4 Ways to Cancel a Life Insurance Policy

A life insurance policy provides financial protection for loved ones upon your passing, but there are several reasons why you may consider canceling a life insurance policy.

You may find that your policy premiums are unaffordable after a change in your financial situations, or you may want to cancel and switch to a policy that’s better for your current needs. Later in life, you may find that you don’t need any form of life insurance coverage. Regardless of why you’re considering canceling your policy, it’s important to know what’s involved in the process so you can make the right choice.

There’s several ways to cancel a life insurance policy, and each option has pros and cons. In this post, we’ll explain each method of canceling a life insurance policy so you can choose the best option for your needs.

Can you cancel a life insurance policy?

You can cancel a life insurance policy at any time, but you may have to pay fees if you’re canceling after the free look period. The free look period is usually 10-30 days starting after you sign your contract, and it allows you to back out if you change your mind and want a different policy type or even a new policy from a different insurer. The length of time you have for your free look period depends on the state you live in, so check your contract for specific details. If you do cancel your policy within the free look period, you’ll be refunded for any premiums you’ve paid to the insurer.

After the free look period you can cancel a policy by letting it lapse, surrendering it back to the insurance, or selling it to a life settlement company. Here’s an explanation of these options:

• Let the policy lapse: You can let the policy lapse by stopping payments. After the grace period ends, you’ll no longer have coverage.
• Surrender the policy: You can surrender a policy back to the insurer to end coverage and receive the policy’s cash value, minus any surrender fees.
• Use a tax-free 1035 exchange: A 1035 exchange allows you to replace your current life insurance policy with a different policy or annuity. It will end your current policy, but you’ll maintain coverage through the new policy you trade it for.
• Sell your policy: If you meet the eligibility requirements, you may be able to sell your life insurance policy to a third-party company through a transaction known as a life settlement. When you sell your policy, the buyer gives you a lump sum of cash that’s more than the surrender value but less than the death benefit. It doesn’t cancel the policy, but it transfers ownership so you are no longer responsible for premiums.

What happens when you cancel a life insurance policy

You can rely on two outcomes when you cancel any life insurance policy. One, your insurer will stop billing you for premium payments. And two, if you die after the policy is cancelled, your beneficiaries will not receive the death benefit. Beyond that, policy cancellations can get complicated depending on the way you cancel it.

If you’re still within the free look period, you can back out of the life insurance policy and receive a full refund of any premiums paid. The insurer will void the contract as if you’d never purchased the insurance at all. 

After the free look period closes, your policy is subject to the normal cancellation rules and procedures. Term life insurance cancellations are generally straightforward, while permanent life insurance cancellations are more complex because it may involve cash value, surrender fees, and taxes. 

You should know, that many insurers allow you to reinstate a policy that’s been canceled if you change your mind in the future. To do so, you’ll need to pay any past due premiums and submit a reinstatement application. Reinstatement, however, is not a legally mandated option; it’s up to the insurer to decide whether to honor your request. You may also be required to provide evidence of insurability, including a new medical exam from a healthcare provider.

How to cancel a life insurance policy

If you decide to cancel a life insurance policy, you have a few ways to do so. Below, we’ll discuss each option including its pros and cons to help you decide which cancelletion method is best for your situation.

1. Let the policy lapse

The easiest way to cancel a life insurance policy is to let it lapse by stopping payments. Life insurance policies usually have a grace period of 30 to 60 days that follows your premium due date. If you are late on a premium payment, you can catch up without consequence during the grace period. If you don’t catch up, your policy is canceled once the grace period expires.

On term life insurance, your policy lapses at the end of the grace period if you haven’t made a payment. A missed premium payment works differently on permanent life insurance. If the payment is still outstanding at the end of the grace period, the insurer will withdraw funds from the policy’s cash value account to cover the premiums. The coverage will remain in force until the insurer consumes all of the cash value. While letting your policy lapse is the easiest option, it also means you won’t get anything back, so it’s worth looking into alternatives.

2. Surrender the policy

If you have a permanent life insurance policy with cash value, you can surrender it to the insurer to get your cash value back. When you surrender your policy, you’ll lose coverage and receive the balance in your cash value account, minus any applicable surrender fees. If your cash value exceeds the amount you’ve paid into the policy as a result of interest or gains from investments, you’ll also have to pay tax on the surrender proceeds. This option is better than letting your policy lapse because you’ll get some money back, though selling the policy will yield a higher value if you’re willing to put in a little more work.

3. Perform a tax-free 1035 exchange

If you want to cancel your life insurance policy and replace it with a new one, you may be able to use a tax-free 1035 exchange. The IRS allows this type of exchange so you can easily replace life insurance policies and annuities that no longer match your financial situation. For the transaction to qualify as a 1035 exchange, the insurer has to move the funds from one contract to another behind the scenes. If you accept any surrender fees or cash payments from the old policy, the transaction will be taxable. 

A tax-free 1035 exchange is a good option when you still want life insurance, but you need something different than the policy you currently have. 

4. Sell the policy

Many term and permanent life policies can be sold for cash in a life settlement. A life settlement transfers your policy, along with the cash value and death benefit, to a new owner. In return, you receive a lump sum of cash that you can use for any purpose, though a portion of the proceeds may be taxable. Once the transaction closes, that new owner pays the premiums. This transaction doesn’t cancel your policy, but since the new owner becomes responsible for paying premiums, it has a similar end result to surrendering it but with a higher payout.

The value of your life insurance in a life settlement is always more than the policy’s cash value or surrender value. Depending on the details of your coverage, your life insurance may be worth up to 60% of the death benefit. This makes the life settlement a great option if your goal is to maximize the cash return from your life insurance.