What is an example of a Nonforfeiture option?

Reduced paid-up insurance is a nonforfeiture option that whole life insurance companies provide to their policyholders.

Find Cheap Life Insurance Quotes in Your Area

It's free, simple and secure.

If you own a whole life policy, the reduced paid-up option would allow you to give up your existing coverage and instead receive a guaranteed death benefit that needs no additional payment of premiums. Permanent life insurance companies also allow policyholders to utilize other nonforfeiture options that include cash surrender and extended term insurance.

What is reduced paid-up insurance?

If you have whole life insurance and no longer want to pay premiums for your policy, you can either opt to surrender it and receive the cash value or use the accumulated cash value to fund reduced paid-up insurance coverage. Reduced paid-up insurance would allow the death benefit to remain in place without you being required to pay any future premiums. However, the death benefit is reduced to the amount of cash value that you had in your original life insurance policy.

Life insurance companies calculate the reduced coverage based on the number of premiums you have paid, the total cash value in the policy and your age. Usually, the amount of cash value directly reflects the amount of reduced paid-up coverage you would receive.

For example, you may pay $2,000 per year for 20 years and have an aggregate cash value of $30,000 in a life insurance policy. If you decide to convert to reduced paid-up insurance, you may be able to receive a $30,000 guaranteed death benefit for the rest of your life without having to pay premiums.

Reduced paid-up insurance is only available for whole life insurance and not term insurance policies since these plans do not have a cash value. Additionally, a life insurance company will usually require three years of premiums before your policy would become eligible for reduced paid-up insurance.

Difference between paid-up additions and reduced paid-up

A paid-up addition is extra life insurance that you can purchase using dividend payments from the policy. The amount of paid-up additions you purchase directly increases the death benefit of your current policy.

Paid-up additions and reduced paid-up insurance also differ in that reduced paid-up options are included with most whole life insurance policies. In contrast, paid-up additions are considered supplemental to your original policy. This means that your insurer will require you to add the "paid-up" rider, which could merit charging larger premiums to your policy when you first purchase life insurance coverage.

Reduced paid-up insurance vs. other nonforfeiture options for life insurance

A nonforfeiture option is a clause in your policy that allows you to receive full or partial benefits from your life insurance if the policy lapses or you want to cancel the plan. Reduced paid-up insurance is a nonforfeiture option that is included with your life insurance coverage. Other nonforfeiture options that are provided by most insurers include:

• Cash value surrender
• Extended term insurance

Cash value surrender is the most basic nonforfeiture option that is available. In this case, you would forfeit your life insurance for the cash value that has built up in the policy. Before issuing the cash value payment to you, any outstanding loans or premiums owed would be deducted by your insurer.

It is important to remember that after surrendering a policy, your original life insurance will no longer exist. You would receive the cash value less any fees that you owed, but you would have no death benefit coverage. For this reason, cash value surrender is often a last-resort option and only recommended if you have adequate life insurance coverage elsewhere or no longer need a policy in place.

An extended term insurance nonforfeiture option would allow you to purchase term life insurance with a death benefit equal to that of the original whole life policy. The new policy would be purchased with the cash value you had built in your old life insurance plan. The length of the new extended term coverage would be equal to the number of years that you paid premiums.

For example, say you bought a whole life insurance policy at 25 and paid premiums until you were 55, at which point you wanted to forfeit the policy. If you chose the extended term nonforfeiture, then your accumulated cash value would purchase an extended term insurance policy with a term of 30 years and death benefit equal to the original insurance plan.

Who is reduced paid-up insurance best for?

Reduced paid-up insurance is best for someone that may be experiencing financial hardship and cannot continue to make premium payments for their current policy.

In this case, instead of having the policy terminated due to lack of payments, you could convert to reduced paid-up insurance that requires no future premiums and gives you a guaranteed death benefit.

Similarly, if you wish to stop paying premiums but do not want to choose the cash value surrender option because you would incur a taxable gain (occurs when "total premiums paid" is less than the "total cash value"), then converting to reduced paid-up could be a smart option. You would be able to avoid any tax implications while still having death benefit coverage for your dependents that would be tax-free if you passed away.

We recommend you have sufficient life insurance coverage to meet your financial needs and provide support for your loved ones in the event that you pass away. Reevaluating your financial situation after major life events is crucial so that you are accurately covered.

For example, say you initially purchased enough life insurance to cover any expenses for sending your kids to college, but they are now employed and the policy has generated plenty of cash value to support and provide for your spouse in the event you pass away. In this scenario, you may choose to utilize a reduced paid-up option allowing you to stop premium payments but still have coverage for your spouse.

Who should not choose a reduced paid-up option?

If you currently depend on policy riders, then reduced paid-up insurance may not be the best choice. Typically, when converting to this type of policy, any riders that your original life insurance had would be eliminated. This is a critical factor to consider, as one of your policy riders may provide you with additional benefits that are vital to your life.

