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Canceling or Surrendering a Life Insurance Policy

The difference between the two, what to check first, and how to do it cleanly

Deciding to end a life insurance policy is usually a money decision, and it is often made in a hurry. The premium has become uncomfortable, or the policy no longer seems to serve a purpose, or a letter arrived asking for more. Ending it is your right as the owner, and it is permanent, which is why the order you do things in matters as much as the decision.

Canceling and surrendering are not the same thing

Canceling generally applies to a policy with no accumulated value, such as term insurance. You tell the insurer to stop the coverage, the payments stop, and nothing comes back to you.

Surrendering applies to permanent insurance that holds cash value. You end the contract and the insurer pays the surrender value, which is the accumulated value less any surrender charge still in effect and less any outstanding loan and interest. The coverage ends on that date.

There is also a right to cancel very early on. Newly issued policies come with a free look period, during which the policy can be returned for a refund of premium. Its length is set by state law and stated near the front of the policy, so check the document rather than a general figure.

Four things to check before you sign anything

• Whether the policy is promised to someone. A divorce decree, a business buy-sell arrangement or a loan may require this coverage to stay in place. Canceling in breach of one creates a legal problem as well as an insurance one.
• Whether the policy was assigned. If it was pledged as security, or a funeral home holds an assignment, the insurer will not act on your instruction alone.
• What the tax position is. On a surrender, any amount received above what was paid in is generally taxable income, and a policy classified as a modified endowment contract is treated differently again. Ask a tax professional before, not after.
• What else the contract offers. Ending it is the last door, not the only one. Ask what the policy allows in writing before you use that door.

The middle options worth pricing first

Most permanent contracts hold something between paying full premium and walking away. Which of these exist depends on your policy.

• Reducing the amount of coverage. A smaller death benefit costs less to carry, and the policy stays in force.
• Reduced paid-up coverage. Premiums stop and a smaller amount of coverage continues, funded by the value already built.
• Extended term coverage. The value already built is used to hold the full or a reduced amount of coverage for a limited period with no further premiums.
• Using cash value or dividends to pay the premium. This can carry a policy through a difficult stretch, while drawing down the value it relies on.
• An exchange into a different policy or an annuity. Value can sometimes be moved without the transaction being treated as income, under rules that have conditions. This is one to get advice on before initiating.
• Selling the policy. For some older insureds a life settlement is possible, meaning the policy is sold to an investor who takes over the premiums. It is regulated, involves fees, and only some policies and situations are eligible.

A licensed independent agent can ask the insurer for figures on the ones your contract contains, so the comparison is made with real numbers rather than assumptions.

If you have decided, do it in this order

First, get the surrender value or the cancellation effect confirmed by the insurer in writing, along with the date it takes effect.

Second, if anything is meant to replace this coverage, wait. Do not end the old policy until the new one is issued, delivered and paid. Applications are not approvals, and a gap between the two is where families get hurt.

Third, submit the request the way the insurer requires it, which is usually a signed form rather than a phone call, and keep a copy of everything you send.

Fourth, and this is the one people get backwards, do not stop the bank draft first. Canceling the payment before the insurer processes the request creates a lapse rather than a clean ending, and the two are not treated the same. Stop the draft once you hold written confirmation that the policy is terminated.

Where people get this wrong

• Underestimating what replacing it costs. New coverage is priced at today's age and today's health, underwriting applies, and older contracts sometimes include terms no longer sold.
• Forgetting the fresh review period. A new policy generally starts a new period during which the insurer can examine the application if a claim arises early. That is a real cost of switching.
• Surrendering to solve a short-term problem. A few difficult months and a permanent decision are not the same size. Several of the middle options exist precisely for a bad year.
• Not telling the family. Beneficiaries who believe coverage exists make plans around it. If a policy ends, the people counting on it should know.
• Assuming a phone call did it. Until you hold written confirmation that the policy is terminated, treat it as still in force and keep paying.

Questions people ask