What Are Nonforfeiture Options? 3 Types Explained

Nonforfeiture options are important provisions within life insurance policies that accumulate cash value. These clauses protect a policyholder’s accumulated value if they cease premium payments or decide to terminate the policy. These provisions are required by state governments to ensure policyholders do not forfeit years of accumulated value due to missed payments.

Understanding Policy Cash Value

Cash value represents a savings component residing within a permanent life insurance policy, such as whole life or universal life insurance. This value grows over time as a portion of each premium payment is allocated to it, along with any interest or investment growth, depending on the policy type. Nonforfeiture options become available when a policy with sufficient cash value is surrendered or when premium payments stop. Generally, a policy needs to have been in force for a minimum period, often around three years, before these options can be activated.

The Cash Surrender Value Option

The cash surrender value option allows a policyholder to terminate their life insurance policy and receive a lump-sum payment of the accumulated cash value. The amount received, known as the cash surrender value, is the policy’s cash value minus any outstanding loans, prior withdrawals, or applicable surrender charges. Surrender charges are fees imposed by the insurer to discourage early policy cancellation and typically decrease over time. Once this option is exercised, the policy ceases to exist, and the death benefit is no longer in force, meaning beneficiaries will not receive a payout upon the insured’s death.

If the cash surrender value received exceeds the total premiums paid into the policy (the cost basis), the excess amount is generally considered taxable income. Policyholders should consult with a tax advisor to understand the specific tax implications for their situation before choosing this option. This option provides immediate liquidity but ends all insurance coverage.

The Reduced Paid-Up Insurance Option

The reduced paid-up insurance option utilizes the existing cash value of a permanent life insurance policy as a single premium to purchase a new, fully paid-up life insurance policy. This new policy requires no further premium payments for the remainder of the insured’s life. While the policy remains in force permanently, the death benefit will be reduced compared to the original policy’s face amount. The amount of this reduced death benefit is determined by the policy’s cash value at the time of conversion and the insured’s age.

This option is suitable for policyholders who no longer wish to pay premiums but want to maintain some level of permanent life insurance coverage. It provides a continued death benefit without ongoing financial obligations.

The Extended Term Insurance Option

The extended term insurance option uses the policy’s accumulated cash value to purchase a new term life insurance policy for the original face amount. This term policy remains in force for a specific duration, which is calculated based on the available cash value and the insured’s age at the time of conversion. During this extended term, the death benefit remains the same as that of the original permanent policy.

Once the specified term period expires, the coverage ends completely. This option provides continued coverage for the full original death benefit for a limited period without requiring further premium payments. It offers a temporary solution for maintaining a substantial death benefit when premium payments are no longer feasible.