Some people view life insurance as an ongoing lottery. They've paid for the ticket, and they're not giving it up until their number has been called.
This tendency stems from a misunderstanding of the fundamental purpose of life insurance. Generally, you shouldn't view insurance as an opportunity to make a profit (although some whole life insurance policies do include savings and investment elements); instead, you should view insurance as a tool for reducing risk, and you should reassess that risk regularly to see if it has changed.
Homeowners insurance alleviates the risk of financial ruin if your house were to burn down. Auto insurance indemnifies you for liability if you injure somebody else in a collision. Life insurance exists primarily to prevent your loved ones from struggling financially if you pass away before your family is in good financial standing.
You wouldn't have a hard time canceling a home or auto insurance policy if you sell your house or car. Similarly, you shouldn't hesitate to cancel a life insurance policy—or allow it to expire—if you've identified that you no longer need it.
Here are four questions you should ask yourself to determine whether you still need a life insurance policy.
Could my family lose the house or car?
Most people purchase life insurance around major milestones, such as buying a house, which may involve substantial long-term loans. If your family can't keep up with those payments in your absence, that property could be repossessed and their lives would be further disrupted. If your life insurance policy is nearing the end of its term, or if you're considering canceling it, you need to revisit these obligations.
Do you still have several years left on your mortgage? Did you recently finance the purchase of a car? Think of major property that could be repossessed by your lenders if the outstanding loans aren't paid off, and evaluate your family's ability to pay them off in your absence.
In some situations, such as if you're 20 years into a 30-year mortgage, it may be a better option to reduce rather than cancel the amount of life insurance coverage you carry. Doing so would continue to alleviate your family from risk while reducing the cost of your coverage.
However, if all of your loan-funded property is paid in full, or if your family's savings and supplemental income is large enough to keep up with payments, you might be able to cancel your coverage.
Do I have any present or future financial obligations?
In addition to major pieces of property that your family uses on a daily basis, you should review other outstanding debts and future financial obligations that could fall to your family.
For example, if your spouse is a co-signer on your credit card, he or she will still be held responsible for any debt associated with that account, and paying it down without your income could be difficult. Or if you're helping your children pay off their student loans, they may struggle keep up with payments in your absence.
You should also think of financial obligations you haven't taken on yet. Are you planning to pay for your child's tuition five years from now? Do you expect to pay for a wedding sometime down the road?
What about your burial expenses? The average funeral costs $10,000. Could your family afford these expenses without taking on new debt?
Hopefully, if you're nearing the end of your policy's term, your major financial obligations are also nearly settled, and you've accumulated a significant savings. If so, and your death wouldn't leave your family with any obligations that they'd struggle to pay for, you might be ready to cancel your policy or choose not to renew it.
Will my family be able to keep up with daily expenses without me?
While large financial obligations should be your biggest consideration when determining whether you need life insurance, you shouldn't discount the financial burden of everyday life. Your family could be debt-free and still struggle to pay for gas and groceries without your income.
Do other members of your family earn enough to support themselves without your income? Have any of them been out of the job market long enough that they'd struggle to get a well-paying job in your absence?
What about retirement? Is your significant other on track for retirement, and would he or she be able to stay on track without your income? The last thing you'd want is for your spouse to have to work through retirement because you don't have enough saved.
If other members of your family earn enough to pay for their daily expenses, or if you're near your target amount for retirement, then you may be able to terminate your life insurance policy.
Would converting my term insurance into a whole life policy make sense?
If you carry a term life insurance policy and you're nearing the end of your term, you may start to receive messages from your agent or insurance company encouraging you to convert your insurance to a whole life policy.
For most people, whole life insurance is a poor tool for financial indemnification. Insurance brokers may appeal to the logic that, because a whole life policy covers you for life, your family is guaranteed a payout. However, whole life policies are substantially more expensive than term policies, and the rate of returns on the investment portion of those premiums is often low.
Average policyholders would do better to maintain their current policies to the end of their terms and invest the difference in premiums themselves.
However, two types of people may want to consider a whole life policy: those with significant pre-existing medical conditions and those with estates greater than the estate tax exemption limit.
Do I Have any pre-existing conditions?
One of the few benefits of converting a term life insurance policy into a whole life policy is that you often aren't required to prove insurability. This means that those with significant medical issues may be able to obtain coverage they wouldn't normally qualify for—at least not at average rates. In some cases, you also may have the option to renew your term policy without a new medical examination, but this is not common.
As bleak as it seems, this is one of the rare occasions when life insurance could be used as a sound investment. Individuals who expect to pass away within the next five years could take advantage of a policy conversion to provide a windfall for their beneficiaries without having to pay decades of whole life insurance premiums.
However, keep in mind that many people outlive their doctors' prognoses. You may have pre-existing medical conditions and live for 15 or 20 more years. If you do, the value of a whole life policy diminishes accordingly.
How much am I leaving to my heirs?
In 2018, the estate tax exemption amount is $11.2 million per individual ($22.4 million for couples). Any assets in excess of this limit will be taxed at 40% when they are passed to your beneficiaries. For example, if your estate is worth $15 million, the $3.8 million that exceeds the exemption limit would generate a tax obligation of $1,520,000 for your beneficiaries.
If you fall into this small pool of individuals, maintaining a whole life policy that covers an amount equal to your estate tax obligation could provide liquid assets to those inheriting your wealth. Doing so would enable them to pay these taxes without liquidating your property, such as your house, to pay the associated taxes.
However, keep in mind that a policy large enough to solve this problem will come with significant premiums.