Should My Mother Let Her Life Insurance Policy Lapse?

Q. My mother, Sandra, is considering letting her life insurance policy lapse. She claims that she is low on funds and that it is difficult to make the monthly payments. She is also concerned about Medicaid eligibility. Do you have any advice on this matter?

Also, I’d like to buy life insurance and long-term care insurance for myself and heard there was such a thing as a hybrid policy. My mother did not know about this when she bought her life insurance a long time ago. Perhaps it didn’t exist yet. Can you provide more information?

Thanks so much in advance for your help!

A. Thanks for your questions. Currently, 500,000 seniors a year will lapse their life insurance policies, meaning they stop making the premium payments on them and let them go. They walk away with very little or nothing. Why would they want to do something like that?

What is Life Insurance?

First, let’s start with the basics. A life insurance policy is a contract that is signed between you, as the policyholder, and an insurer. It guarantees that the beneficiaries you name in the contract will receive a sum of money when you die. In exchange, you will have to pay premiums — usually as either a one-time payment or as regular monthly payments.

When applying for a policy, the insurance company assesses the level of risk that they’re exposed to, based on factors such as your age, gender, health, history, and occupational hazards.

When you pass away, your beneficiaries will receive the death benefit or the face value of the policy. You get to choose what that amount will be, based on your approximation of how much money is necessary for your loved ones to be secure. Common types of life insurance include term insurance, universal insurance, whole insurance, and hybrid LTC policies.

Term Life Insurance

Term life insurance provides protection/coverage for a specified period of time.

• This type of insurance policy provides coverage for a limited time, which may be as short as one year and as long as 30 years;
• It offers the greatest amount of coverage for the lowest initial cost;
• If the policyholder dies within the designated coverage period, a death benefit will be paid out to the beneficiaries;
• If the policyholder does not die while the policy is in effect, the policy expires and no benefit is paid out;
• Term life insurance does not accumulate a cash value, which means the policy cannot be cashed out. Because of this, it is exempt from Medicaid’s asset limit.

Whole Life Insurance

Whole Life insurance offers lifelong protection, including a death benefit, while accumulating cash value in a tax-deferred basis.

• The initial premiums you pay are much higher, and that’s why people often buy term insurance;
• A permanent life insurance policy provides coverage for the entirety of a person’s life and pays out a death benefit to the beneficiaries when the policyholder passes away;
• With permanent life insurance policies, a cash value is accrued, which means that policyholders are able to take a loan out against the cash value or “cash out” (terminate) their policy altogether, at which time they are paid the cash surrender value.
• Since policyholders can take cash from their existing policy, it is not exempt from Medicaid’s asset limit. However, this is not always entirely true, as these policies may be exempt up to a certain face value. (The exemption amount varies by state). Therefore, depending on the face value of one’s whole life insurance policy, it can be counted in connection with Medicaid eligibility.

Two other common types of permanent life insurance are Universal Life Insurance and Indexed Universal Insurance.

Universal Life Insurance

With a universal life policy, the insured person is covered for the duration of their life as long as they pay premiums and fulfill any other requirements of their policy to maintain coverage.

Similar to whole life coverage, universal life insurance combines a savings component (called “cash value”) with lifelong protection. When you pass away, the policy’s death benefit is paid out to your beneficiaries.

Unlike whole life insurance, where the premiums and death benefit are fixed for the duration of the policy, universal life insurance may allow you to adjust your premiums and death benefit over time to better suit your needs.

Beyond lifelong protection, there are a few additional features of universal life insurance:

• You can withdraw money or borrow against the policy’s cash value;
• Your cash value earns interest;
• You have flexibility with premiums;
• You can adjust the death benefit;
• You can withdraw money or borrow against it;
• If you keep up with your policy’s premiums, universal life pays a death benefit to your beneficiaries no matter when you pass away;
• If you want to build tax-deferred savings and don’t expect to tap into the funds for a long time, universal life may be a suitable option for you.

Indexed Universal Life Insurance

Indexed universal life (IUL) insurance is a type of permanent life insurance that pays interest based on the movements of the stock market. It’s a subset of universal life insurance, which means policyholders can change payments and benefits as needed.

The cash accounts tied to an IUL policy can grow quickly, but they can also see years without any growth. Eventually, you may even grow the account to the point where you can stop making premium payments.

All of these benefits come with risks. IUL is complex, subject to shifting fees, returns and benefits. Features of indexed universal life insurance, according to the American Institute of Certified Public Accountants (AICPA):

• Adjustable premium payments (within limits): Your policy will likely specify a planned premium for you. However, as mentioned, if you have enough money in your cash value account, you may be able to use those funds to help pay your premiums.
• Adjustable death benefit: Death benefits are typically flexible with an IUL policy, and you can usually lower them at any time. However, increasing the death benefit may require you to pass a medical examination.
• Access to cash value: you can typically borrow from your indexed universal life insurance policy, although you will likely be charged interest for doing so. You may also make withdrawals from your cash value account. However, doing so may permanently reduce your death benefit. If you don’t maintain a large enough balance in your cash value account, withdrawals may also risk causing your policy to lapse.

