Three Considerations If You Are Thinking to Cancel Your Life Insurance Policy
We are often asked by clients if they should keep or cancel their life insurance policies. Here are three things to consider as you explore this topic in your own family.
First, ask yourself if you still need life insurance. Think about why you bought this insurance policy in the beginning. Some common answers we hear:
- Financial support for dependents: If you have loved ones who rely on your income, life insurance can provide financial support to replace your lost income in the event of your death.
- Debt repayment: If you have outstanding debts, such as a mortgage, car loan, or credit card balance, life insurance can be used to cover these obligations, ensuring that your loved ones are not burdened with the debt upon your passing.
- Funeral and final expenses: Life insurance can help cover the costs associated with your funeral, burial, or other end-of-life expenses, relieving the financial burden on your family.
- Business continuity: If you own a business, life insurance can be utilized to ensure its continuity by providing funds for succession planning, settling business debts, or compensating for the loss of a key person in the organization.
- Estate planning: Life insurance can play a role in estate planning by providing liquidity to pay for estate taxes (if applicable), ensuring that your heirs receive their inheritance without the need to sell assets.
If you would like help calculating the need for life insurance, please read Jim’s Calculating The Need For Life Insurance article. To see if you have enough life insurance check out our Do You Have Enough Life Insurance post by Anna.
Life changes as we age there may no longer be a need for insurance. Maybe you are nearing retirement and no longer need income replacement. Your kids are grown and out on their own. You have saved plenty of resources to pass along if you died prematurely. If you have decided you don’t need the insurance, please read on.
Second, determine what kind of insurance you have and what are the costs.
There are many different flavors of life insurance out there.
- Term Life Insurance. This common type of insurance provides coverage for a specific term, such as 10, 20, or 30 years. There is a death benefit if the insured passes away during the term. The policy has no cash value and premiums are fixed for the entire term of the policy.
- Whole Life Insurance, Universal Life, Variable Life, Indexed Variable Life. All these types of life insurance policies are permanent coverage options that provide a death benefit and accumulate cash value over time. Some allow you to invest a portion of your premiums in various investment options you choose or are tied to the performance of a stock market index, such as the S&P 500. The costs of these types of insurance are the annual premium (which may go up with age), plus policy administration fees, mortality charges, surrender charges (for early policy termination), and investment management fees (for policies with an investment component).
To learn more about Whole Life as an investment, be sure to read Jim’s article “Is Whole Life Insurance An Investment?”
Third, what is the cost or consequence of canceling the policy?
Term policies are the easiest to cancel. All you do is stop paying the premiums and the life insurance policy lapses. There is no tax consequence because there is no accumulated cash value in the policy.
Canceling a non-term life insurance policy and cashing it out may have several consequences:
- Surrender Charges: Some types of permanent life insurance, such as whole life or universal life, may have surrender charges associated with early policy termination. These charges are deducted from the cash value when you cancel the policy and can reduce the amount you receive.
- Tax Implications: If the amount you receive exceeds the premiums you paid into the policy (i.e., the cash value gain), it may be subject to income tax. Additionally, if the policy was held within an investment-oriented policy, like variable or indexed universal life, there could be potential tax consequences upon cashing it out.
In some cases, it may make sense to leave a non-term life insurance policy intact. In this case, you can ask the insurer what the death benefit would be if you stopped making premium payments. The accumulated cash value would continue to make those premium payments on your behalf for some time, up to your age of 100.
I hope this article helps you to understand the considerations for keeping or canceling/cashing in your life insurance. These policies can be very confusing and not at all transparent. We at MainStreet work with life insurance professionals to analyze insurance policies for our clients and we’ll be happy to take a look at yours if you have one.