When you buy a whole life insurance policy, you make a big commitment. Whole life policies are designed to pay a death benefit during your entire life, and also to help you invest for retirement.
A life insurance company doesn’t want you to cancel coverage, and you could lose a lot of money if you give up your policy shortly after you get it.
Depending on how long you’ve had your whole life insurance, you may be able to recover the cash value of your policy when you cancel rather than having to surrender value. You may also have a number of other options.
There are also different types of permanent life insurance that can be important to know about before making a long-term decision. For example, a universal life policy has lower premiums compared to the higher premiums of a term life insurance policy, but there is an investment savings component.
Knowing the specific type of insurance you have can play a significant role in whether or not you’re able to cancel coverage without financial penalties.
On this page:
- Why Do You Want to Cancel Your Whole Life Insurance Policy?
- Understanding the Surrender Period
- Review Your Non-Forfeiture Options
- Tax issues With Canceling Your Whole Life Policy
Why Do You Want to Cancel Your Whole Life Insurance Policy?
Although whole life insurance is also called permanent life insurance, a policy owner with whole life coverage may decide they want to cancel their policies for a number of reasons.
Some policyholders decide to cancel because whole life insurance is more costly than term life insurance. If you don’t need lifetime insurance protection and don’t want to use your life insurance as an investment vehicle – as you can often earn better returns elsewhere – you may simply decide paying high policy premiums for whole life isn’t worth it and you may want a new policy with a lower monthly premium.
Other policyholders decide to cancel their current coverage because they’ve found a better policy that’s more affordable or that provides better benefits.
Your options for canceling coverage vary depending on why you’re canceling, since policy rules differ depending on whether you’re attempting to cash out, changing your coverage, or reinvesting in a different policy. Think through your motives before canceling, as you can explain your goals to your current insurance agent and the agent may have suggestions on how to accomplish them.
Understanding the Surrender Period
When you decide to cancel whole life insurance coverage, be aware that insurers have protections in place to ensure they don’t lose money on your policy. One of the protections insurers have for themselves is surrender penalties which is something you don’t have to worry about with term insurance.
Under the surrender rules of most insurance companies, if you cancel your coverage within the first few years of buying it, you’re considered to be “surrendering” coverage. In that case, you either won’t get back any of the cash value of your policy or will pay a significant surrender charge.
When insured policyholders pay premiums for coverage, part of that money goes toward buying the insurance coverage that provides the death benefit, and some are invested so the policy accrues cash value. This net cash value is why premiums are higher than for a term life policy.
But, if you cash in the policy during the surrender period, you basically lose most or all of the value of the premiums you paid in. This happens because, of course, your beneficiaries don’t receive a death benefit – and you either don’t get the cash value at all or lose a portion of it due to the surrender fees.
This surrender period where you lose the full cash value of the policy or lose a lot of it to fees is typically the first two or three years of coverage. If your policy charges surrender fees, your fees will go down as you maintain coverage for longer. Your policy may be structured so you pay a 10% surrender fee in year one, a 9% fee in year two, and so on.
Eventually, you’ll have had the policy long enough – usually for about 10 years – and you won’t have to pay any surrender fee if you’ve decided to cancel coverage. But it can take a long time to get to the point where you can cash out without a big penalty. Think about how the surrender fees might compare to the annual premium and see which of your options makes the most sense financially. You may be better off continuing to make monthly payments for a while to avoid the surrender charge.
Review Your Non-Forfeiture Options
If you’ve owned your policy for a while and are passed the surrender period, you may have a number of non-forfeiture options. Nonforfeiture options are outlined in your insurance contract and can vary some from policy to policy. Typically, your choices include:
- Taking the full net cash value of your whole life insurance
- Switching to a policy that provides coverage only if you die within a designated time frame such as a term policy
- Keeping your money invested in the whole life insurance policy, but taking a smaller death benefit
If you have a lot of money invested and the dividends from your investments and interest rates are high enough to pay the premiums on your whole life policy, it’s also possible to keep the coverage and just pay premiums from the dividends so the policy costs you nothing out-of-pocket.
You can ask your agent about these nonforfeiture options when you’re considering canceling, but typically your insurer will offer them to you – or will choose one for you – if and when you miss a premium payment.
Tax issues With Canceling Your Whole Life Policy
When you cancel your whole life policy, you’ll need to consider the tax implications. That’s because these policies are intended as investment vehicles and as a way to provide financial security, so the money you pay into a whole life policy grows. When the policy is cashed out, if the amount you receive exceeds the “basis,” or the amount paid for the policy, you must pay taxes on the excess as you do on your taxable income.
You can figure out the “basis” of the policy by adding up the premiums you’ve paid in and subtracting commissions paid to your agent, administrative fees charged, dividends from the policy, and any cash you’ve already withdrawn.
Make sure you’re ready to pay any taxes due in the year you cash out your policy, as the amount you owe could be substantial, similar to what happens with the estate tax.
If you have a life insurance trust, also called irrevocable life insurance, there are important tax implications to be aware of. If someone has a life insurance trust there are tax consequences if certain transfers happen before they are supposed to.
Be Smart About Cancelling Whole Life Coverage
Canceling whole life coverage can make a lot of sense if you’re tired of paying high premiums, want to invest elsewhere such as real estate, or no longer need lifetime coverage. But you need to be smart about the process, understand your options, and understand that you could lose money if you cancel too soon after getting covered.
Don’t just think about the short-term when you’re considering canceling life insurance. Instead, look at the long-term and your larger life plan as well as your overall estate plan before you make a change or try to find a better option. By making an advanced plan to cancel the right way, you can protect the investment you made in your whole life coverage.