“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.” (Anonymous)
What if you can’t (or don’t) pay your whole life insurance premiums—but you still want the policy?
What if you own a whole life policy and can’t afford the premium payments? Or perhaps you don’t want to keep paying the premiums, but you don’t want the policy to lapse? Can you reduce or stop paying whole life insurance premiums without losing your policy?
If you simply stop making payments 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.
You always have the right to give up a whole life policy in exchange for whatever your cash surrender value is. But in most cases, there are better options than simply letting a policy lapse! These 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 again 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 cost. 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 a whole life 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 whole 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 life insurance premiums. Rather than cancelling your policy or letting it lapse, if you still want the policy, explore your options. Remember that it is an asset that grows more valuable over time, not simply to beneficiaries, but to you, the policy owner. You can never have too much in savings, so if you CAN pay the premiums, we highly recommend that you do!
If you have a temporary cash flow emergency or perhaps you have retired and could really use the extra income, consider these options. Here are nine ways to save a life insurance policy, in descending order of flexibility and desirability (plus a “bonus” strategy that is better than cancellation):
1. Natural Vanish
“Natural vanish” literally means what it says… the policy premium “naturally” falls away because the policy has been in force a sufficient number of years. 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. (Note: If you choose to keep paying premiums, both your cash value and the death benefit will continue to grow at a faster pace.)
2. Use Dividends to Pay the Premium
This strategy can be used with older policies that have significant dividends. 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. You can request to have the cash value dividends pay—or at least reduce—your premium.
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. This could buy you time or simply make the payments easier.
You can switch payment plans as needed throughout the life of the policy. (We recommend annual or monthly. You will have a slightly better internal rate of return with an annual payment, but of course, you should do whatever works for your cash flow.)
4. Reduce Paid-Up Additions
If you are paying into a Paid-Up Additions rider, you can usually reduce the PUA portion of your premium. If you are maximizing your PUAs, your premium could drop significantly. Contact the life insurance company to inquire.
Be aware that the PUA rider gives you more death benefit AND cash value, so you will see much slower growth in both death benefit and cash value. We recommend PUAs because they make your policy more efficient! Yet they are not required to keep your policy in force.
5. 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 creates a loan against your policy.
This can be done for quite a few years if necessary, assuming you have had your policy for several years and have adequate cash value. Interest can be paid with the loan too, though it is better to pay the interest out of pocket so that you are not continuing to increase the loan.
You may be wondering if it is better to withdraw cash value (no loan, interest or repayment required) or borrow against it. In most situations, we recommend borrowing against your cash value rather than withdrawing, as this keeps your cash value growing and gives you the best options for the future. However, it is best to withdraw rather than borrow against cash value if you do not anticipate having the means to pay the loan back.
6. Withdraw Cash Value to Pay the Premium
If you don’t think you can pay a policy loan back within a few years and don’t want to keep incurring interest, you can withdraw cash value to pay your premium. This may be a good option in limited situations. (Just make sure you aren’t creating a situation in which you would have to keep doing that until the policy lapsed.)
Perhaps you had a large unexpected expense and are on a fixed income. Perhaps you are 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 the death benefit.
Do keep in mind that once cash value is withdrawn, it cannot be “put back.” This is another reason we recommend borrowing against a policy in many situations.
7. Reduced Paid Up
A 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.
8. 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! (Policy loans are currently between 6 to 8% fixed, sometimes less for adjustable rates. Check with your insurance company for your rate.)
This is 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 in a timely manner.
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.
9. Shrink your policy to REDUCE 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.
Whatever you do… don’t simply give up your policy without exploring your options!
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.
A Bonus 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. If your policy is cancelled due to lack of payments, you would only receive the cash surrender value in return. In some situations, you could receive more—sometimes several times more—by selling it.
When you sell a policy, it is called a “life settlement.” Life settlements are becoming more popular as investors (usually corporate investors or life settlement funds) realize that life settlements are a good investment, and seniors realize their policies are salable assets.
Selling a life insurance policy to a party with investment interest is only an option in very specific circumstances. If the insured is in their 80’s and in poor health and their life expectancy is short, they may be able to find a buyer. When a policy is desirable to investors, the policy owner will receive more than the policy’s cash value amount. If you have already withdrawn or borrowed against most of your cash value, you might be pleased to discover your policy still has value.
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.
Do You Wish to Evaluate a Life Insurance Policy or Stop it from Lapsing?
Don’t just stop paying life insurance premiums! You can contact your insurance advisor who sold you the policy or your life insurance company directly to discuss many of the options above. If you don’t have a Prosperity Economics Advisor and need a sounding board, contact the Prosperity Economics Movement for no-obligation advice. We’d be happy to help you evaluate your policy and your options.