For instance, you may value your guaranteed insurability rider, which gives you the ability to purchase additional death benefit coverage without having to demonstrate your health through a medical exam. If you converted to a reduced paid-up policy, then you would lose the guaranteed insurability rider.

Summary of coverage

At the end of the year, your life insurance provider typically provides a letter or envelope with details about your coverage. In this package, your provider typically includes a chart that outlines how much your whole life policy would be worth if you decided to pay up for a reduced policy. This information can be useful for your financial planning needs and should be your first point of reference if you are thinking about nonforfeiture options like reduced paid-up insurance.

When a permanent life insurance policy lapses due to non-payment, or when the policyholder chooses to surrender the coverage, the nonforfeiture clause helps protect the accumulated cash value. Nonforfeiture clauses stipulate how a policyholder can receive their policy’s cash value, allowing them to receive a lump-sum payment or apply the funds to continuing coverage.

• A nonforfeiture clause helps protect a life insurance policyholder’s accumulated cash value.
• A nonforfeiture clause is triggered when a policyholder stops paying premiums or surrenders their permanent life insurance policy.
• A nonforfeiture clause may offer several payout options.
• Some payout options allow the policyholder to continue life insurance coverage.

A nonforfeiture clause determines how an insurance policyholder can receive their policy’s accumulated cash value in the event of a lapse due to non-payment, or when the policyholder chooses to surrender the coverage. The terms and conditions of a life insurance policy require you to make premium payments.

In addition to a death benefit, permanent life insurance policies also build a cash value over time. A nonforfeiture clause, which stipulates that a policyholder will not forfeit their accumulated cash value if they stop paying premiums, is part of many permanent life insurance policies.

Let’s say you have a $120,000 whole life policy that has accumulated a cash value of $30,000. Six months ago, you lost your job and now can’t afford the premium payments. If your policy lapses due to non-payment, you are still entitled to the accumulated cash value if your policy contains a nonforfeiture clause.

After a policyholder has paid premium payments for a sufficient period, the policy’s nonforfeiture clause may apply if the policy lapses due to non-payment. The nonforfeiture clause may also kick in if the policyholder surrenders the policy. The amount of money an insurer will return to the policyholder depends on the policy’s surrender value. This is the amount the policyholder can borrow or withdraw from the accumulated cash value.

Surrender value and cash value are two different things. The cash value is the amount a policy is worth as it grows over time. If you take an early withdrawal from the policy, you will most likely have to pay a steep fee, which will affect the remaining value—the surrender value. 

When a policyholder chooses to surrender their life insurance policy or if it lapses due to non-payment, they may have several payout options.

Automatic premium loan: When a policy lapses due to non-payment, some insurance companies allow the policyholder to borrow the amount of lapsed payments from their policy’s accumulated cash value. This option is only available when the lapsed premiums amount is less than or equal to a policy’s cash value.

Cash surrender value: With this option, the insurance company cancels the policy and pays its cash surrender value in one lump-sum payment. Most state insurance codes enable insurers to take up to six months to make the payment. And once the carrier cancels the policy, it cannot reinstate the coverage.

Extended term: The extended-term option enables the policyholder to use the cash value from the original policy to purchase term life insurance coverage. The length of the term will depend on the amount of cash value accumulated in the original permanent life policy. Nonforfeiture clauses stipulate a default payout, which is often the extended term option. 

Reduced paid-up: This option allows the policyholder to use the cash surrender value to purchase another permanent life policy of the same type with a single lump-sum payment. The new policy will have a reduced face value but will accumulate a cash value without paying further premiums.

Single-premium annuity: Some carriers enable a policyholder to use the cash surrender value to purchase an annuity. The amount of the lump sum payment will depend on the amount of the original policy’s accumulated cash value and will pay the policyholder for the remainder of their life.

Pros

• Retains accumulated cash value

• Option to continue life insurance coverage

Cons

• Reduced death benefit

• Loss of coverage

Retains accumulated cash value: A nonforfeiture clause safeguards a policy’s investment by allowing the policyholder to cash out the accumulated cash value.

Option to continue life insurance coverage: The cash value of a policy protected by a nonforfeiture clause may also be used to purchase another policy or annuity.

Reduced death benefit: When the policyholder chooses the extended term or reduced paid-up options, they can retain life insurance coverage, but with a reduced death benefit.

Loss of coverage: Choosing the cash surrender value option enables the policyholder to keep their accumulated cash value, but it also cancels the life insurance coverage. 

A nonforfeiture clause ensures that a permanent life insurance policy owner will not lose their accumulated cash value. While it’s an important financial safeguard, it requires the policyholder to make wise choices when selecting a payout option.

Sometimes, a policyholder may no longer need the life insurance coverage. In such cases, receiving a lump-sum payout can prove beneficial. But when a policy lapses due to non-payment and the policyholder still needs life insurance coverage, nonforfeiture options, which often reduce coverage, can leave them with insufficient protection.