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Life Insurance Cancellation: Things to Consider and How to Proceed

Life insurance policies play an essential role in helping Americans provide financial protection for the loved ones they leave behind. Some policies even offer benefits during the insured person’s lifetime, such as access to supplemental income during an illness. 

Still, there are times when policyholders choose to end their life insurance coverage: In 2020, 6.7% of individual life insurance policies were either canceled or surrendered. At times, this may be a good idea — but not always. Learn more about how to cancel a life insurance policy and when this decision makes sense.

Can You Cancel Any Life Insurance Policy? 

Yes, it’s possible to cancel any life insurance policy. Cancellation is possible even when the policy is a whole or a term life policy with several years remaining. The cancellation process varies depending on the insurer and type of policy. 

Following the insurer’s cancellation process is essential, rather than simply stopping your premium payments. When policyholders stop paying premiums, insurers may deduct premiums from the cash value (if applicable) or provide a grace period to keep the coverage active. This delays the life insurance policy cancellation process.

Life insurance policies play an essential role in helping Americans provide financial protection for the loved ones they leave behind. Some policies even offer benefits during the insured person’s lifetime, such as access to supplemental income during an illness. 

Why Cancel Your Life Insurance Coverage? 

Policyholders can cancel a life insurance policy for any reason, and there are several situations when doing so makes sense. Here are some common reasons to consider canceling life insurance:

  • You no longer need life insurance: People buy life insurance for a specific need, such as paying off a mortgage or providing for a spouse or dependent children. Once that need is satisfied, canceling the coverage could make sense.
  • You can’t afford the premiums: More than half of Americans are experiencing financial hardship due to inflation. For some, cutting back on spending means canceling life insurance coverage. It’s important to note that there are ways to reduce life insurance costs without canceling.
  • Your financial goals have changed: Some policyholders cancel their life insurance coverage to save or invest the money they would have spent on premiums. 
  • You have life insurance elsewhere: Buying a replacement life insurance policy is a valid reason to cancel the original policy. 

How to Cancel Your Term Life Insurance Policy 

The process for canceling a life insurance policy varies from insurer to insurer. Check your policy documents or call the insurer for specifics about the life insurance policy cancellation process. 

Some insurers require policyholders to call to cancel their coverage, while others require a signed insurance cancellation letter. Some companies provide cancellation forms on their websites. Whatever the cancellation process, you should be prepared to provide your contact information, policy number, and desired cancellation date.

Ask the insurer for written confirmation of the cancellation effective date and premium refund owed, if applicable. Insurers typically don’t refund premiums when you cancel your term life coverage. Still, you might be entitled to money back if you prepaid their premiums or bought a return of premium rider. 

Things to Consider Before Canceling Your Term Life Insurance 

Before you finalize your policy cancellation, it’s a good idea to consider the following factors carefully.

  • Cancellation fees: Insurers don’t generally impose cancellation or termination fees on term life policies, but it’s a good idea to check the policy documents to be sure.
  • Remaining term length: Term life coverage automatically expires after a set number of years. If the policy is nearing the end of its term, it could be easier to keep the coverage until it expires.
  • Return of premium rider: This rider reimburses the policyholder for their premium payments if they outlive the term . Policyholders who cancel their coverage early may forfeit this refund, though some insurers offer a partial return of premiums.
  • Other living benefits: Policy add-ons like critical illness or disability income riders provide coverage during the insured person’s lifetime. These living benefits expire when the term life coverage ends.
  • Conversion option: Convertible term life insurance policies allow consumers to switch to a whole life policy without taking a medical exam. Consider discussing your conversion options with a trusted agent before canceling.

How to Cancel Your Permanent Life Insurance 

Permanent life insurance is a more complex product than term life insurance. It’s designed to offer lifelong coverage and often has a savings or investment component that may be taxed. For these reasons, canceling whole life insurance or other permanent policies tends to be more complicated than canceling term life.

As with term life insurance, canceling whole life insurance starts with notifying the insurer. When policyholders simply stop paying premiums, insurers may keep the coverage active by withdrawing premium payments from the policy’s cash value. The policy remains active until the cash value is depleted, which delays cancellation and costs you money.

Unlike term life insurance policies, permanent life insurance has a surrender value. The surrender value is the cash value — if any has accrued — minus the surrender fees specified in the policy. Gains in the cash value account are subject to income tax.

Things to Consider Before Canceling Your Permanent Life Insurance 

Since permanent life insurance is designed to offer lifelong coverage, weigh your options carefully before canceling. Some factors to discuss with your agent include:

  • Surrender period: This is the waiting period before you can cancel your coverage and withdraw your cash value without penalty. Surender periods vary from insurer to insurer but typically last for 5 to 10 years.
  • Surrender charge: Insurers charge cancellation fees, known as surrender charges when policyholders terminate their permanent life coverage. These fees are a percentage of the cash value and vary based on the insurer and the age of the policy.
  • Cash value: As a savings and investment vehicle and a convenient way to borrow funds, the cash value account plays a vital role in some people’s financial plans. Policyholders who cancel their policies forfeit these potential advantages.
  • Tax implications: Surrendering a permanent life policy and withdrawing the cash value may affect your tax bills, depending on the gains you’ve received on the policy.   
  • Policy riders: As with term life insurance, any riders you have added to your whole life policy end when the main policy is canceled. This includes living benefits like critical illness riders and long-term care riders.

