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Canceling a Life Insurance Policy
Many of us sign up for a life insurance policy when we are young and have others counting on our income. But as we retire, our children leave the house, or we have a change in our finances, we might find that our life insurance doesn’t fit our needs anymore. We might also find the premiums challenging to pay on a fixed retirement income, or rather spend the monthly payment on something else as our priorities change. This leads a lot of us to wonder about canceling our life insurance policies.
In this article we’ll answer all of the commonly asked questions people have about canceling a life insurance policy. This includes things like:
- If and when to cancel
- If you should expect a refund and how much it might be
- How long any refund might take
- What tax implications could come with getting money back
- If there will be penalties to canceling
- What effect the type of life insurance policy will have on canceling
Can I Just Cancel my Life Insurance?
Yes, in most cases you can just cancel a life insurance policy. However, depending on your specific life insurance policy cancellation rules, you may not get much (if any) money back.
How to Cancel a Life Insurance Policy
There are several ways to go about canceling a policy. Each will give you different returns on your investment. These include:
- Lapsing – stopping paying the premiums, but you will not receive any money back at all
- Surrendering – canceling according to your policy’s rules and potentially receiving some money back (called the cash surrender value), depending on how long you have held the policy
- Life Settlement – selling your policy to an investor and receiving more money back than the cash surrender value
What Happens If I Just Stop Paying for my Life Insurance?
If you just stop paying your life insurance premiums, your policy will lapse. This means you will no longer have an active insurance policy. Your heirs won’t be eligible to receive a payout in the event of your death, and you will not gain any return from your policy while you are alive.
Most insurance companies will attempt to contact you and/or give you a grace period in the event that you miss a payment. In some cases, if you change your mind and want to begin making payments again, you might have the option to reinstate your policy. If you are choosing not to continue to make payments because you no longer want your life insurance policy, it is almost always a better financial decision to cancel it by following the specific cancellation rules for your policy. Doing this means you may receive some of the money back that you have paid in premiums over the years. Selling your policy in a life settlement is another option that will always return more money than canceling.
Can I Cancel my Insurance Policy and Get my Money Back?
If you follow the steps required for officially canceling your life insurance (usually calling the life insurance company, writing a letter, or filling out an online form), you may get some of your money back. Exactly how much you can expect depends on the specific type of policy you have, the terms set out by your insurance provider, and how long you have had the policy.
Typically, term life insurance will not have a cash surrender value, so you will not receive any money back if you cancel. Whole life and universal life insurance policies do typically have a cash surrender value—either guaranteed or non-guaranteed.
The exact terms will vary for each policy type and insurer, but a typical structure for calculating value is based on the length of time you have held a policy. It often follows this pattern:
- No cash value for the first year
- 30% of premiums paid (excluding first year payments) for years two and three
- 50% of premiums paid for years four to seven
- After year seven insurance companies will do individual calculations, but generally the percentage of premiums returned increases the longer a policy is held.
Let’s use these percentages to look at a cash surrender value example. We’ll look at a hypothetical policy holder, Lisa. She pays $100 per month for her life insurance, for a total of $1,200 per year.
- If she cancels in year 1, she would get $0 back.
- If she cancels at the end of year 2, she would receive around 30% of the $1,200 paid in premiums after year one, $360.
- If she cancels at the end of year 5, she would receive around 50% of the $4,800 paid in premiums after year one, $2,400.
- If she sold her life insurance in a life settlement, she could expect to get four to seven times more than the cash surrender value. For our year 5 example, this would mean she may get $9,600 to $16,800 compared to the cash value of $2,400.
Is There a Penalty to Cancel Life Insurance?
It depends. In almost every case, if you choose to cancel your life insurance policy, you will receive less money back than you paid in premiums. So from that perspective yes, there is a financial penalty for canceling. However, this penalty is part of the premium payments you have already paid into the policy. This means you will not receive a bill for a penalty payment from canceling, your insurance carrier will just refund you less of what you already paid them.
