Beware a ‘Friend’ Who Steers You to Variable Life Insurance Scheme

Q: I have a friend who is training to be a financial planner with a financial services company. She is urging me to transfer my 401(k) savings with Fidelity Investments to a variable universal life insurance policy with this firm. She said something about converting my money to tax-free status when I draw it out, as opposed to my 401(k), which will be taxable. I have not been able to find out much about this in my readings or Internet searches and I hesitate converting anything. Are you familiar with this program, and is it a worthwhile choice? I am 50 and my husband is 51, and between us we have approximately $500,000 in our 401(k)s. We already have a universal life insurance policy at group rates covering him and me for $100,000 and $135,000, respectively, at a very reasonable monthly cost.

A: This person is no friend, and if her company is recommending such a policy it should be reported to the state Department of Insurance.

This whole scheme is to benefit her, not you, and it could cost you a comfortable retirement. What she is asking you to do is to withdraw your money unnecessarily from a tax-deferred investment so that she can earn a commission when you buy a new life insurance policy. You would have to pay regular income taxes on any money you withdraw from your 401(k), plus a 10% federal penalty and 2.5% state penalty for taking the money out before age 59 1/2. In other words, you could lose half or more of your nest egg to taxes and penalties. And that’s just to start: You would end up paying more in administrative and management expenses, because investments via life insurance policies are usually much more costly than direct investments in mutual funds.

She’s touting tax-free withdrawals from the policy, but what she’s not telling you is that these withdrawals would be a loan against the policy’s cash value. If you don’t repay the loan, your heirs get less when you die.

I think it’s telling that you didn’t mention a need for more life insurance. It doesn’t make much sense to purchase more insurance if you already have adequate coverage; it doesn’t make any sense to take money out of a 401(k) to buy such insurance.

If you want to learn more about when a variable universal life policy might be appropriate, visit the tutorial at https://www.latimes.com/insure101.

Here’s a final note to all the insurance agents who write to me, complaining I’m too hard on the industry: This is the kind of nonsense that is absolutely endemic to your business. If you’re not willing to do something to clean it up, eventually the regulators will. Given how many people are being talked out of their money in schemes like this, it can’t happen too soon.

Living Trust Isn’t for the Mistrustful

Q: If there is only one copy of a living trust, and it’s in the possession of the successor trustee--the person who takes over managing the trust at the trust creator’s death--then who has the power to override the successor trustee? Couldn’t the successor trustee do anything he or she wanted with the estate? The attorneys tell you that you have to appoint someone you trust, but who can control what happens after you’re gone?

A: Indeed. Your state actually has a mechanism for ensuring your wishes are honored after you’re gone. A judge can be appointed to oversee the distribution of your estate, your desires can be entered in the public record, and everything can be handled very openly in court. This mechanism is called probate--and it’s the very thing your living trust is designed to avoid.

Probate can be expensive, time-consuming and complicated in some states, New York and California in particular. The lack of privacy is a significant deterrent to many who want their affairs handled without publicity. But the advantage of probate is that there is some court supervision, which makes fraud harder to conceal--at least in theory.

There are some laws designed to protect the wishes of those who create living trusts. Under California law, copies of the trust agreement must be distributed upon request to the beneficiaries and heirs-at-law (the people who would have inherited had there been no trust or will). If denied a copy of the living trust, the beneficiaries and heirs-at-law could take the successor trustee to court. Sometimes suspicious heirs will start a probate just to flush out a successor trustee who’s trying to keep the trust a secret.

The successor trustee, like the executor of an estate in probate, also can be held financially liable for any mistakes or misdeeds. That’s a pretty good incentive to do it right.

If you truly trust no one, however, you might want to forgo the advantages of a living trust and subject your estate to the public scrutiny of probate. But talk to an experienced estate planning attorney before making that or any other decision that affects what happens to your money and possessions after you die.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.