Should I Let My Life Insurance Policy Lapse?

Life insurance policies provide financial protection, yet circumstances can lead individuals to consider discontinuing their coverage. Allowing a life insurance policy to “lapse” means its termination due to the non-payment of required premiums. This decision carries significant financial implications and warrants careful consideration.

Understanding Your Current Policy’s Features

Life insurance policies typically fall into two main categories: term life and permanent life insurance. Term life insurance offers coverage for a specific period, such as 10, 20, or 30 years, and does not accumulate cash value. If premiums are not paid on a term policy, coverage generally ceases immediately, and no value is returned to the policyholder.

Permanent life insurance, including whole life and universal life policies, provides lifelong coverage as long as premiums are paid or sufficient cash value exists. These policies build a cash value component over time, growing on a tax-deferred basis and representing a portion of premiums paid. This cash value can be accessed by the policyholder during their lifetime.

The surrender value is the amount a policyholder receives if they cancel a permanent life insurance policy. This value is the accumulated cash value minus any outstanding loans, unpaid interest, and applicable surrender charges. Surrender charges are fees imposed by the insurer to recoup initial sales and administrative costs.

The death benefit is the amount paid to the designated beneficiaries upon the insured’s death. For permanent policies, non-forfeiture options allow policyholders to use accumulated cash value to prevent immediate termination if premiums are no longer paid. These options convert the policy into a smaller paid-up policy or extend the original death benefit for a shorter period.

Direct Consequences of Policy Lapse

Allowing a life insurance policy to lapse means the immediate cessation of coverage. The death benefit is no longer active, and beneficiaries will not receive any payout when the insured dies. This outcome defeats the primary purpose of life insurance, which is to provide financial security for dependents.

For permanent life insurance policies, lapsing can result in the forfeiture of any accumulated cash value, particularly if the policy has not been in force long enough to build substantial value or if the policyholder does not formally exercise a surrender option. If a permanent policy had outstanding loans or withdrawals that exceeded the amount of premiums paid, the difference may be considered taxable income upon lapse or surrender. This can create an unexpected financial burden for the policyholder.

Lapsing a policy can lead to a loss of future insurability on favorable terms. If new coverage is needed later, the individual will be older and potentially less healthy, which can result in higher premiums or even a denial of coverage.

Exploring Alternatives to Lapsing

Before allowing a life insurance policy to lapse, several alternatives can help manage coverage or retrieve value.

Surrendering the Policy

One option for permanent policies is to formally surrender the policy, canceling it to receive its surrender value. This process requires submitting a request to the insurer, who will calculate and remit the cash value minus any applicable fees and outstanding policy loans.

Reducing the Death Benefit

Another alternative involves reducing the policy’s death benefit. Lowering the coverage amount can decrease the required premium payments, making the policy more affordable.

Converting Term to Permanent

For those with convertible term policies, converting to a permanent policy may be an option, though this results in higher premiums due to lifelong coverage and cash value.

Utilizing Non-Forfeiture Options

Non-forfeiture options in permanent policies can prevent a complete lapse. Reduced paid-up insurance uses the existing cash value to purchase a smaller, fully paid-up permanent policy, meaning no further premiums are due. Extended term insurance uses the cash value to maintain the original death benefit amount for a limited, specified period, after which coverage expires.

Accessing Cash Value

Policyholders with permanent life insurance can access their cash value through policy loans or withdrawals. A policy loan allows borrowing against the cash value, with interest accruing on the borrowed amount; the loan reduces the death benefit if not repaid. Withdrawals directly reduce the cash value and the death benefit, and if they exceed the policy’s cost basis, they can be taxable.

Selling the Policy

For permanent policies with substantial cash value, selling the policy in a life settlement may be an option. A third party purchases the policy for an amount greater than its cash surrender value but less than the death benefit, providing immediate liquidity to the policyholder. A viatical settlement is a similar option specifically for individuals with a life expectancy of two years or less.

Contacting the Insurer

Contacting the insurance company directly is a prudent step when considering a lapse. Insurers may offer hardship options, premium adjustments, or guidance on utilizing policy features to help maintain coverage or manage costs. They can provide details about the policy’s cash value, surrender charges, and available non-forfeiture options.

Key Considerations Before Making a Decision

Before deciding whether to let a life insurance policy lapse, evaluate your current financial situation. Assess your income, expenses, and budget to determine if premium payments are unsustainable or if adjustments can be made elsewhere. This includes reviewing your ability to meet other financial obligations.

Consider the needs of your dependents and anyone who relies on your financial support. Evaluate their future needs, such as educational expenses, living costs, or mortgage payments, and how the absence of a death benefit might impact their financial stability.

Your current health status and insurability are important factors. If your health has declined since you purchased the policy, obtaining new coverage later may be more expensive or impossible. A lapse could remove your ability to secure affordable protection for your family.

Assess other financial resources that could provide for your beneficiaries in the event of your death. This includes savings accounts, investment portfolios, or other income streams that could replace the financial security offered by a life insurance death benefit. Relying solely on other assets might not be a robust long-term strategy.

Consider how the decision aligns with your future financial goals, including retirement planning and estate planning. Life insurance often plays a role in these long-term strategies. Any decision about lapsing a policy should integrate with your broader financial objectives.

While this information provides general guidance, consult with a qualified financial advisor or tax professional. They can offer personalized advice based on your financial circumstances, policy details, and potential tax implications.