6 Signs It’s Time to Terminate a Term Life Insurance Policy

Updated

It’s been said that buying life insurance can be an act of love. You cared enough about your loved ones to go through the process of getting quotes, making your selection after carefully reviewing your options, had a medical exam (if the face amount was large enough), and took out your checkbook to pay the initial premium.

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If you bought a term life insurance policy, you probably didn’t just buy it because it was less expensive than a whole life policy - you most likely bought it because you needed it for a specific term, hence the name “term life.” 

Should your term life insurance policy become less important over time, you may want to stop paying your insurance premium. But how do you go about terminating it? Let’s look at some of those and when to stop term life insurance.

How Long Do Term Life Insurance Policies Typically Last?

Keeping in mind that term life insurance is “temporary insurance” and is bought to meet a specific need, policies are generally sold in lengths of 5, 10, 20, or 30 years. A few companies will issue term life policies for 40 years. Premiums remain level for the entire length of these policies. 

Term life policies typically last for the length of your financial obligation. For example, a 5-year term life insurance policy is perfect for a 60-month automobile loan, while a 30-year term life policy can cover a new thirty-year mortgage. 

Even though your debt may be short-term, many financial experts suggest that you purchase a policy that lasts longer than necessary because:

  • It’s cost-effective: Your life insurance rates are lower now than they will ever be. Term life premiums increase anywhere from 5% to 10% every year you get older, and health issues you develop as you age can drive those increases even higher.
  • You’ll be ready for the unexpected: You never know what the future will bring—another child, an unexpected stretch of unemployment, or the need to take care of your aging parents. Having extra coverage can help you be prepared for events like these.
  • You can lower your coverage if you need to: As time passes, you may find you don’t need as much coverage as you once did. At any point, while you own the policy, you can lower the face amount or cancel coverage without penalty.

How Do You Choose the Right Term Life Insurance Policy Length?

People choose the length of the term life policy based on the reason they’re buying the policy. For example:

  • 5-year term life insurance: This is for someone with short-term financial obligations, such as college fees or a small loan.
  • 10-year term life insurance: Alternatively, parents of older children who are still dependent on their parent’s income or for someone nearing retirement and needs coverage until they stop working would benefit from a decade.
  • 20-year term life insurance: 20-year insurance is great for newlyweds or new parents who want to replace the income of a spouse who dies.
  • 30-year term life insurance: Lastly, this is for someone who wants to cover a large, long-term financial obligation, such as a college debt or mortgage. It’s also a good fit for younger people who want to have financial protection for most of their earning years.

If your longest-lasting financial obligation falls between two-term lengths, round up to the next highest length. For example, if you have 23 years left on your mortgage, round up your term choice to 30 years.

There are also three questions you can ask yourself that will help you decide the right term length to meet your needs:

  1. How many years do I have left on my mortgage? Your mortgage payment is probably the biggest monthly expense you have, and it’s often the main reason people buy term life insurance. If paying off your mortgage when you die is important to you, pick a policy length that will expire after you make your last mortgage payment.
  2. How long until my children are no longer financially dependent on me? Raising kids is expensive (food, clothing, education, hobbies, activities, electronics), and you probably don’t want to have your spouse take on all of the responsibility and pressure of taking care of the kids financially if you pass away while they’re still dependent on you. You might want to add a few years to the term length if you plan to pay for college.
  3. How many years are there until I retire? Ideally, you’ve been putting money into a retirement account like an IRA or 401K to fund your retirement years. Therefore, if you buy a term life policy to replace your income, you may not need it after you retire. Once your kids leave home, the mortgage is paid off, and you’re living off your retirement savings, your term life policy will be one less thing to worry about.

When your term life policy expires, you may find that you still need life insurance. You have a couple of options.

First, consider converting your term life policy into a permanent whole life insurance or universal life insurance policy. You may feel better having life insurance to pay for your final expenses, like a funeral and burial. A small permanent policy can provide that security. Your rates will be based on your age when you convert your term life policy to a permanent policy.

Second, apply for a new term life policy. Because you’re now older than when you bought your original policy, your rates will be higher, meaning you may have to buy a smaller death benefit to keep the premiums affordable.

How Long Do People Typically Keep Their Term Life Insurance Policies?

