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Should I cancel my life insurance policy and use it to pay off my consumer debt?

  • Should I cancel my life insurance policy and use it to pay off most or all of my consumer debt? I'm Canadian, 50 years old, single, self-employed, with no dependents. I have about $15,000 in consumer debt and about $200,000 owing on my house. I'm covering my mortgage payments well, and am currently spending about $300/month on servicing the credit card debt. (I have 3% interest until October, but it goes up to 9% after that). There's a good chance that things will be busier for me in the spring, and I may be able to increase my debt repayment to about $1200/month, but I can't count on that. My retirement savings are lower than I would like them to be, but I do have house equity, several RSPs, and two life insurance policies. One policy will pay out $250,000, which will cover the house and any outstanding debts. This policy costs $25/month and has no cash value. The other whole life policy would only pay out $100,000 but can be cashed in when needed. I'm paying just over $100/month for the latter policy, and it is projected to be worth $40,000 when I'm 60, $55,000 when I'm 65, and $120,000 if I make it to 80. To my understanding, there are three reasons to have life insurance: to cover debts when you die (my major debt is the mortgage, which is fully covered by the $250,000 policy); to provide for dependents (again, I have none); and to act as an investment vehicle (I have other investments I'd like to improve). This whole life policy's current cash value is just under $15,000. If I cash it in and apply most or all of this to my debt, it would allow me to put a lot more money towards my other retirement investments every month ($400-$1300, counting the insurance premiums and current/projected debt payments), and give me some peace of mind and breathing space. I have been watching my budget and have been paying down my debt as much as possible, but it's been a horrible year on a number of levels and I'm actually deeper in debt than when I started. Optimistically, I'm about 18 months away from clearing the consumer debt. Pessimistically, it could be another 5 years before it's clear. If I cash in the life insurance, I could be free of debt significantly faster. The possible drawbacks of cancelling the whole life insurance: 1) The tax hit of about $3000-$4000 on the $15,000 I get from the policy. This would mean paying only $11,000-$12,000 to debt immediately, which is still a huge improvement, or paying it all off and budgeting carefully for the rest of the year to cover the expected taxes. 2) The loss of potentially $40-55,000 (taxable income) at retirement age. I could almost certainly make this up or exceed this with other investments once my debt is gone. 3) At 50, if I do need to buy a new life insurance policy for any reason, it could be much harder to get and more expensive. But I can get $10,000 of coverage for $20/month from the same company that provides my supplemental medical insurance. I don't need lavish life insurance, just something to cover any remaining small debts and a funeral. I do need to be out of debt as soon as possible and to have a much larger retirement fund. Given these issues, is it worth cashing in the policy? I think it is, but I could be missing something important. If necessary, you can contact me at [email protected].

  • Answer:

    I think you've answered your own question. If the return an investment vehicle makes (factoring in tax advantages and cashing out costs) is less than the amount a debt is costing you, and you can't clear the debt another way, you should clear the debt with the investment. This seems to be the case here: in october unless you make more than 9% APR on your investment including tax/cashing out fees, then you should clear your debt then. Cash out in october.

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I'm not sure about how it is in Canada, but in the States, whole life insurance is usually a lousy investment vehicle compared to a tax-advantaged retirement account. Ditch it and use the money to pay off your debt. I'm kinda "meh" about waiting until October, too. Probably you are making jack on the whole life, once you sit down to figure it out. There is no reason to have life insurance "to cover debts." Your creditors will fight it out over your assets, if you have any, and that'll be that. It won't bother you a bit. The sole purpose of life insurance is to replace income -- what you would have earned had you lived -- for your dependents. No dependents, no life insurance. So you should also ditch the $250,000 policy. (A small policy, say $10,000, is nice so your parents or friends won't be burdened with burial expenses should you happen to die unexpectedly, but you can also just prepay those, or make those people the beneficiaries of your retirement accounts, or whatever.)

kindall

I would do it. You take the ~$15000, hold aside $4000 for the taxes (put it in one of your investments until you send it to Ottawa, if possible) and reduce your consumer debt to ~$4000. If you're servicing the $15000 debt with $300/month, you should now be able to service it with $100/month. You'll be saving the $100/month from the life insurance policy you cash in. So you have $300/month more discretionary cash, which you can apply to the debt, retirement savings, or paying your mortgage off faster to increase your home equity. (make sure there are no penalties if you want to do this, it's only really a good idea if you think the house is increasing in value.) To make the remaining $4000 in debt as manageable as possible, either consolidate it to another low-intro-rate credit card in October or get a small bank loan/line-of-credit for less than 9%. It should be easy. Sure the policy will be worth $35000 more in ten years, after you pay $12000 more in premiums, but the $300/month adds up to more than that over ten years, anyhow. And the reduced insurance on your life is acceptable because of the other insurance and insurance opportunities you have. In case the crowd here doesn't help you make a confident decision, you should go see an advisor at a bank like Scotia or TD... they'll give you a free consultation and I'm guessing they'll tell you your situation is even rosier than it seems. This is a question for the crowd, since you can't reply directly: When someone dies with no dependents, what would happen to an outstanding mortgage if the estate had no money?

chudmonkey

Call your agent/broker, ask about taking a loan against the cash value of the life policy. It's really the best of both worlds, you can pay off all your debt, and you keep the life insurance. All you have to do is pay back the interest each year (not sure on rate, usally not much above prime - since its kind of your money anyways, which means you don't have to qualify, they just cut you a cheque for the amount you want).. plus there's little to know tax implications as long as the policy stays active. You technically don't ever have to pay back the principle, it's just taken from the benefit at the time of death. Explore all your options with your agent.

jazzman

chudmonkey - in answer to your question.. the bank gets the house.

jazzman

If I am reading the original question correctly, you have no dependents, but you have life insurance. There is no reason to have life insurance. You seem to be somewhat concerned about paying off your mortgage in the event of your death, but you say you have some equity in the house. Chudmonkey, it presumably depends on the laws in Canada in this case if you diehttp://en.wikipedia.org/wiki/Intestacy presumably the nearest relative gets the house (and the mortgage). If one truly does not have any living relatives then one should really not care what happens to one's property when one dies. As a practical matter for surviving, unrelated people (say, for example, the bank, or the neighbors) it's an interesting question. Eventually I imagine the bank tries to foreclose only to discover that the owner is dead.

thomas144

You should cancel even if you didn't have debts to pay off. http://www.smartmoney.com/insurance/life/index.cfm?story=lifeterm.

joshrholloway

I am in agreement with kindall. Life insurance is used to replace the income lost due to the death of the insured so that the needs of dependents will still be met. No dependents, no need for insurance. Why have insurance to pay off the debts? The asset will be sold, the loan paid off, and the equity left goes to your heirs. Also, you will be doing the executor of your estate a huge favor if you have a will in place and all of your important documents in one place accessible to him/her. Dying without a will will leave a huge problem to those you leave behind.

Daddy-O

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