When and How to Cancel Life Insurance

by Neal Frankle, CFP ®

The right time to cancel life insurance is when you no longer need it. That may seem like a smarty pants response, but I’m completely serious. Maybe if I share a story or two with you, you’ll see what I mean.

Jean bought whole life insurance years ago in order to pay estate taxes. (To understand why, please read term life insurance versus whole life.) She wants her children to inherit her home when she dies. Since most of her estate is tied up in her home, she realized that she had to buy the coverage in order to provide liquidity to pay estate taxes when she dies.

But now she’s older and her main objective is income. And she desperately needs to reduce her outflow. Also, her house has dropped in value. While nobody knows what estate tax rates are going to be when they die, she’s made an educated guess that she’ll probably be below the taxable estate threshold.

On top of that, she realizes that her children don’t have the resources to hold on to her beautiful home once she goes. They’ll have to sell the home anyway because they won’t be able to afford the property tax let alone the upkeep. So in summary:

a. Her objective changed.
b. The tax laws have changed.
c. Her children’s capabilities have shifted.

This all adds up to one thing: time to cash in her life insurance policy and enjoy life. When she dies, the kids are going to sell the house anyway. The life insurance doesn’t help avoid that. And she needs the income that she’s spending on insurance premiums so she can party.

Here’s another illustration.

Tom and Nancy bought life insurance years ago. Why?

Well…Nancy needed insurance on Tom since he was the main income provider. Tom didn’t really need insurance on Nancy, but the agent was probably really slick and convinced him that he did. They bought term life insurance they thought was inexpensive that ended up being very expensive.

Over the years, the term premiums increased. Before they knew it, the annual payments on Nancy’s insurance were enough to pay for a cruise to Alaska – for the two of them.

The reality is that Nancy never needed life insurance. They finally realized it when they ran their financial plan.

In summary, you should examine every expense – especially large ones. Life insurance is a tool – not an ornament. If you need it, fine. I’m a huge fan. But make sure you carry the right kind of insurance and don’t spend more money than you have to on life insurance. And finally, if you no longer need it because your situation has changed, dump it quick…(just send me a postcard from Alaska, will ya?)

Before you take off on your cruise, make sure you check out this week’s Pilgrim Posts on Parade:

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{ 3 comments… read them below or add one }

DIY Investor July 24, 2010 at 3:25 AM

Good post. People sometimes hold on to insurance they don’t need through pure inertia. These are the kind of things that need to be reviewed on an ongoing basis. If you wouldn’t buy it today get rid of it.

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Evolution Of Wealth July 23, 2010 at 8:58 AM

For Jean shouldn’t there be a lot more to this story? It sounds like she probably had a permanent policy with cash value built up. Might she do a reduced paid up policy, to cut expenses and still be able to leave some liquidity to give the children the six months to a year it could easily take to sell the house? Or maybe even generate tax free income from the life insurance policy?
If she just cashes it in there might be a big tax bill. There’s also the 1035 option?

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Little House July 23, 2010 at 7:16 AM

Thanks again for mentioning my link! I’ve included your link on mine. :)

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