Your whole life insurance policy may be an important source of financial security. The coverage can last your entire life, premiums are generally guaranteed and may even only be payable until a certain time, and you have the opportunity to accumulate tax deferred cash values to diversify your investment portfolio. The premiums for whole life insurance can be significantly more expensive than term insurance. You may find yourself considering cancelling your whole life insurance policy when you have trouble meeting or justifying the cost.
Tax Treatment of Cash Value
When you cancel your whole life insurance you will receive a check for the cash value, less any applicable surrender charges and administration fees. Since you paid no tax on the cash value accumulation while the contract was in force, you will have to include in taxable income the amount of the cash value that exceeds the policy’s basis. The basis generally comprises the premiums you paid, less an adjustment for cost of insurance, and the insurance company usually provides it to you.
If you still need life insurance but you want to pay less in premiums, your can typically choose between term insurance to cover short-term needs or universal life to cover long-term needs. You will have to go through the insurance company’s underwriting process all over again, which involves providing new evidence of your good health. Term insurance may also only cover you until age 75, so consider your needs carefully. If you need the insurance to last your entire life, you may be able to find a universal life policy where the minimum premiums are cheaper than whole life.
Alternative to Cancelling
If you’re considering cancelling your whole life policy because of temporary difficulty in paying the premium, the insurance company may offer certain solutions that would allow you to maintain the policy. An automatic premium loan lets you borrow the premiums from the insurance company using the cash value as collateral. The loan grows with interest and you either pay it back eventually or the insurance company takes it out of policy proceeds on the event of your death.
If you are thinking of cancelling your whole life insurance simply due to the costs, consider certain advantages before doing so. The higher premiums you typically pay for whole life insurance generate cash value in the policy. The growth inside the plan is generally not taxable until you make a withdrawal. Cash value paid out on death with the tax free insurance proceeds is typically tax free as well. This lends itself fairly well to a number of estate planning issues where you wish to transfer wealth from one generation to another. The cash value can also be used as collateral to secure a loan from a bank. The loans are not taxable and you repay the loan plus accumulated interest on your death with the tax free policy proceeds.
Philippe Lanctot started writing for business trade publications in 1990. He has contributed copy for the "Canadian Insurance Journal" and has been the co-author of text for life insurance company marketing guides. He holds a Bachelor of Science in mathematics from the University of Montreal with a minor in English.