if I still need it, thank you very much.
The bottom line is that if you have a term, whole life or universal life policy, there are valid reasons to exchange it for something else. But before you do so, ask the agent who is making these recommendations to prove it. I’ll end by saying that my experience with life insurance salespeople has not been good. I’ve yet to meet one who puts clients’ interests first. That has been my experience, and it clearly colors how I write about the issue of life insurance exchange. Having said that, I know there must be plenty of people who sell life insurance who are honest and put clients first. You might be dealing with someone who meets that criterion. Just make sure of it by taking the steps I outlined above.