An indexed universal life insurance offers both potential for growth based on the market, as well as protection from losing value if the market falls.

Variable Universal Life Insurance

Another type of universal life insurance is variable universal life insurance. VUL policies have investment sub-accounts that allow for the investment of the cash value. The function of the sub-accounts is similar to a mutual fund — exposure to market fluctuations can generate significant returns in an up market, but are also exposed to substantial losses in a down market.

VUL policies used to be very popular, but fell out of favor starting around the 2008 recession, because when the market crashed, the cash value in  VUL policies went so far down that many policies completely imploded very quickly, with policy owners not even aware that this was happening.

Hybrid Long-Term Care Life Insurance Policies

Hybrid long-term care insurance policies most often combine permanent life insurance with an accelerated death benefit rider that pays benefits for long-term care or chronic illness. These hybrid policies have been rapidly gaining in popularity because they address most of the shortcomings of traditional LTC insurance policies. The primary advantages of these hybrid policies are that:

• They offer tax-free reimbursements for qualified long-term care expenses.
• They offer tax-free death benefits to your heirs if your LTC benefits are not fully used.
• There is a potential return of your premium if you change your mind down the road.
• For still-healthy individuals, these policies can generally be issued up until age 80.

The appeal of these hybrid products is that you are guaranteed to receive the benefits you pay for, and these products are usually easier to qualify for than traditional long-term care insurance. These hybrid products can:

• pay for some or all your long-term care costs should you need care;
• provide you with income or provide your heirs with a tax-free life insurance benefit if you don’t use up all the benefits for long-term care;
• offer you a 100% money-back guarantee should you change your mind.

A hybrid life insurance policy with a long-term care benefit may be worthwhile for you to consider if you have liquid assets that you probably will not need for retirement income.

When Should You Let Your Life Insurance Policy Lapse?

You mentioned that your mother was considering letting her life insurance policy lapse. These are some things to keep in mind.

Letting the policy lapse:

If your mother and her spouse/partner/dependents etc. (you didn’t mention if there are any) are in a position to keep up with their regular payments (mortgages, auto loans, student debt, etc.) while still retaining their current standard of living, and if their financial obligations are settled, there is little reason to renew the policy. The purpose of life insurance, generally, is to keep our loved ones financially secure if we should pass — and if the criteria listed above have been met, your mother and her loved ones/dependents are likely to already be in a secure position. Thus, renewing her policy could have the sole effect of putting undue strain on her finances.

Selling your life insurance policy:

Before letting a life insurance policy lapse, the owner should always consider the possibility of selling the policy. Selling a life insurance policy can be a good way to bolster savings, increase retirement income; make home modifications; take that long-awaited vacation; pay for assisted living, memory care or home care; pay down debt; donate to her favorite non-profit organization – anything! The proceeds are unrestricted. Unfortunately, not all life insurance policies can be sold. To look into whether your mother’s policy can be sold, contact a life settlement company, also called a viatical settlement company.

Renewing the policy:

If your mother still carries a significant amount of debt that is yet to be settled, or if she and her loved ones/dependents have enough saved for retirement, renewing her policy can be a good way to ensure that her beneficiaries will be safe in the years to come, no matter what happens.

What to Do If Your Mother’s Policy Will Disqualify Her from Medicaid Eligibility?

Having a policy over the exempt amount does not mean that your mother cannot qualify for Medicaid. Rather, it means that she would need to implement planning strategies in order to meet Medicaid’s asset limit if and when the time comes on she needs nursing home care, or the nursing home level of care. While some people may think that letting a policy lapse by stopping premium payments is the only option, there are other commonly used planning techniques, as described in my article, “ Ask the Expert: Will a Life Insurance Policy Affect my Mother’s Medicaid Eligibility?”

Before making any decisions, your mother should consult with an experienced Elder Law Attorney.

Planning Ahead for Long-Term Care

The handling of life insurance policies is just one facet of Medicaid qualification. We can help your mother design and implement a personalized comprehensive plan for Medicaid qualification. To discuss strategies specific to her situation, your mother should call us to make an appointment for a consultation.

Besides being a Certified Elder Law Attorney, I am also an experienced retirement planning advisor and long-term care financial advisor through my affiliation with Protection Point Advisors. I have been helping clients since 2006 purchase and use hybrid LTC insurance policies to assist in paying for long-term care, especially home care and assisted living, before the need for the nursing home level of care arises.

It is always wise to plan ahead for when the need for long-term care eventually arises. Life Care Planning and Medicaid Asset Protection is the process of protecting assets from having to be spent down in connection with entry into nursing home care, while also helping ensure that you and your loved ones get the best possible care and maintain the highest possible quality of life.

To begin retirement planning and/or long-term care planning — whether Medicaid Planning and/or Veterans Planning, and/or planning with hybrid insurance coverage, please call us now to make an appointment for an initial consultation:

Elder Law Fairfax: 703-691-1888

Elder Law Fredericksburg: 540-479-1435

Elder Law Rockville: 301-519-8041

Elder Law DC: 202-587-2797