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Buying Your Father’s Term Life Insurance Policy

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Over the holidays, Reader John emailed me a question about secondary sales of life insurance policies. He had learned that his father was going to cancel his term-life insurance policy at the end of the month and he was considering “buying” it off his father by paying the premiums and collecting the death benefit. We didn’t get into the numbers but he said that the premium was increasing over the next three years, until his father hits 65, and then the value is cut in half. He ran the numbers and believes there’s a 5% annual return if he passes within 28 years (by age 91). He wanted to know if I thought this was a good idea.

It’s always tricky when it comes to family and money and it’s especially tricky if it involves death, family and money. All of the problems I see with this plan have to do with relationships and navigating those issues are going to prove more challenging than navigating the financial aspects of this idea.

The Investment

A 5% annual return over the next 28 years is good compared to the alternatives available right now. You can’t get a 28 year certificate of deposit but the yield on a thirty year Treasury today is around 4.40%. A 5% annual return is 13.6% increase over the safest of safe investments. It’s less than what you’d get in the stock market but it’s far safer.

I don’t know how John calculated the 5% return. I don’t know if he calculated it based on the premiums, whether he accounted for present value, or any of the other stuff that a true apples to apples comparison would consider. Ultimately, I believe the decision isn’t about money and more about the “other stuff” so I think this comparison is good enough.

The last few years have seen a boom in secondary sales of life insurance policies, where investors buy life insurance policies from individuals who are looking to cash out today. If investors can buy life insurance, that is to say they are paying someone for the right to make their premium payments, then certainly John should be able to generate a positive return if he can get a life insurance police for “free.”

The Other Stuff

In my brief emails with John, it’s obvious he’s able to separate the emotional from the financial. That may not be the case for his siblings. While he’ll probably discuss it with them all, when it comes down to the actual financial transaction (when his father passes), things may not be so easily resolved. Death is almost always a very emotional time and things decided, and documented, when the sky is sunny may not be so easily remembered when the clouds roll in. (John foresees this though, saying “Some potential issues that I foresee are disputes by my siblings at the time of payout and the claim that my mother would have on the benefit if she were still living at the time. Everyone seems onboard with the agreement today, although a couple decades may change their opinions.”)

There’s also the less significant issue of pitting your financial interests against your social interests. When an investor buys a policy, hopefully he isn’t sitting around hoping that the policy’s former owner dies. Even if he is, it doesn’t matter. If John sits around hoping he’ll die, that’s not very healthy. :) That said, it’s clear that John doesn’t feel this way but it could become an issue.

Here’s where you guys come in. John was curious whether you guys thought it was a good idea and whether it was worth causing potential drama between his siblings later on?

{ 29 comments, please add your thoughts now! }

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29 Responses to “Buying Your Father’s Term Life Insurance Policy”

  1. Glenn Lasher says:

    I think that if I were in John’s shoes, I might do this, but for entirely different reasons. I would do it because I would want Mom taken care of, and because I would want the funeral expenses paid, and because I would want Dad to have a nice funeral, and maybe list my siblings as beneficiaries as well so as to provide some consolation, but not because I wanted to make an investment of it.

    As such, I might do this as a gift to my family. I think making an investment of it is a sure-fire way to alienate myself from the rest of the family.

    I think doing this as an investment is an exceedingly bad idea.

    That said, if he doesn’t care about the rest of his family, then that might be another matter. Using the analogy of burning bridges, this is kind of like setting a time-bomb on a bridge. He’s got to make absolutely sure he’s good with never talking to his siblings or seeing his nieces and nephews again, and remember, in doing so, that he is also making that decision for his kids never to see their cousins. That’s the worst-case scenario, but it needs to be contemplated.

  2. echidnina says:

    I agree on both of your points – it looks financially sound but emotionally tricky. Even if he doesn’t see it this way, other people could interpret it as him essentially ‘betting’ that his father will pass by 91. Obviously it will depend on the context and the personalities of the people around him, but it could be delicate to maneuver through.

  3. DIY Investor says:

    I don’t know about the family stuff. From the investment perspective it is a matter of when the father dies. If he lives until he is 91 then it is a bad investment (speculation), especially if there is no inflation adjustment.
    Over the past 20 years stocks are up over 8%/year and this includes the worst period since the 1930s. At 8% money is up by a factor of 8 every 27 years. This will be a huge difference compared to the 5% he calculated. Plus, by investing it he has use of the money if he needs to get to it.
    If the father isn’t healthy, has bad genes, is a daredevil in the circus then it might be a good speculation. But if you want to speculate you might be better off buying gold.

  4. The only way I can see this arrangement working is if no one knows about it.

    If dad gives permission, then no one else needs to know. It’s too late now.

