A nonforfeiture clause is an insurance policy provision that protects policyholders by ensuring they can receive full or partial benefits or a refund of premiums if a policy lapses due to nonpayment.
Key Takeaways
- A nonforfeiture clause allows insured parties to receive benefits even if premiums lapse.
- This feature is typically available in permanent life insurance and long-term care policies.
- Policyholders can decide how to utilize their policy’s cash value through various options.
How a Nonforfeiture Clause Works
When the owner of a whole life insurance policy surrenders it, they have several nonforfeiture options. The insurance company guarantees a minimum cash value after a specified period, usually three years from the policy’s inception.
Life insurance policyholders can choose from the following nonforfeiture benefit options:
- Cash Surrender Value: Terminate the policy and receive the remaining cash value.
- Extended-Term Insurance: Use the cash value to purchase a term insurance policy with the same death benefit but for a fixed number of years.
- Paid-Up Insurance: Reduce coverage and future premiums by converting the policy to a paid-up version.
- Policy Loans: Use the accumulated cash value to pay future premiums (automatic premium loan).
If the policyholder fails to select an option, the policy terms usually dictate the default action.
Payout Options Under a Nonforfeiture Clause
After surrendering a whole life insurance policy, the death benefit ceases, subject to deductions for any outstanding loans. Loss mitigation can include:
Cash Surrender Value
By opting for the cash surrender value, the policy is terminated, and the cash value is paid out within six months. This applies to the savings element of whole life policies. Be mindful that fees may reduce this amount, especially in the early years.
Paid-Up Policy
A paid-up policy allows using the cash surrender value to secure a version of the life insurance that requires no additional premium payments, albeit with a reduced death benefit and cash value growth rate.
Extended-Term Insurance
Selecting extended-term insurance uses the cash value to buy a term policy equivalent to the original policy’s death benefit. This option is often the default if the policy is surrendered and continues for a predetermined number of years based on the accumulated cash value.
Policy Loans
Unlike conventional loans, policy loans do not necessarily need repayment, though any amount borrowed will reduce the death benefit. These loans accrue interest and add it to the outstanding loan amount.
Why Do Nonforfeiture Clauses Exist?
Nonforfeiture clauses protect policyholders who may find themselves unable to continue premium payments. Legal requirements ensure that accumulated cash value is not forfeited to the insurance company should the policy lapse.
Frequently Asked Questions
What Is an Extended-Term Option?
This option allows using the cash value in a whole life policy to convert it into a term policy with equivalent death benefits, eliminating premium payments.
What Is Cash Surrender Value?
Cash surrender value refers to the savings portion of a whole life policy, available to the policyholder upon surrender. Depending on the policy’s age, this value may be less than the total accumulated cash value.
The Bottom Line
Understanding nonforfeiture clauses aids in choosing the best option for your financial goals, whether it’s extended-term insurance, cash surrender value, or another choice. Consulting a financial advisor can provide personalized guidance tailored to your situation.
Related Terms: cash surrender value, term insurance, policy loans, extended-term insurance, death benefit, permanent life insurance.
References
- American Income Life Insurance. “What Are Life Insurance Non-Forfeiture Options?”
- National Association of Insurance Commissioners. “Standard Nonforfeiture Law for Life Insurance”.
- International Risk Management Institute. “Extended Term Insurance”.
- MassMutual Blog. “Is Life Insurance Taxable? FAQs You Need to Know”.
