Hidden Assets: Stop paying for unneeded life insurance
Some simple steps to stop paying so much - without triggering a big tax bill.
By Carla Fried, Money

(MONEY Magazine) -- It's easy to outgrow the need for life insurance. The kids become independent adults, you accumulate other assets for your family to fall back on or you finally burn your mortgage.

But it's not so easy to figure out what to do with the whole life insurance policy you bought years ago, still pay a hefty annual premium for but no longer need.

Cashing out - that is, taking whatever cash value has built up - is an option, but it can trigger a big tax bill. Any withdrawals you make that exceed what you paid in premiums will be taxed as income.

Peter Katt, a life insurance adviser in Mattawan, Mich., suggests a strategy that can save you from paying the premium, free up some cash without generating a tax bill, and keep a tax-free inheritance intact for your heirs.

Your first step is to check whether the internal rate of return on the policy's investment component is at least 4 percent or 5 percent. (To calculate that, divide the current cash value by the sum of last year's cash value and your annual premium.) "If your policy is earning that much, then it can definitely be worth keeping," he says. "That's 4 percent or 5 percent tax-free."

With an old policy, chances are your annual dividends are larger than your premiums. If so, stop paying the premium and tell your insurer to deduct that cost from your dividends every year.

Your cash value will still grow, just more slowly. Eventually, you may want some of that cash. As long as you keep your withdrawals to less than your cost basis (the total value of the premiums you've paid so far), you won't owe taxes.

As for the remainder: Unless you absolutely need the money, leave it untouched. When you die, it goes to your heirs tax-free. If the return is below 4 percent, however, you're better off withdrawing all the cash value, paying the taxes, and reinvesting the money.

One potential drawback to all this is the hassle factor; call your agent to put a stop to paying the premium, and you're likely setting yourself up for a sales pitch for another insurance product.

Katt recommends contacting the insurer directly to see if a kind soul in customer service will send you the paperwork. The good news is that even if you must endure a chat with an aggressive agent, you shouldn't have to pay a fee to cancel your premium when the policy is old.

7 Steps to Uncover Hidden Assets:

1. Cash in old savings bonds

2. Boost your savings rate

3. Stop paying for unneeded life insurance

4. Consolidate your retirement accounts

5. Prune your credit cards

6. Unload unused gift cards

7. Finally sell that lousy investment  Top of page

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.