  5. Capt. Monterey Jack says:

    As we don’t know the details, it is apparent that John’s siblings are not paying any part of the premiums. So in my opinion, the money upon death should go first to John’s mother (as it appears that was what the insurance was originally for), and if she’s not around John can decide how it’s used. If the siblings want a say, they should go in with him on paying the premiums.

    • Jim says:

      If John is paying the premiums, why should his mother get the proceeds?

    • Russel.G says:

      If John’s parents live in one of the 10 community property states, John’s mother may have a community property interest in the policy that John’s father is not able to sell without her consent.

      • Jim says:

        Excellent point, I think he has consent so that wouldn’t be an issue in this case.

      • Attny says:

        I have to be honest, I think everyone on this site needs to do a little more research and be more hesitant to give financial advice. No one here seems to know what they are talking about. Jim Wang fails to take into account certain realities about life settlments and the people commenting do also. Jon should seek advice from a professional to understand the risks assocaited with these actions. Where you are screwing up is that you are not factoring in the risk of loss assocated with an ins. co. challenge. You aren’t factoring in legal expenses w/r/t securing the funds post death. There is also a reasonably risk of no return if the ins. co. refuses to pay. Then, you need to consider the “settlement aspect” and the return will be decreased to likely 10% face value if you have a decent attorney. There are a mutltitude of issues here. I would say a ball park return, when risk of loss is factored in, reasonably speaking, is 1% – 2.5% per year (off of his 5% analysis) and that is spreading risk, ie. there is a reasonable risk of total loss if he is an outlyer. You should watch giving advice like this when you are not experience in this area.

  6. Ketan says:

    With so many other investment options, why bark up this tree?

    I like the first response – it’s only okay to do for your family, not inspite of.

  7. rob says:

    Don’t assume its sound financially – depending on the status of his dad’s estate, the estate may need to come after the life insurance benefits to pay taxes.

  8. freeby50 says:

    Speculating on the death of your family members is not a nice idea and would look pretty bad to outsiders or other family. For that reason alone I would avoid this kind of thing.

    Paying the premiums to help out his parents for that reason and that reason only is just fine though. Paying the premium to make sure mom is provided for makes sense. But I wouldn’t do it with any obligation that John gets the death benefit.

    I’m surprised that a term policy would last till age 91. Did he get a 30 year term policy at age 61? Thats pretty unusual to have a term policy that late in life. I’d assume the premiums would be very high.

    If he wants a 5% return he should just pay off his home mortgage.

  9. zapeta says:

    This isn’t an attractive investment to me because this could really end up backfiring and hurting a lot of feelings in the family upon death. I don’t know John’s risk tolerance but a 5% yield is good but not great as far as I’m concerned. I’d try to find another investment.

  10. Demi says:

    Unless it is done out in the open and everyone contributes with the understanding that mom (or dad) comes first, THEN the proceeds are split between the kids or the balance is given to the other parent…steer clear. Personally I would never stiff my brothers and sisters nor would I stand for any one of them not helping with the cost (if there was any out of pocket by the kids or parent) to bury either of my parents. If I were an only child…then I would consider it an investment but ONLY after mom or dad is/are properly taken care of.

  11. daenyll says:

    If the father were planning on dropping the policy it would not eventually be available to any family upon his death. If John approaches it as an investment he should offer the rest of the family the chance to buy in a part of the premiums for equivalent proportions of the payout. And if the surviving mother is in need it should be determined ahead of time what claim she should have to the support from any proceeds( keeping all in understanding that if the father drops this policy there will be NO Proceeds to make claim on)

  12. govenar says:

    How much risk is there that the insurance company won’t pay? For example, if they consider the death to be a suicide, will they not pay? Or if they claim that the son caused the death?

  13. Really, this seems like an extremely risky decision, from almost all angles. If John was an only child, that would be one thing – but siblings are the wild card, and unless he’s including them in the decision there’s no way they’ll feel good about it when the time comes.

  14. Shirley says:

    If Dad is going to drop the policy because he can no longer afford the premiums, and if siblings cannot afford to help with them but you can, then just take over the payment of premiums and leave everything the way it was originally written.

    This is not an investment chance. It’s a chance to lend a helping hand to those who have helped you many times in one way or another.

  15. Evan says:

    Legal aspects:
    No one is bringing it up and I would BE SHOCKED if John knew about it, but there is something called “Transfer for Value” associated with the sale of life insurance. Policies which are sold and don’t meet an exception would be subject to income taxes when paid out.

    If, however, dad were to gift the policy and John left his brothers or mom as beneficiaries there may be a problem known as the Goodman rule. In which is making a gift to his brothers/mom. This may or may not matter depending on the size of John’s estate.