The answer might surprise you. Penn State University conducted a study that found that 99 percent of all term policies never pay out a claim. Proponents of term life insurance believe this is because most people let their policies lapse after serving their purpose.

Opponents of term life insurance believe that people who purchased term insurance made a poor buying decision because they paid thousands of dollars in premiums and never got a penny’s worth of benefit.

Regardless of where you stand on the value of term life insurance, you may need to cancel it at some point even before the term lapses.

How to Tell When You’re Ready to Cancel Your Term Life Insurance Policy

If you have people in your life that are financially dependent on you – like a spouse, children, siblings, parents, or business partners – then taking the time and finding the best life insurance policy for your particular situation can be a worthwhile endeavor. 

If you take the time to talk with a life insurance agent and calculate how much life insurance you may need, you probably have a specific need in mind. In the event things work out in your favor and you no longer need your protection (meaning you’re still around), then it might be time to cancel your policy.

The best way to tell when you’re ready to cancel your term life insurance policy is to keep track of the financial need you have for buying the policy, and when you see that you no longer have that need, you’re probably ready to cancel.

Let’s look at some everyday needs people have for buying term life insurance and the signs when it’s time to terminate the policy.

1. Income replacement 

If you’re like most families, you have a standard of living dependent on two incomes. As incomes grow, expenses tend to grow right along with them. Before we know it, a two-income family becomes one out of necessity, not by choice. For this reason, life insurance becomes a necessity to replace income in the event a spouse dies.

Often, policies are taken out on both spouse's lives at the same time, so each spouse is protected and the death benefit they receive can replace the deceased's income.

With this need, you’ll be able to tell it’s time to cancel your policy when you’ve either reduced your expenses to the point where only one income is needed to sustain the family’s lifestyle, or both incomes have continued to grow, but you’ve kept your expenses constant while growing your savings. In either case, the surviving spouse is able to live on one income.

2. Mortgage protection (or rent)

The thought of your family driving away from the family home for the last time after you died because they didn’t have enough money to continue to live there is heartbreaking. Nobody wants their children to have to leave their friends and their school during a traumatic and challenging time of their lives. They need familiar surroundings to help them get their bearings.

Term life insurance can be helpful for this kind of situation. If you have a standard 30-year mortgage, then you’ll want to take out a 30-year level term policy or a 20-year policy if you plan on paying the mortgage off early. The calculation can be trickier for renters, but a good financial calculator or an experienced agent can help you decide on the right amount of coverage.

When protecting your mortgage, it’s time to cancel your policy when your mortgage is either paid off, or you have enough money in the bank for your survivors to pay off the mortgage balance if you died. One other reason to cancel would be your spouse’s income has grown to the point where yours is no longer needed to cover the mortgage expense.

3. Debt elimination 

The total amount of credit card debt in America is about $416 billion in 2020. If you’re like most people, you probably have a bit of plastic in your wallet as well. In fact, each of us averages about $5,300 in personal credit card debt. 

If we take a close look at student loan debt, we’ll see over $1.5 trillion in student loan debt outstanding in the U.S., with the average amount per borrower exceeding $37,000.

When we assume any type of debt, our creditors expect to be paid when we pass away. Leaving that debt to family members isn’t a kind way to say goodbye to them. For this reason, many people will buy term life insurance. They want to take care of their financial obligations when they die and not let that burden fall on someone else’s shoulders.

It’s time to cancel your term life policy if you took it out for debt elimination when you either no longer have that debt outstanding, or you’re leaving enough cash for your survivors to be able to pay off your debts.

4. Fund college costs

A public four-year institution’s median tuition cost is over $10,000 per year, and it’s over three times that amount for private, nonprofit four-year schools. Some parents fund their children’s education with savings, some children acquire help with scholarship money, and others work their way through college.

However, many parents are unable to fund their children’s education because of income limitations or other extraneous reasons. Parents in this situation may consider purchasing term life insurance policies to rest assured that their children will still get to go to college if they die.

You’ll know to stop term life insurance coverage for education after your kids all have graduated, they’re assured of scholarships when they do go, or they have decided not to pursue higher education.

5. Final expenses 

When we pass away, the need for liquidity doesn’t die with us. The funeral costs, burial expenses, outstanding debts, estate taxes, probate costs, and many other items all require payment. Term life insurance policies can provide the money for survivors to pay all of these final expenses.

