In unstable economic times when jobs are scarce and pennies are pinched, it might be tempting to cancel your life insurance policy in order to use that money towards immediate expenses.
While this may help family cash flow in the short-term, it could have dire consequences for your family in the long run, especially if the insured has developed health problems and cannot obtain life insurance coverage again at affordable rates.
People choose to cancel their life insurance policies for a variety of reasons, many of which are money-motivated: a change in financial situation (loss of job, reduction of salary or hours, additional expenses) or familial situation. Some even get rid of their policy under the assumption that nothing will happen to them – a serious roll of the dice, indeed.
Regardless of the situation, it is highly advised to consider all the consequences and alternatives before canceling one’s life insurance policy. If you have financial dependents, any outstanding debts or future family expenses (i.e., mortgage or college tuition), you should not cancel a life insurance policy until you have first thought through all of the consequences.
While term life plans have no fees or penalties for cancellation, many kinds of permanent whole life or universal life plans do, especially if you’ve bought them recently. When canceling a permanent policy, you might be charged a fee or “surrender” penalty for the early termination of the policy. This will often depend on the size of the life insurance company and its surrender penalty schedule. It all has to do with the clause that was built into the policy when it was first purchased.
In most cases, there is standard fee or percentage that is charged, which does not change. So any money that you are due when the policy is canceled will have this fee deducted before the refund is issued.
However, there are some life insurance companies that offer no fee for early cancellation. This is something that is built into the policy from the start but means that you will pay more for the policy. Again, one of the very desirable attributes of owning term life insurance is that there is no penalty for early cancellation.
The most serious ramification is the potential that you may be financially crippling your family forever should you die with no coverage in place. This could include loss of house, of higher education for your children, or bankrupting your immediate family, according to Joe Clauson, a spokesman for Mutual of Omaha.
Even if you change your mind later, it could result in higher premiums, tax issues for your dependents, and even refusal of coverage if your health has worsened.
Wealth Management Director at Hartford Life, Rick Blaser, believes the fundamental problem is that many people don’t fully understand and appreciate the value of their life insurance policy.
“They can’t afford to pay the premiums and they don’t understand why they have it,” Blaser says. “They feel they are losing money by continuing to pay the premiums.”
There are alternatives to canceling your policy if you want to save some money. For instance, Clauson advises trying to simplify your policy or getting group coverage through work.
“If folks can’t afford coverage, they can call the company to reduce the cost in order to maintain some coverage,” Clauson says. “They should really talk to a [life insurance] agent to help them assess their needs and make some recommendations.”
Another thought is to borrow money to pay the premiums, especially if you think that your financial situation is temporary. This allows the policy to remain in force and allows indebted premiums to be paid from the death proceeds, often a much better solution for families than having no life insurance in force at the time a breadwinner dies. If you decided to borrow money to pay life insurance premiums for a spell, expect the lender to want to be named as a beneficiary up to the extent of the loan.