There are several ways this can happen, depending on your insurance company and specific policy.
- For many insurance policies, the fee for surrendering a policy is listed in the policy document or contract. It is often higher when a policy is new and decreases over time. So in the first year of an active policy, this penalty might be 10% of the annual premium, then be reduced in year two to 9%, all the way down to 0% after the first decade.
- For other policies, like the one discussed above for Lisa, there may not be a surrender fee specifically. But, Lisa’s policy only returns a percentage of what was paid in premiums. In this case, 70% of the premiums paid in the first three years could be thought of as a penalty since it is money she isn’t getting back.
- There are also life insurance policies that do not provide cash payout at all if the benefit has been held for too short a time. This time limit varies from one year to over ten years, but in these cases the penalty for canceling before you reach that threshold is 100% of your premiums lost.
- Life settlements, selling your insurance policy to a third party for a lump sum, typically return the highest percentage of your premiums back to you. Because life settlements don’t come from the insurance company, the difference between what you paid versus what you receive back doesn’t exactly fall into the category of a penalty. In some cases, you may even receive more cash for your policy through a life settlement than you paid in premiums—an anti-penalty, if such a thing exists.
Can You Cancel Life Insurance at Any Time?
In general, yes, you can cancel any type of life insurance at any time. But the timing can predict whether and how much cash back you receive.
All 50 US states require a mandatory “free look period,” which spans the 10-30 days (depending on the state) after you first purchase a policy. During this time, if you decide to cancel, you will not be charged fees and normally get your premiums refunded. This is meant to give consumers extra time to understand their policy and consider their commitment before being fully vested in the policy.
After the free look period is over, some policies will not pay any of the surrender value for a set time, usually from one to ten years. Although you would not receive any of your premium payments back during this time, you are still free to cancel your life insurance.
Can You Cancel Term Life Insurance at Any Time?
Similar to a standard life insurance policy, you are able to cancel term life insurance any time you decide. However, there is typically no cash surrender value of term life insurance, so you will not receive any money back regardless of when you cancel.
Term life insurance works differently than other options. You get term insurance for a set period of time, often 10, 20, or 30 years. If you pass away during this time, your beneficiaries will receive a death benefit. If you outlive the term of the policy, no death benefit is available and no refund or cash value will be returned to you.
There are some policies which offer the optional add-on of a “return of premium” rider. If you choose this option and outlive the term of your policy, you will receive a lump sum payment of your premiums back. Choosing this add on will make your monthly premium payments higher. If you have a ‘return of premium’ term policy, you typically will only get the premium payments back at the end of the term. Canceling before the policy ends means you will not get the premiums back.
Some term life insurance policies are convertible to permanent policies through a convertible rider in the contract. In this case, they can be turned into a policy that has a cash surrender value. This can be done to collect the cash surrender value, or to sell the permanent policy in a life settlement.
What Companies Offer a Return of Premium on Life Insurance?
Return of premium is an add-on option typically only available for term life insurance. Several of the options for term life insurance coverage will include this as an option. However, it significantly increases the premiums you will pay, often making these policies cost two to three times as much as the same term insurance coverage without the return of premium option. It is important to remember that in the event of the cancellation of your insurance policy, you will not get your premiums back. The return of premium only comes into play if you outlive the term of the insurance.
How Much Will I Receive If I Surrender my Life Insurance Policy?
The amount you will receive when you surrender a life insurance policy can vary significantly. It is usually only available for permanent policies, like whole life or universal life insurance. The exact details for a policy will be given in the policy contract, so refer to that document for your specific case. The reason the amount of money received for surrendering a policy can change so much is because of what goes into calculating it. Let’s take a look at how the premiums are used by an insurance company to better understand how to predict what cash back you could expect.
