This is a guest post from my friend Eric Rosenberg, a personal finance blogger and podcaster at Personal Profitability in partnership with Mason Finance. He writes about personal finance, credit cards, entrepreneurship, and technology.
You may be cheap, but that doesn’t mean you are stingy. Knowing where and how to spend and invest is important for your family’s long-term stability. One common and important investment is life insurance, which protects your family from a loss of income in case of a loss of you.
While no one likes to think about this worst-case scenario, life insurance is important. But what should you do when you don’t need your life insurance policy anymore? You should not just stop making payments and let your policy lapse. You can turn it into a one-time cash payout with a commonly misunderstood process called a life insurance settlement. Let’s dive in and learn how it works so you can decide if it makes sense for you.
Term life insurance 101
Life insurance comes in several forms, but the most popular is term life insurance. Term life insurance is popular because it is relatively inexpensive for a big payoff. The younger you get life insurance and the healthier you are, the less you will pay each month for your life insurance benefits.
If you pass away while insured, your beneficiaries get a one-time lump payout. Because your family likely relies on your income for regular expenses and long-term savings goals, losing your income could be devastating in addition to losing you. While no one likes to think about this, it can happen. That’s why life insurance exists.
With term life insurance, your policy is good for a certain number of years. My policy is good for 30 years, though many policies are shorter in duration. If you pay for the insurance every month for the remainder of the policy and live past the end date, your policy ends and you don’t get a benefit.
If you want to end your policy before that end date, you can stop making payments and the policy will lapse. But that is not the right way to end a life insurance policy. We’ll get back to that in a minute.
When you really do need life insurance
In most cases, life insurance is a very good thing. To ensure my family is safe and secure if anything happens to me, I have a $1 million term life policy. I pay about $78 per month for my policy, and it is well worth the cost.
Add up your monthly living expenses and compare them to your savings. If your savings look like most people’s, you don’t have enough to make it more than a month, let alone years. A recent study found the average family has $1,000 or less in savings. If that sounds like you, life insurance is incredibly important for your family.
Because term life insurance policies cost relatively little for a big benefit, they are a good choice for any family looking to ensure long-term financial security even in a worst-case scenario.
When it makes sense to end your life insurance
Term life insurance makes sense for a lot of people and families, but not for everyone. For example, if you rocked and rolled so much in the side hustles that you can consider early retirement, you may want to cancel your life insurance.
Hopefully, you don’t struggle too much making the monthly payment. If you do, you might be considering ending your policy for cost reasons. Be careful doing so, however, as a new policy will probably cost more than your old one.
If you have saved enough that you can support your family from your savings and investment, life insurance is no longer needed. Why should you pay for something you can do yourself for free? You shouldn’t!
But don’t just let your life insurance policy lapse. You can “sell” your policy for a one-time cash payment through a process called a life insurance settlement.
Converting your policy from an expense to cash
In a life insurance settlement, you can hand over your life insurance policy to investors. When you settle, they take over your monthly payments and also get any future death benefits. They do this for a lot of insurance policies so the risk that they won’t get any payout is spread out among many policies.
But that part isn’t an important part of you. What matters to you is the cash payment. The part where you stop paying every month and get a lump cash payment in return is what matters most. Check out this free estimator to find out what your life insurance policy might be worth.
Letting your life insurance lapse is so ratchet
At a recent conference where Sandy and I were able to share a stage, she taught the audience the meaning of the term “ratchet.” I’m about as much of a finance nerd as they come, so I’m probably using this wrong. But I would say that letting your life insurance lapse is so ratchet.
Don’t waste money on life insurance payments when you don’t need to, but also don’t let the policy go and get nothing in return. Consider a life insurance settlement if you think you’ve outgrown your need for life insurance. And give yourself a big high five for reaching financial independence.