What Happens When a Life Insurance Policy Lapses, and the Options Before It Does
If premiums stop, a life insurance policy may lapse after the grace period. Permanent policies often have non-forfeiture options that preserve some value. Here is how lapse, reduced paid-up insurance, and extended term work.
A life insurance policy lapses when required premiums aren't paid by the end of the grace period and no other provision keeps it in force. For term policies, that usually means coverage ends. For permanent policies with cash value, there are often non-forfeiture options that keep some value or coverage.
Term vs. permanent
| Term life | Permanent life with cash value | |
|---|---|---|
| After grace period without payment | Coverage generally ends | Non-forfeiture option applies, often automatically |
| Cash value | None | Can be used to preserve coverage or taken as cash |
| Reinstatement | Sometimes possible within a set time, with evidence of insurability | Often possible, subject to conditions |
See grace periods for late premiums.
Non-forfeiture options on permanent policies
Cash surrender value. Cancel the policy and receive the cash value, minus any surrender charges and loans. Gains above premiums paid may be taxable.
Reduced paid-up insurance. Use the cash value to buy a smaller, fully paid-up permanent policy. No more premiums; the death benefit is lower.
Extended term insurance. Use the cash value to buy term insurance for the full original death benefit, for as long as the cash value will pay for it.
Automatic premium loan. Some policies use cash value to pay missed premiums as a loan, keeping the policy in force while the loan grows; see whole life insurance.
- Missed premium. Grace period begins.
- Automatic premium loan?. If elected, cash value pays premiums as a loan.
- Choose a non-forfeiture option. Cash surrender, reduced paid-up, or extended term.
- Default option applies. If you don't choose, the policy specifies one.
Universal life lapses
Universal life policies can lapse when the account value can't cover monthly charges, even if you've been paying premiums; see universal life and why policies lapse.
Taxes on lapse with loans
If a permanent policy with a large outstanding loan lapses, the loan may be treated as a distribution, and gains above your basis can be taxable, even though you receive no cash. Get tax advice before letting such a policy lapse.
Before letting a policy lapse
- Ask for an in-force illustration and your non-forfeiture options.
- Consider reducing the death benefit to lower premiums.
- Check whether you could reinstate later, and on what terms.
- Compare with new coverage, remembering that health changes can make new coverage expensive.
- Consider a life settlement in some situations, with professional advice.
The takeaway
Term policies typically end when premiums stop; permanent policies usually offer non-forfeiture options that preserve value. Know your options, and the tax consequences of loans, before letting a policy go.
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