Life Insurance: When To Cancel And Why

Life insurance is a financial tool that helps reduce the risk of financial troubles for your loved ones after your death. However, not everyone needs life insurance for their entire lives. If you're considering cancelling your life insurance policy, it's important to carefully weigh the pros and cons of doing so. On the one hand, cancelling your policy can save you money on premiums, especially if you no longer need the coverage or if the premiums have become too expensive. On the other hand, cancelling your policy can have far-reaching financial consequences and leave your loved ones vulnerable to financial loss in the event of your death. Ultimately, the decision to cancel your life insurance depends on your individual circumstances, such as your age, health, financial situation, and the type of policy you have.

When is life insurance no longer needed?

Life insurance is a tool that helps reduce the risk of financial troubles for your loved ones after your death. However, there are times when life insurance is no longer needed. Here are some scenarios that indicate you may no longer need life insurance:

Your children are financially independent

If your children have established careers and are financially independent, the need for life insurance may decrease. This is because one of the primary purposes of life insurance is to ensure your loved ones can maintain their lifestyle and financial obligations in the event of your death.

You have paid off significant expenses and accumulated savings

If you've paid off your most significant expenses, such as your mortgage, and have accumulated significant savings, your family may be able to keep up with daily expenses and payments even in your absence. In such cases, the need for life insurance may be reduced or eliminated.

You have no present or future financial obligations

If you have no outstanding debts, such as credit cards, loans, or future financial commitments like college tuition for your children, then the need for life insurance is diminished.

You can afford end-of-life expenses

End-of-life expenses, such as funeral costs, can be significant. If you or your family can afford these expenses, life insurance may not be necessary.

Your income is no longer relied upon

If you are no longer the primary breadwinner, and your family can maintain their lifestyle and financial obligations without your income, then life insurance may no longer be required.

You are switching policies or insurance companies

If you've found a new policy that better suits your needs, it's important to ensure that your new policy is in force before cancelling your existing one. This will prevent any gaps in coverage and protect you and your loved ones.

It's important to note that the decision to cancel life insurance should be made carefully and in consultation with a financial advisor or insurance expert. Cancelling life insurance may have financial implications and leave your loved ones vulnerable. It is also important to review your financial situation and risk regularly to determine if life insurance is still necessary.

What are the downsides of cancelling?

Cancelling life insurance can have several downsides, depending on your specific circumstances and the type of policy you hold. Here are some key considerations:

Vulnerability to Financial Loss

Cancelling life insurance means those who were protected by it will lose out on the death benefit and become vulnerable to financial loss. This is especially true if you have minor children or a spouse who depends on your income. Without life insurance, they may struggle to maintain their lifestyle and cover essential expenses in the event of your death.

Difficulty in Obtaining Future Coverage

It may not always be easy or possible to obtain life insurance coverage again in the future. Cancelling your current policy could result in higher charges or even denial of coverage if you reapply due to the development of pre-existing medical conditions or simply because of aging. The two-year contestability period will also reset if new coverage is purchased, increasing the risk of loved ones not receiving payment in the event of a death during this period.

Loss of Accumulated Cash Value

If you have a permanent life insurance policy, such as whole life insurance, it includes a savings component called a cash value account. Cancelling this type of policy means losing any accumulated cash value, as insurance companies may charge high-interest rates on missed premium payments, resulting in a balance that quickly outpaces the cash value.

Tax Implications

Cancelling a permanent life insurance policy can have tax implications. Cashing out the policy is considered a taxable event, and you may owe income tax on the gains made from the policy. This could significantly reduce the amount of money you receive when cancelling.

Surrender Fees and Reduced Payouts

Cancelling a permanent life insurance policy may also incur surrender fees, especially if you cancel within the first ten years of owning it. The surrender value will be reduced by any outstanding policy loans and unpaid premiums, resulting in a lower payout than expected.

Impact on Beneficiaries

Cancelling life insurance leaves your beneficiaries and family members without protection in the event of your death. They will no longer receive the financial support that the policy would have provided, which could be crucial for covering expenses or maintaining their standard of living.

How to cancel term life insurance

Cancelling term life insurance is a fairly simple process. Here is a step-by-step guide on how to do it:

Step 1: Understand your policy

Firstly, it is important to understand the terms and conditions of your policy. Check the fine print for any specific instructions or requirements for cancellation. This will ensure you are aware of any potential fees, charges, or penalties that may apply.

Step 2: Contact your insurance provider

Notify your insurance provider of your intention to cancel. You can do this by calling them or sending a letter or email. Include your full name, contact details, policy number, and the date you wish to cancel the policy. Some providers may also offer an online cancellation form.

Step 3: Stop premium payments

To cancel a term life insurance policy, you can simply stop paying the premiums. This will trigger a grace period, usually of 30 days, during which you can make up any missed payments and keep the policy active. If you do not make any payments during this time, your coverage will end.

Step 4: Confirm cancellation

If you have not received a confirmation of cancellation from your insurer within a few business days, be sure to follow up with them to ensure the policy has been cancelled as requested.

Other considerations:

• Free look period: Many policies offer a "free look" or "cooling-off" period, typically lasting 10 to 30 days from when the policy is issued, during which you can cancel without penalty and receive a full refund of any premiums paid.
• Alternatives to cancellation: If you are struggling with premium payments or are unhappy with your current policy, consider alternatives such as reducing your coverage amount, switching to a different policy, or shopping around for a new provider.
• Beneficiaries: Before cancelling, check with your beneficiaries to ensure they will not be negatively impacted financially.

