Life insurance loan is underwater? Is there anything I can with the tax hit?
January 23, 2012 10:03 AM   Subscribe

Many moons ago, my parents took out a loan against a whole life insurance policy on me. Now the policy is underwater and the insurance comapny wants to terminate it and I'm taking a tax hit. Can I avoid this?

This is kinda complicated and weird I don't really know if there is anything I can do. Details here are sketchy I guess since I don't really know much and the statements I get are not very detailed.

My grandfather bought a whole life insurance policy on me in 1980 (when I was 5). At some point in my life, my mom took out a loan on the policy and never repaid anything. When my mom died (4 years ago), I started getting interest bills for this loan that I never knew about on a policy I didn't even know existed. I've irresponsibly ignored them for 4 years. I assume she was ignoring them before that. She never mentioned anything to me about it.

At this point, the loan + interest is now more than the policy, so the company wants to terminate it. When they terminate it, the value of the loan will turn in to taxable income for me.

Is there anything I can do to avoid this? I don't know if what my mom did was illegal or not, but I don't want to cause any problems for my family. But if there is some way I can get out of the tax burden caused by this policy I'd like to, since I didn't get any money out of it.

If my mom were alive and asked me for money, I would have given it to her. So if I need to just suck it up and pay, I of course will. Who knows how to deal with this stuff? Instead of the internet (you all rock by the way, no offense meant), should I be asking these questions to the insurance company? A tax person?
posted by cmm to Work & Money (12 answers total) 1 user marked this as a favorite
Well, first, it would help to know the relevant jurisdiction, i.e., where you live and where the policy was written.

Second, this is, in part, what tax lawyers deal with, at least in the US.
posted by dfriedman at 10:09 AM on January 23, 2012

Response by poster: I live in Illinois as did my grandfather when he bought the policy. The "financial representative" listed on the payment notices is in St. Louis MO.
posted by cmm at 10:11 AM on January 23, 2012

Seconding advice to see a tax attorney.
posted by smorange at 10:18 AM on January 23, 2012

You might also talk to that St. Louis rep on the account.
posted by small_ruminant at 10:47 AM on January 23, 2012

I strongly suspect they can't do this, since you didn't take out the policy and you were a minor at the time of all of this... but you need to talk to a tax lawyer.
posted by zug at 11:02 AM on January 23, 2012 [7 favorites]

that is a weird one. Let an attorney deal with the company. You shouldn't have been designated as the owner of the policy as a 5 year old and you wouldn't be a beneficiary of your own life insurance policy, so i can't imagine they could hold you responsible. Most of the time for a loan to be taken out on a life insurance policy, that policy would have to have been "paid up" or it would have a cash value that is only a fraction of the face value of the policy. Add that to the fact the loan was taken out long ago, and the whole thing is weird, weird, weird.
posted by domino at 11:15 AM on January 23, 2012

Best answer: It seems that if the loan was issued to your mom, the burden of settling any outstanding debts would fall to her estate. If you had an attorney probate her estate, you might start with a call to that attorney. But it would probably be in your best interest to follow up with a tax attorney.
posted by vignettist at 1:01 PM on January 23, 2012

Best answer: I can't see what the harm would be in contacting the financial representative listed and asking them some of these questions. Do you want a life insurance policy? The fact that it was taken out when you were so young might mean it's a pretty good policy, if not for the loan. The insurance company that issued it (or the administrator) can give you a better picture of how the policy is intended to be functioning. Hopefully they can also lay out your options for you in a non-biased fashion- but if you're sure you're going with an option where you take a tax hit, then yeah, you need a tax attorney.

The one other question that keeps coming up in my mind is- who actually owns the policy? Who is the beneficiary? It's weird that your grandfather would purchase a policy that he would be very unlikely to receive a death benefit from. If the statement you have doesn't show this, it might be good to check with the insurance company to make sure this really is your problem.

disclaimer: I am an insurance agent, but I am not your insurance agent and not qualified to give tax advice.
posted by Secretariat at 9:14 PM on January 23, 2012

Best answer: Who is the beneficiary? It's weird that your grandfather would purchase a policy that he would be very unlikely to receive a death benefit from.

I was once strongly encouraged by an agent to take out a whole life policy for my child. The reasoning being that (a) it would guarantee them cheap rate whole life insurance, guarding against them one day becoming uninsurable due to a future condition, (b) it would lock in a cheap rate and (c) it could be used as a vehicle for college savings. I consider all three to be weak arguments and would never do this.

I wish I had a definitive answer as to whether you are eligible for this liability--I doubt it. But note that this article explains that there should have been a formal transfer of the policy to you. If didn't occur, then the liability wasn't yours, unless it was passed on to you from your mother's estate.
posted by NailsTheCat at 6:11 AM on January 24, 2012

Response by poster: My grandpa bought this for like $500 a very long time ago as a gift probably for the same reasons NailsTheCat mentions. It's worth ~$15k now if you ignore the loan. Honestly, if my mom hadn't taken the loan out on it and then all the years of interest on the loan accruing, then it is something I would like to have. But I'd never buy non-term life insurance myself. We do carry term life insurance for both myself and my wife completely separate from this policy. I do not view this whole life insurance as key to my family's well being or anything. Right now, it is a pain in the ass!

I contacted the financial representative and am waiting a call back.

I have no idea who actually owns the policy. I started receiving the once-a-year loan repayment bills about a year after my mom died. I do not know if I was "receiving them" at her house and never seeing them before this or if they were in her name before this. I do not recall ever signing anything to move the loan over to me. But you never know what I did when I was 18 because my mom told me to.
posted by cmm at 8:54 AM on January 24, 2012

Response by poster: I'd imagine all the people looking at this are gone, but I got some more information from the Financial Rep.

The loan was taken out in 1996 and I was changed to the owner also in 1996. Because they don't have electronic records from then, they have to request records off microfiche. They didn't know whether the owner change was before or after the loan, but I'd imagine it was before. The loan was for $4800 in 1996 and to pay it back is ~$15k right now. Death benefit on the policy is ~$53k.

Once they get the official records from microfiche I should be able to see the loan papers and the ownership change papers. I assume if my name is on that (whether it was forged by my mom or not) then I'm going to be liable. Anyways, we'll see!
posted by cmm at 9:35 AM on January 26, 2012

Best answer: I'm still looking! I was curious about this. So it was taken when you were 21 huh. That raises further interesting questions:
1. If loan was taken out before you were an owner, whether you can be responsible for the tax on that loan. Logic (at least!) would suggest that you would not be liable for taxes on a loan you didn't receive.

2. If loan was taken out after you were an owner, one has to question how that happened. If it was forged can you really be held liable I wonder?

This article was interesting but reading the Surrender section there doesn't seem to be much wiggle room on the taxbility. The only thing you might want to consider is maybe delaying when you do surrender it if you think there will be a time when you will be in a lower tax bracket.

I'm not clear why the loan value + interest of $15k results is considered to be more than a $53k policy. (Although it's been a couple of years since I looked closely into whole life and decided it wasn't for me so maybe I've forgotten how it works.)
posted by NailsTheCat at 12:00 PM on January 26, 2012

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