What steps should you take if a grantor says they want to surrender their policy?

In the decade-plus that we have been managing life insurance for TOLI trustees, we have noticed that the weak link in their services usually is remediation. The inability to analyze policy options in changing situations is an area of future liability. Some trustees we have spoken with have surrendered policies because of a grantor request – with no policy review at all. This is a huge mistake.

If a grantor comes to you and requests a policy surrender, start by asking them the reasons why. There could be a legitimate reason. These days, it is often because they feel the policy is no longer needed since the rising federal estate tax exemption has sheltered over $22M of a married couple’s assets.

While the exemption amount did rise, and it did lower the number of those affected by the federal estate tax, things can change.  It seems like we just finished a presidential election, but another one is starting up, and though President Trump was successful in lowering the estate tax burden on the wealthy, his Democratic challengers are taking aim at the change. While the Republicans have introduced legislation to repeal the estate tax entirely, Bernie Sanders has suggested the exemption be lowered back to $3.5M, with a top federal estate tax rate of 77%, and others are following his lead. (1) While politics is beyond the scope of this blog, we would be remiss if we did not point out that the political winds of the next few years will dramatically affect the future taxation of many of your clients.

For those grantors who believe the estate tax will never affect them, that still does not mean the policy should be surrendered. The savvy TOLI trustee will point out the policy has more – not less – value for the beneficiaries since none of the benefit will go to the government. The additional amount the recipients will receive frees up other monies for the grantors to enjoy during their lifetime – a plus for them and another reason to keep the policy.

If a grantor insists on surrendering a policy, a TOLI trustee still has to review all options for the policy. A TOLI trustee cannot take orders from the grantor – they only provide policy funding for the trust, not guidance or direction.

The first step is to reach out to the beneficiaries. Do they know the policy is no longer going to be funded? Would they be able to support the policy? Do they want to? Remember, it is the beneficiaries who will sue you, not the grantor. So, make sure they are brought into the discussion if a policy benefit is to be reduced, and document all conversations in the trust file.

Assuming the beneficiaries do not want to fund the policy, a simple surrender still may not be the best option, and as a trustee, you will need to review all alternatives. Can the policy death benefit can be maintained until life expectancy without additional funding? If not, the death benefit may be able to be reduced so it does. If the client is still healthy, there may be a better option for the cash value in the policy in a more efficient policy, or if not healthy, maybe an annuity? If no options are attractive, before surrendering a policy, a review of the life settlement options should occur and be documented for the trust file. A life settlement can provide the trust with an amount much more significant than just the cash surrender value, and it can maximize the benefit of the policy for the beneficiaries.

No matter what option is chosen, make sure the trust file contains a logical explanation for the decision that was ultimately made along with a review of all alternatives examined. Whatever decision is made with the policy should be a prudent one that can be defended in court if required.

  1. Bernie Sanders to Propose Dramatic Expansion in Estate Tax on Richest Americans, Including 77 Percent Rate on Billionaires, Jeff Stein, The Washington Post, January 31, 2019.