Is It Time to Let Your Life Insurance Policy Lapse?

You’ve had your life insurance policy forever, and you’ve paid a lot in premiums over the years. If you let the policy lapse, you forfeit any benefits and you don’t get any of those premiums back. But sometimes that’s the right move.

By Tim Fries

published 16 June 2021

in Features

A hand throws a balled up piece of paper in a waste basket.

(Image credit: Getty Images)

Taking out a life insurance policy is a smart move if you have anyone who depends on you. It’s no wonder then, that an estimated 54% of Americans have some type of life insurance. This figure only increased in the wake of COVID-19, which caused the demand for life insurance policies to increase. If you’re young, recently married or looking to start a family, most agree that the right path is clear — you should take out a life insurance policy.

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But what do you do when, 20 or 30 years down the line, if all goes well, your policy is close to expiring or the financial well-being of your loved ones has changed significantly? You might think that this is a no-brainer, and that simply buying a new policy is always the best call — but that isn’t quite so.

The fact of the matter is that in some cases, letting your policy lapse even before it is about to expire can be the wiser choice. The feeling of security that you get from holding such a policy is always comforting — but in some cases, that feeling could be misguided.

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It’s difficult to find trustworthy sources of information that deal with this topic, as most will feature a financial incentive to get you to renew your policy or buy a new one. Here, we’ll cover the situations in which you should renew your policy, but we’re also going to illuminate an often overlooked topic: When does it make sense to let your policy lapse?

What is Life Insurance?

A life insurance policy is a contract that is signed between you, as the policyholder, and an insurer. It guarantees that the beneficiaries you name in the contract will receive a sum of money when you pass away. In exchange, you will have to pay premiums — usually as either a one-time payment or as regular monthly payments.

If the worst comes to pass, your beneficiaries will receive the death benefit or the face value of the policy. You get to choose what that amount will be, based on your approximation of how much money is necessary for your loved ones to be secure.

When applying for a policy, you will go through the process of underwriting — the insurance company will assess the level of risk that they’re exposed to, based on factors such as your age, gender, health, history and occupational hazards.

What Happens When Your Life Insurance Policy Lapses?

If you have a term life insurance policy and it lapses while you are alive, your beneficiaries will not receive a payout. Your policy will lapse if you stop paying premiums — and you won’t receive anything in the way of a refund for premiums paid up to that point.

However, missing a single payment won’t automatically render your life insurance policy void. All life insurance policies in the United States must offer a grace period by law, usually 30 days — although with the advent of the Coronavirus, plenty of life insurance providers have extended that grace period to 60 or even 90 days.

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Keep in mind, however, that grace period payments are usually substantially higher than regular payments. After the grace period expires, your policy is officially void in most cases. Nonetheless, some insurance companies offer a period, known as a reinstatement period, during which you can renew your policy.

You should always be aware of whether your insurance provider offers such an option. In the vast majority of cases, where applicable, you can reinstate your policy without underwriting within a month of your policy lapsing.

However, if you exceed your reinstatement period, the insurance company will most likely want to find out if your risk profile has changed. Thankfully, the underwriting process that is required with reinstating a policy is much less time-consuming and grueling than the initial process of taking out a life insurance policy.

Reinstating a policy always comes with fees. However, on the whole, reinstating a policy is much cheaper than taking out a new life insurance policy altogether. If you do not reinstate the policy, it will lapse.

Now, let’s take a look at some of the reasons why you might decide to let that happen.

When Should You Let Your Life Insurance Policy Lapse?

The simplest way to find the answer to this question is to ask yourself: If I died tomorrow, would anyone who depends on me face significant financial challenges?

If you’ve saved up enough for retirement, paid off the house and don’t have any major debts, letting your policy lapse can be the more cost-effective decision. Keep in mind that renewing your policy always comes with much higher premiums — and since the policy is renewed year after year, it is perfectly reasonable to explore whether paying for such coverage has continued value.

If your family is in a position to keep up with their regular payments (mortgages, auto loans, student debt, etc.) while still retaining their current standard of living, and if your financial obligations are settled, there is little reason to renew your policy. The purpose of life insurance is to keep our loved ones financially secure if we should pass — and if the criteria listed above have been met, your family is likely to already be in a secure position. Thus, renewing your policy could have the sole effect of putting undue strain on your finances.

When Should You Renew Your Life Insurance Policy?

Conversely, if you still carry a significant amount of debt that is yet to be settled, or you don’t have enough saved for retirement, renewing your policy is a good way to ensure that your beneficiaries will be safe in the years to come, no matter what happens.

Although premiums are higher when you renew a life insurance policy, you can still opt to sign up for a payout that is smaller, yet more affordable for your current needs.

In your 20s or 30s, leaving a spouse or children without your financial support makes policies with $1 million or even more in payouts justified. However, if you’re close to retirement age, a couple hundred thousand dollars might be more than enough should the worst come to pass.

Keep in mind that some employer-sponsored policies can come with tax benefits. Group-term life insurance policies, for example, are not taxable for the first $50,000 worth of coverage, allowing you to reduce your taxable income by a sizable amount.

You should also keep in mind that plenty of life insurance policies also come with living benefits. If you run into long-term health complications, this can greatly reduce the financial burden that you and your family will be subject to.

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Disclaimer

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

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Tim Fries is co-founder of Protective Technologies Capital, an investment firm focused on helping owners of industrial technology businesses manage succession planning and ownership transitions. He is also co-founder of the financial education site The Tokenist. Previously, Tim was a member of the Global Industrial Solutions investment team at Baird Capital, a Chicago-based lower-middle market private equity firm.