When you bought your whole life policy, things were different. Maybe you were single with a higher disposable income, and now you’re married and starting a family, and the thousands you’re pouring into your whole life insurance policy sure would buy a lot of baby supplies. Maybe you bought it at the urging of a friend or agent but even after all this time you’ve still never figured out how it works or if it’s truly a good investment.
Or maybe you’ve decided, like us, that it makes more sense to keep your retirement investments separate from your life insurance, and you want to switch over to a lower cost term life policy that will protect your family until your child is through college.
The question you now face is, how do you go about canceling your whole life policy?
If you’ve purchased a whole life policy, you know how complicated it can be, and—surprise!—canceling a whole life policy is also a complicated affair. It’s yet another reason to avoid whole life policies and stick to simpler and cheaper term life. (Here are some other reasons.)
Below are the basics to help you along. But before you start, we recommend you take out your policy and carefully read the fine print, or take it to a fee-only financial advisor who can help go over the details with you. Every state and every insurer is different when it comes to the rules we’re about to describe below, so you’ll need to apply what you read here to your specific situation before you can decide on the best route forward.
Why do you want to cancel your whole life insurance policy?
Your answer is none of our business, but it matters because it determines which options you should consider. Are you wanting to get rid of your whole life policy because you want to buy a cheaper term life policy? Or are you trying to access the cash value portion of your whole life policy?
If you’re looking to give up the policy completely, you may have a few options depending on how long you’ve owned it and the policy’s fine print.
If you’re canceling the policy to access the cash value portion then there are other approaches you should review before you decide how to proceed.
Option 1: You just want to cancel the policy
When you cancel your whole life insurance policy, you’re officially "surrendering" the policy in insurance lingo. But unlike term life, you can't simply stop paying the premiums and assume the policy will end, because most whole life policies have something called a "nonforfeiture clause" that kicks in. (We’ll talk more about this later.) So remember that if you want to surrender your whole life policy, you should contact your insurer and tell them first, then settle on when you’ll make your last payment.
What happens next — and your available options — will depend on the age of the policy, the insurer’s rules for handling missed payments, and the potential tax consequences.
The age of your policy
How long you’ve owned the policy is the most important factor in what your options will be when you surrender it. A quarter of whole life policies are terminated within the first 3 years, and nearly half are terminated within the first 10 years, so insurers like to make sure they recover their expenses if you bail on them. How they do this varies from policy to policy, but the general structure is this: the longer you’ve owned the policy, the easier it is to get the full cash value out of it.
- The first 2-3 years that you own the policy
The first few years of the policy make up a "surrender period," which has different surrender rules than the rest of the policy’s lifespan. Some insurers will stipulate that you don’t get any cash value portion returned if you surrender during this period, while other insurers will apply steep surrender penalties in order to recoup their own front loaded expenses in selling and setting up the policy.
- The first 10 or so years that you own the policy
Insurers typically reduce the surrender fees by a yearly percentage over the first decade, meaning if your surrender penalty is 10% in year 1, it might be 9% in year 2, 1% in year 10, and 0% after that.
(Some late shopping advice: if you’re going to buy a whole life policy, avoid those that don’t permit any cash value to be withdrawn in the first years, as well as policies with long-than-average surrender fee periods.)
Considering your "nonforfeiture" options
Another factor that could impact your options is something called "nonforfeiture." The easiest way to understand it is to compare it with term life insurance. With term life, if you stop paying your premium, the policy lapses, your coverage ends, and that’s that. With whole life, you’ve got more moving parts to work with, and if you’re past the surrender period and miss a payment then the insurer may offer you some alternatives (or even apply one by default):
You can take the full cash value and run, or
You can keep the death benefit for a shorter term, or
You can retain the cash value in the policy but receive a reduced death benefit.
You may even be able to let the policy lie dormant for years and then resume paying premiums into it at some later date. If your dividend is strong enough, you may even be able to let your dividends pay the premium while the cash value continues to grow.
These nonforfeiture rules are really meant for policy owners who miss payments but still want to hang on to some part of the policy. If you’re simply trying to get rid of your whole life policy, they may not matter to you, but you can ask your agent or insurer about them just so you know all of your options.
The tax situation
Finally, there are taxes to consider. At a basic level, the cash value you get out of your whole life policy is tax free, but there’s an exception. If the amount you receive is larger than the "basis" of the policy, you’ll be taxed on the amount over the basis. You can determine the basis by taking all the premiums you’ve paid into the policy and then subtracting any dividends you’ve been paid, any cash you’ve already withdrawn, and any agent commissions or administrative fees that were paid by your premiums.
If you just want out, know what you plan on doing next
If you’re canceling a whole life policy but you still need life insurance, keep in mind that you will have to go through the application process again to buy a new policy – and you’ll probably want to pick term life insurance this time around. This means another health exam, and of course your age will be a factor in determining the cost of a new insurance policy — even though term life insurance is cheaper than permanent life insurance, you’ll naturally pay more for a term policy today than you would have 5, 10, or 20 years ago, and if you’re above a certain age you may have trouble getting a term life policy at all.
Talk to an agent first (or compare free quotes on our site) so you know what your options are before getting rid of your current life insurance protection.
Option 2: You want to access the cash value portion of your whole life policy
If you’re looking at canceling your whole life policy just to get at the cash value it contains, then you should know that there are more options available to you than simply surrendering the policy. The details of those options are beyond the scope of this article (go to a no-fee financial advisor for help), but in general they include:
- Withdrawing cash from the cash value portion
Doing this will likely reduce your death benefit, so be sure to talk to your agent or financial advisor first.
- Taking out a loan against the cash value
You’re essentially borrowing from yourself, but there’s still an interest rate to be aware of.
- Selling the policy to a life settlement group
This is typically only available to older policy owners who are expected to live another 5-10 years.
Although it’s definitely more complicated to cancel a whole life policy than it is to cancel a term life policy, it’s not impossible. Just take the time to review all of your options and understand the fine print (with the help of a no-fee financial advisor).