24/7 Wall St. Key Takeaways:

• Life insurance policies can be surprisingly complicated, especially when they’re used as investment vehicles. Never take ownership of the policy until you understand the financial implications.
• Working with a professional can help you navigate your potential tax requirements and translate the policy’s fine print.
• Also: Take this quiz to see if you’re on track to retire (Sponsored)

Recently, a Reddit poster lamented about a life insurance policy their parents had taken out during childhood, and sadly, I don’t think this situation is all that uncommon!

Simply put, the Redditor’s parents had taken out a life insurance policy on them when they were younger, transferring ownership to the poster when they reached adulthood. Over the years, the policy’s cash value accumulated, but the parents ceased making direct premium payments, opting instead to cover costs through policy loans or dividends.

This decision eventually led to an outstanding loan balance of almost $27,000, with annual interest and premiums constantly adding to the cost! As the new policyholder, the Redditor is struggling with what to do.

Here’s some of my advice. But, remember, this is just my opinion and not financial advice:

Understanding the Policy

Life insurance policies can be surprisingly complicated, and we aren’t given the details of the policy in the post. That said, this is likely a whole life insurance policy, which typically requires an annual premium payment.

The accumulated loan balance can escalate over time by allowing the loan to cover premiums without contributing new cash. Eventually, this led to the loan threatening the policy’s viability.

Generally, policy loans are tax-free, which means that the Redditor wouldn’t owe taxes on the loan amount itself. However, taxes can arise on any gains from the original investment if the Redditor surrenders the policy.

With all that in mind, here are the Redditor’s options:

1. Maintain the Policy

The Redditor could decide to put enough money into the policy and maintain premium payments to keep the policy active. However, this does require financial commitment. That said, it does prevent lapsing and preserves the policy in case the poster passes.

2. Surrender

Alternatively, the Redditor could surrender the policy. This would allow the poster to cash out on the remaining value. However, this would also trigger taxes on the gains over your cost basis (how much he owes on the policy loan). In all likelihood, he would get a tax bill.

However, depending on how much the policy is worth, the gains may not be significant enough to matter! Plus, the cash value could be used to pay the taxes. It may be worth eliminating the debt, though this would mean losing the policy.

Because we recommend everyone have a life insurance policy, this would mean picking up another plan.

3. Seek Professional Guidance

Because life insurance policies and tax situations can be complicated, I would highly recommend seeing a professional in this case. They can help look at the policy’s fine print and calculate potential tax implications. This guidance could help alleviate some of the burdens that have come from the mismanagement of the policy thus far.

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