Proper insurance planning is a pillar of any well-rounded financial plan. The right type and coverage can protect you and your family when the unforeseen happens. Life insurance is especially important if you carry significant debt like a mortgage or support financially dependent loved ones.
If you’ve had your policy for a few years, you might be wondering if it is time for a change? When does it make sense to update your coverage? Let’s explore.
Life Insurance Categories
Before you can decide how effective your current policy is, it’s essential to know the type of coverage available. Life insurance falls into two broad camps:
- Term life insurance
- Permanent life insurance
Term life insurance covers you for a certain period, typically from 10 to 30 years. Term insurance is a popular choice for convenience and price. For example, you can obtain reliable coverage at a reasonable rate until your mortgage is paid off or your kids leave the house. Once the term is up you can renew it, often for a higher cost.
As the name suggests, term life insurance provides coverage within that specific time frame. Should you pass away 15 years into your 30-year policy, your beneficiary would receive the payout — but once the term expires, so do the benefits.
Permanent life insurance offers a more comprehensive solution. It comes in many sub-categories like whole life, universal life, variable universal, and more. Along with safety protection and death benefits, these policies can act as an investment and accumulate a cash value that can be accessed through low-interest policy loans or outright withdrawals. Cash values start out small but grow over time, depending on which type of permanent insurance you choose.
Due to the nature of coverage, permanent insurance has a much higher price tag and isn’t right for everyone.
Understanding the type of insurance you have helps inform your options. Let’s take a closer look at when you should change, cancel, or keep your life insurance policy.
When It’s Time For a Change
Changing life insurance policies can be a massive undertaking. Between new agents, paperwork, and fine print, it can be tough to know if you’re getting a good deal by switching providers. Before signing on the dotted line, keep these ideas in mind.
Key Things to Consider
First, talk with your current company about any upgrades or changes you want to make to your policy. Depending on your needs, your current provider may still be able to help.
Most agents will want to keep your business, and you might be able to make policy changes without having to switch providers. This could save you on the added costs and hassles of switching. You might also be able to get a better deal.
Changing policies may require you to have a new medical exam. Most life insurance providers require a medical exam to gauge the risks of insuring you. When you’re younger, passing a medical exam is generally easier as you are often healthy and in good shape. But as you age, even if you maintain your health, the insurance company takes on more risk by insuring you and your premium could increase dramatically. You may even be denied coverage altogether or have more restrictions in your policy. It is a significant risk for many people. In many cases, you can convert a term policy to a permanent policy without a medical exam, if you remain with the same carrier.
Additionally, watch out for the contestable period on a new policy. By switching to a new provider, this contestable period may reset. On any new life insurance policy, there is a contestable period stating your death benefit may be denied or contested by the insurance company if claimed within 2 years. A new policy means the contestable period renews, which could cause issues for beneficiaries.
Lastly, know the full scope of your costs. Depending on the type of insurance you have (term, whole life, universal life, etc.) your costs and consequences when changing policies will differ. Be sure to compare these costs. While price shouldn’t be the only factor in choosing a policy, it is an important one. Overall, keep in mind:
- The Premium
- Will your premium increase? Is it variable?
- Tax Consequences
- Would a new policy have better tax advantages or more tax consequences?
- Total Costs
- Will the total cost of insurance increase? Will the cash value of your policy cover your new one?
3 Reasons Change Can Help
Despite concerns over the contestable period and the medical exam, there are some good reasons a new policy can be an excellent move:
- You found a policy that provides similar or better coverage at a better price. Some old policies are full of fees and requirements that have become obsolete. It’s worth checking out if your policy seems expensive when you compare it to what’s available in the market.
- Your financial needs and strategy have shifted. Weddings, births, divorces and other life events often lead to changes in your need for life insurance. Or perhaps you want to “lock in” the cost of coverage and avoid changes to this cost in your retirement years. Permanent life insurance can also help with tax management as you near retirement, especially if you want to delay taking money from retirement accounts or taking Social Security. Alternatively, you may have other, better investment alternatives.
