Life Insurance: Missed Payments And Their Consequences

Whole life insurance is a type of permanent life insurance that provides coverage for the entirety of the insured person's life. It is different from term life insurance, which only provides coverage for a specific number of years. Whole life insurance policies have a cash savings component, known as the cash value, which the policy owner can draw on or borrow from. However, if the policy owner stops making premium payments, the policy may lapse and the insurance company may terminate the policy, leaving the policy owner without coverage. The specific consequences of failing to make payments depend on the terms and conditions of the policy.

Grace periods

If you miss a premium payment on your whole life insurance policy, be sure to take advantage of the grace period to get your account up to date. Contact your insurance provider to confirm the length of the grace period and make the necessary payments as soon as possible. It is important to note that if you do not make the required payments within the grace period, your policy may lapse, and you may have to pay reinstatement fees or face other consequences to resume coverage.

To avoid missing premium payments in the future, consider setting up automatic payments or switching to a monthly payment plan. These options can help you stay on top of your payments and ensure that your policy remains active. Additionally, reviewing your policy documents or consulting with your insurance provider can help you understand the specific grace period and payment requirements for your whole life insurance policy.

In summary, grace periods offer a second chance to maintain your whole life insurance policy in the event of missed payments. Taking advantage of this period can help you avoid a lapse in coverage and ensure that your policy remains active.

Cashing out

If you have a whole life insurance policy and can no longer afford the premium payments, or you simply no longer want to keep paying them, you do have the option to cash out the policy. This means that the insurance company will disburse the cash savings to you and you can use the funds as you see fit. However, it is important to note that if you cash out your policy, you will lose your life insurance coverage. Additionally, you may be responsible for paying income taxes if the amount you receive is more than what you paid in premiums.

Before cashing out your policy, it is recommended that you explore other options to maintain your coverage. This is because you will likely pay more for the same coverage later, as age is a key factor in determining rates. Additionally, if your health changes, you may not be able to get coverage again, or it may be very costly. There could also be tax implications if you cash out your policy, as the cash value in a whole life policy accumulates on a tax-deferred basis. If you terminate your policy and take the cash value, a portion of it could be considered ordinary income and be taxed at your current tax rate.

If you are considering cashing out your whole life insurance policy, it is important to weigh the pros and cons of this decision. On the one hand, you will have access to a lump sum of cash that you can use for other purposes. On the other hand, you will lose the financial security that comes with having life insurance coverage. Additionally, there may be tax implications and you may end up paying more for coverage in the future if your health changes.

If you decide to cash out your policy, you can contact your insurance provider to discuss the process and any potential fees or penalties that may apply. It is also a good idea to consult with a financial advisor to understand the tax implications and how this decision could impact your overall financial plan.

Policy reinstatement

If you miss a premium payment on your whole life insurance policy, the grace period to bring your account back into good standing begins, after which the policy will lapse. However, if you miss a payment, you can usually reinstate your policy within two years of it lapsing. The process for reinstatement varies depending on the insurance company, but there are some general steps you can take.

Firstly, contact your insurer directly to find out your options. You will likely have to submit a reinstatement application and pay back any missed premiums (plus late fees or interest). You may also have to fill out a questionnaire about your health and attest that your health condition hasn't changed since your policy was approved. Your insurer might also check your medical records or require you to take a life insurance medical exam. If your health has deteriorated, the insurance company might not reinstate your policy.

If the insurer agrees to reinstate the policy, you will have to pay all of the premiums owed, plus any interest charged on past-due premiums. A common interest rate for this is 6%.

Reinstating a lapsed policy is often cheaper than buying a new one. The benefit of reinstating an existing policy is that you'll likely pay less. If your health hasn't changed, your insurer will honour the original pricing on your policy. If your health has changed, that could affect your rate, but your age won't be a factor as the premium will still be based on the age you were when you first applied for coverage.

How to Avoid a Lapse

To avoid missing a premium payment, you can set up automatic payments or switch to an annual payment schedule. You can also take advantage of flexible premiums if you have a universal life insurance policy, or use the cash value or dividends in your policy to pay premiums.

Dividends to pay premiums

Dividends can be used to pay your life insurance premiums. This is a great option if you want to keep your policy and don't need the dividend payments.

Dividends are extra money paid out to you by the insurance company. They are generated when the company performs better than expected. When this happens, the company chooses to pay some or all of the surplus money back to its shareholders and policyowners.

If you have an older policy that generates significant dividends, you can request to use these dividends to pay your premium. This is a good option if you don't need the dividend payments and want to keep your policy.

Some companies allow you to leave the dividend as a "credit" on your premium, so you pay less per month and keep your coverage. Other companies may require you to use the dividend to purchase additional coverage, which will increase your cash value.

It's important to note that dividends are not guaranteed and are determined by the insurance company's board of directors.

Tax implications

If you stop making payments on your whole life insurance policy, there can be several tax implications, depending on the specifics of your policy and your circumstances. Here are some key points to consider:

• Interest on loans: If you have taken out a loan against the cash value of your policy, you will be charged interest on that loan. This interest is generally not tax-deductible. If the loan is not repaid before your death, the insurance company will reduce the death benefit paid to your beneficiaries by the outstanding loan amount and any accrued interest.
• Policy lapse: If your policy lapses due to non-payment of premiums or insufficient cash value, any outstanding loan balance that exceeds the total premiums you have paid (your cost basis) will typically be treated as taxable income. This can result in an unexpected tax bill.
• Surrendering your policy: If you surrender (cancel) your policy, the cash surrender value (CSV) you receive may be subject to taxation. If the CSV is higher than the total premiums you have paid, the excess amount will generally be taxed as ordinary income.
• Modified endowment contracts (MECs): If your policy is a MEC, the tax treatment of withdrawals and loans is different. Withdrawals are taxed on a last-in, first-out (LIFO) basis, meaning all withdrawals are treated as taxable income until they equal the total interest earnings in the contract.
• Dividends: While dividends received on a whole life insurance policy are generally not taxed, any interest earned on those dividends is considered taxable income and must be reported.
• Estate taxes: If you name your estate as the beneficiary of your policy instead of a person, the death benefit may be subject to estate taxes if the total value of your estate exceeds the federal estate tax exemption.
• Beneficiary taxes: While the death benefit paid to your beneficiaries is generally not taxable, any interest earned on those payments is taxable income for the beneficiary. Additionally, if the policy was transferred to the beneficiary for cash or other valuable consideration, the taxable amount of the proceeds may be limited to the sum of the consideration paid, additional premiums paid, and certain other amounts.
• Business-owned policies: If a business owns your policy or pays the premiums, there may be additional tax implications. For example, if your employer pays for more than $50,000 in life insurance coverage, the value above this amount is generally considered taxable income to the employee.

Frequently asked questions