Remember, cancelling your term life insurance policy is a big decision and it is important to carefully consider your options and the potential consequences.

How to cancel permanent life insurance

Permanent life insurance is a type of insurance that provides coverage for the duration of one's life. It is not cheap, and many people choose to cancel their policies within the first three years. However, some hold on to their policies for much longer, opting to cancel after 10 or more years.

Cancelling After 2-3 Years

During the first 2 to 3 years, policyholders typically have not accumulated a lot of cash value in their policies, so cancelling during this period is different from cancelling in subsequent years. This initial period is considered the surrender period, during which most insurance companies do not refund the cash value. Instead, they apply penalties and calculate their losses for early termination, resulting in no accrued value being returned to the policyholder.

Cancelling After 10 to 20 Years

The longer you hold on to your policy, the lower the surrender amount will be. While it may still be a significant percentage during the first 5 years, after 10 years, it could drop to 1% or even 0%. At this point, policyholders can cancel without incurring a penalty or fee. The amount required to surrender the policy should be listed in the policy documents.

Cash Value and Surrender

When you decide to surrender your policy, the cash value collected is paid back after all penalties and fees are deducted. This amount is called the cash surrender value of your policy and depends on how long you have had the policy.

Calculating Cash Surrender Value

The cash surrender value is always lower than the whole cash value amount due to the fees involved in cancelling a whole life insurance policy. Insurance companies calculate the surrender value by subtracting fees charged for the management of the policy from the current cash value.

Cash Surrender Value and Taxes

Whole life insurance policies are attractive because they are tax-free. This means policyholders don't pay taxes on the accrued value, which can save them a lot of money annually. However, a portion of the cash surrender value of a whole life policy is subject to taxes. This portion is determined by comparing the amount due to the policyholder to the cost basis, and any amount over the cash basis paid out is taxable.

Cancelling Your Policy

To cancel your permanent life insurance policy, you have the following options:

• Surrender the policy for its net cash value: Whole life and universal life plans include a savings component, and the policy's cash value grows over time, tax-deferred. After your policy has been in force long enough, you can surrender it for its net cash value. When you surrender the policy, you will receive its net cash value, not the actual cash value, after any surrender fees are deducted. If you have had the policy for more than 15 years, the net cash value is likely to be very close to the actual cash value.
• Go for a reduced paid-up option: If you no longer want to pay premiums but still want some insurance protection, consider a reduced paid-up option. The insurer will cancel your existing policy and use its cash value to fund a new policy with a guaranteed death benefit. Since the new policy is paid up, you won't have to make any further premium payments, but the payout will be lower than the original policy.
• Stop paying premiums: If you stop paying premiums on a cash-value life plan, some providers will cash out the policy and end coverage, while others will use the cash value to cover premium payments. When the cash value is exhausted, the coverage will end. If the policy had insufficient cash value to begin with, it will automatically lapse once the grace period for premium payment ends.

When to Cancel Your Permanent Life Insurance Policy

Cancelling a life insurance policy is a significant decision that can have repercussions. While you can cancel your policy at any time, it is essential to consider the financial implications and whether you still need coverage. Cancelling a policy may make more sense at certain times, such as when your dependents have become financially independent, or you find a better rate with another insurer.

Considerations Before Cancelling

Before cancelling your permanent life insurance policy, consider the following:

• Consequences: When you cancel a policy, your beneficiaries and family members will be left without protection if you die. It is essential to assess your finances and estate to ensure they are sufficiently protected through other means.
• Financial difficulties: If you are struggling to make premium payments, consider discussing a lower coverage amount with your insurance company to reduce your payments.
• Alternatives: Instead of cancelling, you may be able to switch to a different policy, ask for a new medical exam to qualify for lower premiums, or let your policy's cash value pay your premiums.

Receiving Money Back After Cancellation

Whether you receive any money back after cancelling your permanent life insurance policy depends on various factors. Whole or universal life plans will provide a refund if they have accumulated enough cash value. Additionally, if you cancel during the free-look period (usually 10-30 days) or in the middle of a payment cycle, you may receive a refund for the unused portion of the premium.

What are the alternatives to cancelling?

Alternatives to Cancelling Life Insurance

Cancelling your life insurance policy isn't advisable if anyone still relies on your financial support. Here are some alternatives to consider:

• Ask for a new medical exam: If you've lost weight, quit smoking, or made other lifestyle changes to improve your health, you could qualify for lower premiums.
• Lower your coverage amount: Most life insurance providers will allow you to decrease your coverage amount at least once, helping you maintain some coverage.
• Let your policy's cash value pay your premiums: If you have a whole life policy, you may be able to use the cash value to cover your premiums until you can afford to pay them out of pocket. This will keep the policy's death benefit intact while giving you the cash infusion you need.
• Sell your policy: This can be complicated, but it's possible to get offers from reputable brokers or settlement companies who will act as intermediaries. While it enables you to get cash, it may take a few months to complete the transaction.
• Switch to a different policy: Consider shopping for a new policy with a lower rate or switching to a reduced paid-up option for your insurance.
• Tax-free exchange: This is a 1035 exchange that allows you to replace your current life insurance policy with a new one without paying taxes. You surrender your whole life insurance policy and roll over the money into a new life insurance policy or annuity, avoiding income taxes.

Frequently asked questions