Alice Holbrook| NerdWallet
Life insurance policies aren't always for life. Whether you have a whole life or a term policy, there are sometimes good financial reasons why you might decide to cancel it.
Giving up a policy isn't an easy decision. Once people decide to buy life insurance, they rarely opt out. Just 5.7% of individual policies were terminated in 2013, the fifth straight year the rate declined, according to the American Council of Life Insurers.
Still, dropping a policy isn't necessarily a bad idea, particularly if you've had a major lifestyle change. But there might be hidden costs, and if you'd like to stay insured, you could have options other than cancellation.
Here are some reasons to consider a change.
Scenario No. 1: You have fewer financial obligations
Most people purchase term life insurance to cover specific expenses, such as to ensure support for children living at home or to help pay their college tuition. Those expenses may decline or disappear over time.
"As people get older, the original reason they had for taking the life insurance policy may no longer be relevant," says Alison Salka, director of research for LIMRA, a life insurance research organization.
In the best-case scenario, you pay off your mortgage and see your children graduate college around the time your insurance term expires. In that case, you can simply elect not to renew coverage. But if you've miscalculated and would prefer not to pay premiums, speak to your agent. If you have what's called a return-of-premium rider on your policy, you could get a check back if you cancel.
Scenario No. 2: You've experienced a loss of income
Term policies tend to be relatively inexpensive. But if you've bought a whole life insurance policy, you'll often pay at least twice as much, and that could strain your budget if you've lost your source of income.
Unfortunately, canceling a whole life insurance policy can be complicated. In many cases, you'll lose value if you cancel in the policy's early years. There may also be tax consequences for cancellation, and buying a new policy in the future will be more expensive.
Job loss can also bring the importance of life insurance into sharper focus. Carl Bailey, a compliance professional from Chicago, maintained his policy during a recent period of unemployment.
"I felt that I needed it even more," he says. "Life insurance is really crucial for people who are in transition."
If you'd prefer not to cancel your policy during a tough time, you do have options. "You may be able to reduce the face amount rather than dropping the policy outright," Salka says. You might also be able to cover some of your premiums with the plan's cash value.
Scenario No. 3: You're no longer happy with your plan
Some consumers cancel a life insurance plan because they find they can get a better deal elsewhere, especially on term life insurance. "It's gotten a lot more competitive in the last few years," Salka says. "People [are] getting new policies at better rates."
Others might wish to switch from whole to term life insurance, says Scott Johnson of Marindependent Insurance Services in Mill Valley, Calif. "Often [whole life insurance policies] are dropped when people fail to see the 'gains' materialize that they thought would come out of them. There seems to be a general misunderstanding … about when the cash-value life insurance plans will actually begin to develop 'cash' in the cash account."
Swapping plans? Read your new policy carefully before committing, and never cancel a policy until you're 100% certain the new policy has gone into effect, Johnson says.
The bottom line
You might cancel your life insurance for other reasons. Changes to your personal circ*mstances, including business failure or divorce, can affect your need for coverage.
"I think it's an individual consumer's decision. If they're dropping a policy, usually it's for a very important reason," Salka says.
But if you do have a need, and you can afford it, there's no substitute for the right amount of life insurance. Keeping your policy active should be a priority – and for most policyholders, it is.
"We noticed during the recession, lapses didn't increase dramatically, even though unemployment nearly doubled," Salka says. "It's not the first thing that [people] look at in terms of cutting costs."
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