If you’ve taken a term life insurance policy out for this reason, you can cancel it when you have enough money saved and stashed away to pay all of your final expenses.

6. Unpaid medical bills or taxes

Some people are fortunate enough to pass away quietly in their sleep at a ripe old age. However, some others have lengthy hospital stays and countless doctor’s visits while they fight off illness or disease in their final days. These medical bills are expected to be paid at death.

Likewise, an unpaid tax bill also needs to be settled at death. Some people take out term life insurance because they have a family history of certain illnesses, and they want to make sure their loved ones aren’t left with medical bills. Though there’s often Medicare or insurance to pay some of the costs, there can be deductibles and copays that need to be taken care of.

The right time to cancel a term policy when this need exists is after you’ve accumulated enough savings to cover unpaid medical bills and when your taxes are current.

What Happens After You Cancel a Term Life Insurance Policy?

After your financial needs have all been covered and you decide it’s time to cancel your term life insurance policy, you can be certain of two things:

  • The insurance company will not pay any beneficiary you had previously named any type of death benefit when you die. The insurer is absolved of any financial obligations, and the contractual agreement is over.
  • You won’t be receiving any cash back from the insurance company unless you had a specific rider stipulating that you would. Term policies don’t accumulate any cash value like whole life policies do, so the insurance company won’t owe you anything when you cancel your policy.

The good news is that you won’t be financially penalized for canceling. 

How to Cancel a Term Life Insurance Policy

While having a term life insurance policy is vital for your family’s financial protection, at some point, you may need to cancel the policy. Canceling a term life insurance policy is easily done and can be accomplished in several ways:

  • Stop paying premiums: Your policy will automatically be canceled if you miss a premium payment’s due date and don’t pay it within the 30 to 31 day grace period specified in your policy.
  • Write the insurance company a letter: Even though some policies state that issuing a stop-payment order is considered written notice, you may also send them a simple letter to confirm cancellation. Here’s an example: “Dear INSURER, I am notifying you that I am canceling POLICY NUMBER, effective DATE. Sincerely, NAME.”

Check the insurance company’s website too. You may be able to submit a notice of cancellation online.

  • Call your insurer: Most life insurance companies will let you cancel verbally by phone, or at least begin the cancellation process for you. Be sure to have your policy number handy. A customer service agent can guide you through the cancellation process.

When you cancel your policy, you probably won’t receive a refund of any premiums you’ve paid unless:

  • Free look period: Life insurance companies are required by states they conduct business in to include a “free look period,” which typically lasts anywhere from 10 to 30 days. If you cancel during this period, you will get back the initial premium you submitted with your application.
  • Billing cycle: If you cancel mid-cycle, the insurance company will refund you for the time remaining between your cancellation date and the next payment date. However, any other premiums you’ve paid the insurer won’t be refunded.

Keep in mind that your life insurance company cannot initiate the cancellation of your policy, except for two specific reasons:

  • Non-payment: The company can cancel your policy if you don’t pay your premiums before the grace period ends.
  • Fraud: The insurer can cancel your policy if you were intentionally dishonest on your application. This may even apply after the two-year contestability period has expired, when the company has the legal right to investigate your cause of death.

Other than these reasons, your life insurance company can’t cancel your policy, including if you become ill, pick up a dangerous hobby, or start smoking. 

However, group life insurance is different from your individual term life insurance policy in that employers can cancel a group life insurance policy at their discretion. You can also lose your group life coverage when you leave your employer since most group life policies aren’t portable or convertible into individual life insurance policies. 

Lastly, be aware that you can cancel your term life insurance policy at any time and without paying a penalty for canceling. Contact your state’s insurance department if you’re told by an agent or company that you have to pay a penalty for canceling your term life insurance policy (whole life policies may have cancellation fees if you cancel the policy during the “surrender period.”)

Knowing When to Terminate Your Term Life Insurance Policy

As long as you’re in good health and can afford the premium, you can take out a term life policy pretty much any time you’d like. You also can cancel your policy whenever you deem it appropriate to do so.

Evaluating your entire financial situation at least once a year will help you determine if you still need to continue paying your monthly premiums. If in doubt, a financial planner can help you do your analysis and decide accordingly.

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