In general, insurers take the premium you pay them and split it into three parts: death benefit, insurance company costs, and cash value. Typically the insurance company will invest the portion that is cash value, so that it grows with the market and as your premium payments come in. Exactly how much of each premium payment goes into each of these three categories will vary by policy and by factors like your age and length of time you have held the policy.
How Is the Cash Surrender Value of Life Insurance Calculated?
For a simplified example, let’s look at Lisa from earlier, paying $1,200 per year for her permanent life insurance. If her policy states that a third of her annual premium ($396) is going into a cash value account, after ten years she would have a policy with a cash value of $3,960 plus whatever investment growth accrued.
Her insurer may also charge a 5% surrender fee on canceling this policy in year ten, so she would receive $3,762. Not all life insurance will divide premiums in this way, and many will change the percentage of the premium that goes to each of the three categories over time. This example is only intended as a way to help you think about how the system works.
What Is the Cash Value of a $25,000 Life Insurance Policy?
It depends on the policy type, insurer, and specifics of how long the insured has had the policy. But according to Investopedia, a $25,000 policy would likely have around a $5,000 cash value once it has been held for a significant length of time. The only way to know the exact cash value for any policy is to contact the insurer and ask.
How Long Does It Take to Get a Refund after Canceling Insurance?
Once you have found out exactly how much money you can expect to get back after you cancel your life insurance, most of us will probably be wondering “how long does an insurance company have to refund your money?” Generally it is within 30 days.
What Are the Tax Consequences of Surrendering a Life Insurance Policy?
If you receive money back when you surrender your life insurance policy, there is unlikely to be tax consequences. This is because you would only be responsible for paying taxes on the money that is returned to you if it is more than you paid in premiums. In nearly all cases of surrendering a policy, you will get less money back than you paid in, so you will have no income from this transaction. It is always a good idea to consult your tax advisor to ensure you do not have any special circumstance that would change your tax liability.
What Is a Good Reason to Cancel Insurance?
The two most common reasons for canceling are at opposite ends of the financial spectrum. These reasons are that the individual:
- No longer has financial dependants who need the coverage when they pass
- Can no longer comfortably afford the premium payments
Many people get life insurance coverage when they begin working, get married, have children, and/or buy a house. At this stage of life, the people who are financially dependent on you would be at a huge disadvantage if you passed away and your salary was no longer part of the family budget. Your family may lose their house or car, or not be able to keep up with other important bills. And when you are younger, it is less likely that you will have a significant amount in savings to offset these expenses.
But as the years go by, you should regularly reassess your financial needs to see if you and your loved ones still need this coverage. If you have paid off a mortgage, your children have moved out, and you have enough in savings to cover any outstanding debts in the case of your demise, it may make financial sense to reduce (or even cancel) your coverage. If you have invested a large amount into your life insurance policy, this would also be a good time to investigate selling it in a life settlement, so you could enjoy the lump sum payment you could receive.
On the other hand, you may have purchased life insurance when you were in a financial position to comfortably make the monthly payments, but circumstances changed. If life insurance is now an expense you can no longer afford, that may be a reason to cancel your life insurance policy. In this case, you definitely want to explore your options for surrendering your policy for its cash value or selling it as a life settlement, so that you can get the financial benefit from making premium payments over the years.
Life Settlement Advisors: Let Us Help When It’s Time to Cancel Your Life Insurance
Whatever your reason for no longer wanting your life insurance, we can help you decide if a life settlement is a good fit for you. Our family company has decades of experience helping people just like you get the money they deserve from their life insurance. Visit our website to find out if you qualify, request a free consultation, or read more in our “Unlock a Hidden Asset” resource.
Did you know you can sell all or a portion of a life insurance policy, even term insurance? Selling an unwanted life insurance policy is no different than selling your car, home, or any other valuable asset that will create immediate cash. Contact us today to learn more.
Get in touch with Life Settlement Advisors today to take the first step toward converting your policy into cash.