- You are interested in a different type of insurance — for example, transitioning from term to permanent. This usually happens when people become more financially successful and want to make sure their heirs will benefit from life insurance. It may also make sense if one of your dependents has special needs that will need to be covered after your death. Some term policies are convertible to permanent, so you won’t actually need to change policies.
Of course, after all of this research you might also be leaning toward canceling your policy altogether. Is that a good move for you? Let’s find out.
Should You Cancel Your Policy?
In general, canceling your life insurance policy is simple: just notify your insurer or stop paying your premiums. But what happens after that can be much more complicated. Canceling your policy largely depends on the type of insurance you have and what you can get out of it.
How to Cancel Term Insurance
For those with term life insurance, the process is straightforward. Since the policy didn’t accrue any cash/interest/investment, you can end coverage by following the insurer’s policy (usually by writing a letter or making a phone call).
You can also stop any automatic payments made toward the premiums, and once you receive formal confirmation, you are good to go.
How to Cancel Permanent Insurance
While you can simply stop making payments toward your premium, this isn’t the best approach. Your policy likely has a cash value, and by not paying you forfeit that money. Instead, call your insurer and discuss your options. A few common ones are:
- Surrender the policy.
- Sell the policy.
- Take a reduced death benefit.
Surrendering your insurance policy allows you to cancel it and collect the cash value. But this option has significant fees. While you will walk away with some cash, it won’t be the total policy value and a big chunk will be eaten up by fees and penalties.
These vary in percentages depending on how long you owned the policy. You should expect to pay a fee if you cancel within the first 20 years of opening the policy. Fees in the first few years are much higher and tend to taper off the longer the policy is yours. A general rule: the longer you hold onto a policy means less fees and more money you can recoup.
You can also sell your policy to a third party who becomes the beneficiary and takes on the remaining payments and receives the death benefit. The sale is usually a one-time, upfront payment. But keep in mind, selling your policy means you will receive more than the surrender value, but less than the policy’s prescribed payout at death. This payment is usually tax-free.
Sometimes you can cancel your permanent insurance but retain a reduced death benefit. In essence, this means you can stop paying premiums and your beneficiary will still receive a (reduced) payout upon your death.
When Canceling Life Insurance Makes Sense
Just like changing your coverage, there is a time and place when canceling life insurance can be the best choice for you. Here are some situations that could warrant cancellation:
- You’re debt-free (i.e. your mortgage is paid off, credit card debt, personal loans, auto loans, etc.)
- You have no financially dependent beneficiaries like children or relatives who need long-term care or assistance.
- You’re wanting to alter your investment strategy ( i.e. use the money you were paying into premiums to invest in an account with potentially higher returns).
- You need or want the cash from your policy (i.e. you can’t afford your premiums each month and want to cash out your policy to find a better option).
These are just a few scenarios where canceling your policy makes sense. Work with your financial advisor to discuss more specific options based on your needs.
The Case For Keeping Your Life Insurance Policy
Life insurance protects your beneficiaries in the event of your passing. For those who have debt or dependent beneficiaries, retaining a life insurance policy is a smart move. Passing away with mortgage debt, for example, could put a spouse or child in a tough position, especially if they can’t afford payments on their income.
Retaining life insurance provides a financial safety net for your family and can bring peace of mind to you, knowing your loved ones will remain financially secure.
By shopping around for a policy that fits your unique needs, you can find the best coverage at a price to match. The right amount of coverage depends on many factors like age, health, income, debts, future expenses, beneficiaries, lifestyle expectations, and more. It is essential to get a policy that matches you and your family’s vision for the future.
Abacus understands how the right type of insurance can align with the values of your overall financial plan. If you want trusted advice about your insurance needs, or any of your unique financial needs, reach out today.