Do you realize that life insurance contracts are unilateral contracts? This means that we, as the policy owners, have only one obligation, paying the premium, while all of the other obligations lie with the insurance company. But what happens if you can’t pay your insurance premium? What are your options?
When it comes to life insurance contracts, especially whole life insurance policies, you’re entering a long-term commitment. It’s a contract between you and the insurance company, where you agree to pay the premium. But life doesn’t always go as planned. What if cash flow is tight? What if you don’t have access to the money? As a policy owner, what can you do to keep the policy in force?
This question comes up a lot, especially when people are considering purchasing a policy. And when you do find yourself in a cash flow pinch, the key becomes how much equity or cash value you have in the policy. For a term policy, you don’t have any equity. If the premium isn’t paid on its due date whether that’s monthly, quarterly, semi-annually, or annually you may have the flexibility to change the payment frequency to suit your cash flow better. But if you don’t pay it within the grace period, usually 30 or 60 days, the policy will lapse and you’ll lose your coverage.
That loss can be a big issue for your family. But with permanent life insurance like whole life, there’s a very different dynamic. The question becomes: how much equity have you built up in the policy? In the early years, there’s usually very little equity. However, when structured properly especially with the use of paid-up additions riders you can build significant equity in the early years. This can provide you with the option to borrow against the policy’s cash value to pay your premiums going forward, or at least cover a portion of them.
The key is having that option available. If you have a standard whole life policy with no additional funding beyond the base premium, it will still accumulate cash value each year. So, in the later years let’s say year four, five, or six you should have built up enough equity to cover one, two, or even three years of premiums if needed. That can absolutely be a lifesaver if you’re facing a temporary cash crunch.
We had a client who was 67 years old when we met him. His father had purchased a policy on him when he was 13, but tragically, his father passed away when the client was 16. Only three years of premiums had been paid on the policy. Decades later, the client contacted us because he was still receiving premium notifications and wasn’t sure if the policy was still active. He sent over the documents, and it turned out the policy was indeed still in force. We helped him obtain an in-force ledger to understand the current status. Sure enough, there was a $7,500 loan against the policy, but he was in a good financial position and chose to repay it.
The policy his father had bought was a “life paid up at 65” plan. By repaying the loan, the client restored the policy to its fully paid-up status. Originally, the death benefit had been $5,000, but it had grown to $12,000. On top of that, the policy continued to earn dividends and interest, meaning both the cash value and death benefit would keep growing. All in all, his father had paid premiums for just three years, and the client ended up with a strong, active policy decades later thanks to the built-in safety net of whole life insurance.
Most people in these situations don’t want their policies to lapse. They reach out because they’re trying to find a way to maintain their coverage. One option is to take a policy loan, provided there is equity available. Another option is to surrender dividends or some portion of the cash value to cover the premium. That choice has more of a long-term impact, though. When you take a policy loan, it reduces the available cash value and death benefit dollar for dollar. But when you surrender dividends, it reduces not just the cash value and death benefit, but also impacts future growth, since you’re no longer earning dividends on those surrendered dividends.
Another possibility is to reduce the policy. For instance, if you’re in a long-term cash flow crunch and can only afford half the original premium, you might be able to lower the face value of the policy and pay a smaller premium based on that reduced death benefit. The key here is that you have options, and the insurance company has built in safeguards to help you avoid losing coverage due to situations beyond your control.
One more option is what’s called a “reduced paid-up” policy. Let’s say you’ve had your policy for 30 years and accumulated a healthy amount of cash value. You want to retire and stop paying premiums. While not always recommended, you do have the choice to convert your policy to a reduced paid-up policy. This freezes the current cash value and uses it to purchase a smaller, fully paid-up policy. You’ll never pay premiums again, and the policy will continue to grow, just on a smaller scale. It’s kind of like a limited-pay policy—you start with the intention to pay over a certain period, but cut that period short when you hit your desired milestone.
With a reduced paid-up policy, you may go from a $500,000 death benefit to a $300,000 benefit, but you eliminate the need for future premiums. Many people like this option in retirement, especially if they’re living on a fixed income. It doesn’t trigger any taxable events, and you continue earning dividends and interest on the new, smaller policy.
Finally, there’s the option to surrender the policy altogether. If you decide not to keep the policy, you can surrender it and receive the accumulated cash value. You’ll get your premiums back on a tax-free basis, and anything above that amount will be taxable as income in the year of surrender. If you’re struggling to afford premiums, your best move is to contact your insurance agent or company to review the specific options available for your policy.
Don’t wait until a cash flow crisis catches you off guard. Visit our website www.tier1capital.com and click the “Schedule Your Free Strategy Session” today. We’d be happy to chat with you about your specific situation.
Remember: It’s not how much money you make, it’s how much money you keep that really matters.