If You’re Switching to a New Policy: Understand the ‘Free Look’ Period 

New life insurance policies have a trial period known as the “free look” period. Essentially, this is a return policy for life insurance. It allows consumers to cancel a life insurance policy for any reason and receive a refund of their premiums paid without cancellation or surrender fees.

The free look period helps consumers ensure their replacement life insurance policy meets their needs before they cancel their original coverage. The length of this period varies based on state laws but typically lasts ten or more days. 

Why Your Life Insurance Company May Terminate Your Policy 

Insurance companies can also terminate life insurance policies. However, unlike policyholders, who can cancel a life insurance policy for any reason, insurers can only cancel policies under specific circumstances. The two main circumstances are fraud and non-payment of premiums.

Insurers may cancel life insurance policies when they discover material misrepresentations in policyholders’ applications. These false or misleading statements would have changed the insurer’s decision to sell the policy or the premium they set for the coverage.

Suppose you stop paying for coverage, and the policy lapses. This doesn’t mean insurers immediately cancel coverage when a payment is late. Typically, life insurance policies have a 30-day grace period after the premium due date.

Understand the Drawbacks of Canceling Coverage 

There are some situations when canceling a term, or permanent life insurance policy is the right choice. However, before terminating coverage, it’s essential to understand the potential downsides of this decision. 

You Are Unprotected if You Have a Lapse in Coverage 

Once your life insurance coverage ends, the policy’s death benefit is no longer available for your chosen beneficiaries. Carefully weigh the decision to cancel or replace coverage if loved ones are on the policy’s death benefit.

When switching life insurance policies, consider waiting before canceling the original policy until a new one is in effect to avoid a coverage gap. This also gives you the flexibility to change your mind during the free look period and keep your original policy.

A lapse in coverage isn’t necessarily a drawback for policyholders who’ve decided they no longer need life insurance. However, there are other downsides for policyholders without financial dependents, so read your policy documentation before canceling.

You Will Likely Have Higher Insurance Rates if You Decide to Reapply Later 

Policyholders who cancel their coverage can expect to pay higher premiums if they reapply for similar coverage in the future. Age is one of the significant factors affecting life insurance premiums. As applicants get older, their decreased life expectancy and higher risk of developing serious health conditions tend to result in higher insurance rates.

For example, a healthy 30-year-old who buys a whole-life policy with a $500,000 death benefit might pay around $370 per month for the life of the policy. If they canceled that policy and reapplied for the same amount of coverage at 60, it might cost closer to $1,380 per month, assuming they were still in good health.

Your Options for Eligible Plans Will Decrease as You Age 

Not only do coverage costs typically increase as you age, but fewer life insurance options tend to be available. Insurance companies often set an upper age limit for new life insurance applications. This limit varies by company and policy type. 

Some insurers don’t issue term or whole-life policies to applicants older than 65. Others limit the term length available to older applicants. For example, an insurer may issue 30-year term policies up to age 50 or 55.

There are some plans available for elderly consumers. For example, final expense life insurance, which helps cover funeral and end-of-life costs, is generally sold until age 85.

You May Pay Tax Penalties 

While there are no tax penalties for canceling a term life insurance policy, canceling whole life insurance with cash value may have tax implications. The cash surrender value policyholders receive is considered taxable income in certain situations.

Per IRS rules, cash surrender value gains are taxable income. This means the earned interest or other investment gains are taxable. Insurers are required to issue a Form 1099-R showing the taxable portion of a policyholder’s cash surrender.

Other Options to Consider Instead 

Canceling a life insurance policy isn’t the only option when the coverage no longer meets your needs. Consider exploring the following options with your agent or insurer.

Work With Your Current Insurer to Adjust Your Existing Coverage 

Insurance companies allow policyholders to make changes to their existing life insurance policies. This helps consumers get life insurance coverage that meets their needs without canceling. Permitted changes vary based on the insurer and policy. 

Many term life policies have a conversion option that allows policyholders to switch from a term policy to permanent coverage if their needs change. Adjustable life policies allow consumers to raise or lower their death benefit. For any type of policy, there’s the option to add or remove riders. Discuss your options with your agent.

Take out a Policy Loan Instead of Surrendering Your Policy to Access Funds 

Permanent life insurance policies that include a cash value component offer a source of funds for policyholders. Surrendering the policy isn’t the only way to access this cash; policyholders with sufficient cash value can borrow against their life insurance policy.

Generally, policy loans are limited to 90% of the cash value, though this varies from insurer to insurer. Since the cash value secures the loan, there’s no need for a credit check. Note, however, that any outstanding loans reduce the death benefit available to beneficiaries.

Contact Your Insurer About Significant Health or Lifestyle Changes That Could Lower Your Premium 

Life insurance premiums are determined based on your health at the time of application, but these premiums aren’t necessarily set in stone. Through a process known as reconsideration, people who’ve made significant improvements to their health could be eligible for lower premium rates on existing policies. 

To request a rate reconsideration, contact the insurer and explain your health changes, whether that’s quitting smoking, losing weight, or improving the symptoms of a chronic condition. If the insurer agrees to reconsider, be prepared to complete a detailed health questionnaire and undergo a medical exam. 

Plan for your family’s future. Get a life insurance quote today.

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Plan for your family’s future. Get a life insurance quote today.

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