What happens if you stop paying life insurance premiums

If you stop paying, nothing happens on the due date: the policy stays in force through a grace period, usually about a month. If the premium is still unpaid when that ends, a term policy lapses and coverage stops with no money back. A whole life policy with cash value usually switches to a paid-up or extended-term benefit, or surrenders for cash, depending on what the policy says. A universal life policy keeps running until its cash value can no longer cover the monthly charges.

After a lapse, your beneficiaries get nothing if you die. The Texas Department of Insurance puts it directly in its life insurance guide: when you don't pay within the grace period, your policy lapses, you no longer have coverage and your beneficiaries won't get the death benefit.

The timeline when a payment is missed

1. Due date passes. The insurer usually sends a reminder or a notice of unpaid premium.
2. Grace period. The policy stays fully in force. Most policies give 31 days, and some states require more (see life insurance grace periods and lapses). If the insured dies in this window, the insurer pays the death benefit, though a policy may deduct the overdue premium from it; Texas law, for example, allows that deduction.
3. Lapse. If the grace period ends unpaid, the policy terminates or moves to whatever the contract says happens next (see the table below).
4. Reinstatement window. Insurers will often restore a lapsed policy if you apply within a set period, usually with proof of good health and back premiums. New York law, for example, requires reinstatement rights for three years from the date of default, and Florida's Department of Financial Services says an insurer may reinstate within three years on evidence of insurability and payment of back premiums with interest. The full process is in reinstating a lapsed life insurance policy.

What happens by policy type

Whole life: three ways to stop paying

The NAIC's model Standard Nonforfeiture Law, which states adopt in some form, requires permanent policies to keep some value for the owner when premiums stop. Under the model, the insurer grants a paid-up benefit if you ask within 60 days after the missed premium's due date. Your policy names which option applies automatically if you do nothing, and it lists the values in a table. The choices are:

• Surrender for cash. The insurer pays the cash surrender value, and all coverage ends.
• Reduced paid-up insurance. The cash value buys a smaller whole life policy that needs no more premiums.
• Extended term insurance. The cash value buys the full original death benefit as term coverage for a limited number of years.

nonforfeiture options: reduced paid-up and extended term explains the three choices in detail. If you have a loan against the policy, the balance reduces the amount available.

Universal life: the slow lapse

A universal life policy can survive a missed premium for months or years if cash value remains, because the insurer deducts its monthly cost of insurance charge from that balance. The danger is not noticing. The Texas Department of Insurance warns that if a universal life policy's cash value reaches zero, the policy could lapse. Rising charges at older ages can drain a policy that looked fine for decades; see why universal life policies lapse, and how to prevent it and no-lapse guarantees.

A hypothetical example

The following is invented for illustration. Say Dana, 52, owns a $200,000 whole life policy with a $4,200 annual premium she can no longer afford. After 20 years, the policy's table shows a cash surrender value of $62,000. She has not taken a loan. She calls the insurer before the premium is due and asks for her options in writing:

• Surrender for $62,000 in cash, ending coverage.
• Convert to a reduced paid-up policy worth, say, $118,000 of lifetime coverage with no further premiums.
• Take extended term of $200,000 for, say, 20 years.

She chooses reduced paid-up because she wants some lifetime coverage for final expenses. Had she simply stopped paying, the policy's default option would have applied, which might have been different from what she wanted.

Before you stop: cheaper alternatives

• Lower the face amount. Many insurers will cut the death benefit and the premium together.
• Use dividends or cash value to pay the premium. Participating whole life policies often allow this; see automatic premium loans. Be careful, because borrowing to pay premiums compounds interest and can eventually collapse the policy.
• Check for a waiver-of-premium rider. If you are disabled, the insurer may pay premiums for you under waiver of premium riders: what they cover and when they pay.
• Ask about a different payment mode or due date, or switch from monthly bank draft to annual billing if the timing is the problem.
• Compare keeping, surrendering and selling. The keep, surrender or sell your policy? and life settlements cover options for older policies with real value.
• If you want to end the policy on purpose, cancel it formally instead of letting it lapse; see how to cancel a life insurance policy, and when not to.

Taxes and other consequences

Surrendering a policy for more than you paid in can create taxable income. The IRS says in Publication 525 that if you surrender a life insurance policy for cash, you include in income any proceeds above the policy's cost, generally your premiums minus dividends and unrepaid loans not included in income. A policy that lapses with an outstanding loan is generally treated as if you received the loan balance, so a policy you stopped paying can produce a tax bill with no cash to pay it. Ask a tax professional before letting a policy with a large loan lapse.

A lapse also means you may have to qualify again. A new policy at an older age costs more, and a health change since you first applied could make you uninsurable or push you into a worse rate class. A new policy starts a new the two-year contestability period too.

Notice rules that protect you

Some states require insurers to warn you before a lapse. California requires a 60-day grace period and a mailed notice of pending lapse at least 30 days before termination, and requires insurers to let you name a second person to receive lapse notices. Florida's Department of Financial Services says a policy covering someone 64 or older that has been in force at least a year may not lapse for nonpayment unless, after the grace period, the insurer mailed notice at least 21 days before the lapse date to the owner and to any secondary addressee. Rules differ by state; see California, Florida and your own state's guide.

Key takeaways

• A missed premium triggers a grace period, usually about 31 days, during which coverage continues.
• After the grace period, term coverage ends with no payout; permanent policies use their cash value according to a nonforfeiture option.
• Tell the insurer before you stop paying: you may be able to reduce coverage, convert to paid-up insurance or use cash value instead of losing everything.
• Lapsed policies can often be reinstated within a few years with proof of insurability and back premiums, but not forever.
• A lapse with a policy loan outstanding can create taxable income, and a replacement policy will cost more at an older age.