Can I Cancel a Life Insurance Policy?

Life insurance policies are designed to provide financial security for beneficiaries after the policyholder’s passing. However, circumstances change, and policyholders may consider canceling their policy. While generally possible, the process and financial implications vary by policy type.

Steps to Cancel a Policy

Canceling a life insurance policy typically involves direct communication with the insurer. Policyholders can contact them by phone, through an online portal, or by sending a written request. Have your policy number and personal identification details readily available.

The insurer will provide specific instructions, possibly requiring a surrender form or formal written notice. For permanent policies, this form authorizes the release of any accumulated cash value. Sending written requests via certified mail provides a record of the communication.

After submitting documentation, expect written confirmation of cancellation, including the effective date and financial disbursements. Confirm full termination to avoid future premium obligations.

Financial Implications of Cancellation

Canceling a life insurance policy has significant financial consequences, particularly for permanent policies like whole life or universal life. These policies build cash value, which can be accessed upon cancellation. The amount received, known as the cash surrender value, is the accumulated cash value minus any applicable fees.

Surrender charges are fees deducted from the cash value when a policy is canceled prematurely. These charges are higher in the early years, often ranging from 10% to 35% of the cash value, and decrease over time, sometimes disappearing after 10 to 15 years. The actual cash surrender value is calculated by subtracting these fees and any outstanding loans from the policy’s cash value.

Tax implications arise if the cash surrender value exceeds the total premiums paid. The Internal Revenue Service (IRS) considers any amount received above the “cost basis” (total premiums paid) as taxable ordinary income. Policyholders may receive a Form 1099-R for such taxable distributions, which must be reported. Term life policies do not accumulate cash value, so canceling them does not involve a cash surrender value, surrender charges, or associated tax implications.

Other Options Instead of Full Cancellation

Before fully canceling a policy, several alternatives can provide financial flexibility or continued coverage.

Policy Loans: Available with permanent policies, these allow borrowing against accumulated cash value. Interest accrues, and an outstanding balance reduces the death benefit, but repayment is flexible.
Reduced Paid-Up Insurance: Use accumulated cash value to purchase a smaller, fully paid-up policy. This stops premiums while retaining some permanent coverage with a reduced death benefit, typically for whole life policies with sufficient cash value.
Accelerated Death Benefits: Often included as riders, these allow access to a portion of the death benefit while alive under specific circumstances, such as a terminal or chronic illness. This provides funds for needs without fully surrendering the policy.
Life or Viatical Settlements: Policyholders can sell their policy to a third party. A life settlement is for a lump sum greater than cash surrender value but less than the death benefit, often for individuals with reduced life expectancy or those aged 65 and older. A viatical settlement is similar but specifically for individuals with a terminal illness, often resulting in a higher payout and being tax-exempt.

Key Considerations Before Cancelling

Before canceling, evaluate your personal financial circumstances and future needs. Assess financial dependents, such as a spouse or children, who rely on the death benefit. Re-examine the policy’s original purpose, whether for income replacement, mortgage protection, or estate planning.

Your current health status is a significant factor. New life insurance coverage becomes more expensive with age and new health conditions. Premiums for new policies can increase by 8% to 10% annually, with larger increases after age 50. Obtaining new coverage might also be difficult or impossible with certain pre-existing medical conditions.

Understand the cost of new insurance compared to your existing policy’s value. Weigh the financial implications of losing coverage, including the absence of a death benefit for beneficiaries, against the benefits of cancellation.