    Investment aspect:
    There is an entire successful industry based on STOLI, Stranger Owned Life Insurance – so if John is doing his math right he may actually have a good investment that is none of his family’s business when it pays out.

    Notwithstanding from the facts the contract seems like it was a 20 year term that is ending when dad is 65 and then going through the roof, so the calcs done by John are VERY important.

  16. Gates VP says:

    There is an entire successful industry based on STOLI, Stranger Owned Life Insurance…

    Though it’s kind of perverse, I can indeed “see” such a thing. The only problem with this case is that it’s not really “stranger-owned”, it’s owned by a possible beneficiary (in this case, the expected beneficiary).

    Honestly, even if “John” gets all of the relevant paperwork signed by everybody, he’s still running some serious risks.

    – His father living past 91
    – Insurance taking years to pay out the policy pending court cases. (clearly John is the first suspect in any unusual death)
    – Inability to cover the premium at some point in the next 25 years. If he loses his job, he still has to pay for the policy.
    – His father voiding the policy in some way (lying about smoking, jumping out a plane, etc.)
    – John should probably not be in line to make any medical decision on his father’s behalf as this would represent a serious conflict of interest.
    – Lost cash flow. This is basically a multi-year gamble that you pay for using free cash-flow. At least if you drop the money in some investment vehicle you can grow it slowly and cash out partway through. This bet costs today’s money and may never pan out.
    – Strange local laws. Some places have basic practices that over-ride wills. For example, I know someone who has allocated money to all of their children, even those who should not get anything (black sheep, stolen money, etc). Those children are getting allocations only to ensure that they were included in some way.

    Either way, there are lots of risks to mitigate and that has no real consideration for family concerns. It’s not clear that the payout on this is terribly stellar either.

  17. eric says:

    I didn’t even know you could buy off someone else’s policy. On paper it might sound good but I sense a lot of drama in the future that can come up. Personally, I would rather avoid it.

  18. CameoWalkin says:

    It’s smart. Many people have had to choose between insuring themselves to protect surviving family, and buying a plot and burial package through their preferred morgue; there wasn’t enough money to buy both, and pay bills. So when they die, they leave the burial and plot costs to survivors. Even worse, when they’re forced to live on social security alone, they cannot continue to pay their life insurance. This leaves survivors holding the debts with no way to cover the costs. (That’s not the desired result!) Do the smart thing, and communicate regularly with family about the practical reasons, putting them in remembrance of all the financial obligations at death. Ignorance is too costly to ignore, and the pretense that somehow there will always be enough to pay costs is reckless and foolish.

  19. CameoWalkin says:

    You might want to designate, both through the will of the potential future deceased, and through a codicil to the policy, by the policy owner (if this is possible), that burial plot and funeral costs are to be paid in their entirety out of the policies proceeds First — after that, the lifetime costs of policy premiums should be reimbursed (first to the current policy owner; and second, to surviving spouse of the deceased, but only a spouse) — and that whatever remains should go to the policyholder(s)

  20. SavingWisely says:

    Its sad that life insurance involves someone dying but its a great way to protect your family from bills that are unpaid if you were to leave this world. I was also wondering if you can add me to your blogroll.

    Blog: 30sfinance.blogspot.com
    1 Million Dollars by age 35!

  21. Matthew says:

    We know that the life insurance industry is profitable. We know they only take money in through premiums. We know, therefore, in order to stay in business issuing policies like this one, they must include in the premium:

    The face value of the policy, multiplied by the fraction of the population which is expected to die.
    (+)
    Overhead expenses.
    (+)
    Profit.

    This is just legalized gambling. We’re talking odds. Except instead of cheering on horses, you’re hoping – financially – that you father dies sooner than later.

    And if his father lives to 92? He doesn’t gain 5%. He loses 100%. He gets zilch, zero, nada.

    Yes,the average life for men is in the 70s. But by the time you reach 62, your expected life is longer. You see, when the teenagers die in a car crash it skews the number down significantly.

  22. Leah says:

    Its not that uncommon, I pay for my parents life insurance, because the 400 dollars a month I pay for the Permanent policies, (not terms) ensure that if something happens, I will have the cash to bury them. They’re not an investment, my brothers and sisters are aware, and when my parents retired and lost thier employer life coverage, I was more than happy to help them with this expense. I am beneficiary cause I’m paying the bill. Same note, if something happens to my mom before my dad, my dad is not able to take care of himself and that will be my responsibility. If something happens to my mom, I will pay for my dads funeral because she doesn’t have that much cash to take out of her savings. She spends most of her income taking care of my dad. Niether of us have 10 -15k to pay for a funeral without the insurance.


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