“I bought a new life insurance policy but the small print is impossible to understand. All I´m sure of is that after I die, I can stop paying.”
Do You Want to Stop Paying Your Life Insurance Premiums?
What happens if you own a whole life policy and you don’t want to keep paying the premiums, but don’t want the policy to lapse? Or when you can’t afford the premiums any longer, but still want coverage?
If payments are stopped without altering the policy or communicating with the insurance company, you could lose the policy, just like a homeowner can go into foreclosure if they stop making mortgage payments.
But there are other options to simply letting a policy lapse! These options are well-worth considering, especially because:
- You will likely pay more for the same coverage later, as a key factor in determining rates is age. So if you intend to buy coverage later, letting your policy lapse could cost you more in the long run.
- If you have health problems now or in the future, you may not be able to get coverage again…at any price. Under your existing coverage, changes in your health do not affect your premium, but changes in your health can mean that you’ll be denied coverage later.
- There could be tax implications of policy cancellation. Cash value accumulates in your policy on a tax-deferred basis. However, if you terminate your policy and take the cash value (not the same as policy loans, which are generally not taxable), a portion of the cash value could be considered ordinary income and be taxed at your current tax rate.
- You probably obtained life insurance for reasons such as insuring your income, protecting beneficiaries or building up an emergency/opportunity fund. Those are important reasons and we urge you to find an affordable way to keep your policy in force.
So don’t simply stop paying. Rather than cancelling your policy or letting it lapse, if you still want the life insurance policy, explore your options. And remember that is an asset, an asset that grows more valuable over time, not simply to beneficiaries, but to the policy owner.
Here are six ways to save a life insurance policy, in descending order of flexibility and desirability:
1. Natural Vanish
“Natural vanish” literally means what it says… the policy premium “naturally” falls away because the policy has reached a certain state of maturity.
This is the best option in many cases, but it is not available until the policy has been in force for some time, as it requires a certain level of cash value to make a natural vanish viable.
Typical time frames from the start of a policy to natural vanish eligibility:
- 7-10 years if maximum PUAs (paid-up additions) have been utilized
- otherwise 17-20 years if no PUAs have been utilized (in which case options #2, 3 or 4 may be worth your consideration)
Policies may be set up with natural vanish option, or converted to one. Dividends, cash value and death benefit remain intact.
2. Use Dividends to Pay the Premium
A strategy that can be used with more mature policies with significant dividends is to have the cash value dividends pay the premium. This is a great option when the policyholder wishes to keep the policy and does not need the dividend payments. Sometimes the dividends have been set to reinvest, or automatically add to the cash value, and the policy owner may not be aware that they can utilize the dividends in other ways.
3. Change to a Monthly Payment Plan
If you are on a quarterly or an annual payment plan, you can ask the company to switch you to a monthly plan if budgeting for larger premiums is problematic, or if you have a temporary cash crunch.
You can switch payment plans as needed throughout the life of the policy. (We recommend annual or monthly.)
4. Automatic Premium Loan
An automatic premium loan is perfect to use when short term cash flow issues cause a temporary lack of money to pay premiums.
You borrow against the cash value to pay the premium, which raises the cash value and creates a loan against it.
This can be done for quite a few years if necessary, and interest can be paid with that loan too, though it is better to pay the interest out of pocket so that you are not continuing to increase the loan.
As discussed in our post, “Should Your Borrow Against Your Cash Value or Withdraw It?“, in most situations we recommend borrowing against your cash value rather than withdrawing, as it keeps growing and gives you the best options for the future. However, it is not best to borrow against cash value if you do not anticipate having the means to pay it back.
5. Withdraw Cash Value to Pay the Premium
If you do not believe you can pay a policy loan back within a few years and do not wish to keep incurring interest, you can withdraw cash value to pay your premium, if this makes sense numerically.
This may be an option in limited situations. Perhaps you are on a fixed income and close to having a paid-up policy or a natural vanish option available to you, but do not wish to take a policy loan or reduce death benefit.
Do keep in mind that once cash value is withdrawn, it cannot be “put back.” For this reason, we recommend borrowing against a policy in many situations.
6. Reduced Paid Up
Reduced Paid Up is a permanent strategy. Whereas options #1-4 are temporary and changeable, withdrawing cash value or causing a policy to be “reduced and paid up” are not.
A reduced paid up does exactly what it says it will; it reduces the policy’s death benefit (though not the cash value) and pays it up permanently. No further payments are ever needed, and the death benefit is guaranteed.
This can be a good option when the policy-holder wishes to keep their cash value intact and stop making payments.
7. Re-arrange Your Cash Flow
Are you struggling to pay both your credit cards and your life insurance? You may be able to pay off a high-interest credit card with a policy loan at a lower rate (check with your insurance company, policy loans are currently around 8% fixed, less for adjustable rates). That’s a smart strategy even if you’re not struggling to make premium payments! You would be refinancing your own debt at a lower rate with greater flexibility. (Just be sure to pay off the policy loan.)
Or perhaps you are in a cash crunch and can stop or lower your retirement contributions. A 401(k) doesn’t have the flexibility, liquidity, or death benefit of a life insurance policy, so you’d be wise focus on the policy and resume your qualified plan contributions later, if you choose.
Look at your overall budget and determine if there is a way to re-arrange your cash flow to keep saving in your policy. Evaluate if your spending has fallen out of line with your long-term values and goals, or if you simply don’t have adequate cash flow.
As you can see, you have quite a few options of how to save a life insurance policy, even when you can’t afford the payments. And there is one more important option that may be preferable to letting the policy lapse (which will leave you only with the cash value.)
A different option: selling the policy
In the event that a policy cannot be saved (or not in an acceptable manner), you may wish to explore selling the policy. Selling it to a party with investment interest is only an option in very specific circumstances, such as when life expectancy is very short, in which case, the policy could be a desirable asset for a life settlement fund or direct fractional investment purchase. When a policy is desirable to investors, the policy owner will receive more than the policy’s cash value amount.
Selling a policy can also be a possibility to discuss with family and trusted friends, as there are situations when the best “win-win” is finding a private buyer, perhaps a family member or friend who would be willing to maintain the policy and become the beneficiary.
And finally… consider REDUCING premiums
Perhaps none of the above options work, for various reasons. Perhaps your dividends can’t cover the premium, you don’t wish to take loans, you’re too young to sell the policy and you don’t want to reduce a policy as much as a reduced paid-up would require.
Investigate to see if you can simply shrink your policy and, correspondingly, your premiums. Want to downsize your policy to two-thirds, half, or even less of the size of your original policy? Often it can be done. Just contact your insurance company and usually they can work with you for a solution.
Do You Wish to Evaluate a Life Insurance Policy or Stop it from Lapsing?
Contact us and we’ll be happy to help you evaluate your policy and your options. You can also contact your insurance company directly to discuss many of the options above.