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Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.
Updated February 01, 2023 Reviewed by Reviewed by Marguerita ChengMarguerita is a Certified Financial Planner (CFP), Chartered Retirement Planning Counselor (CRPC), Retirement Income Certified Professional (RICP), and a Chartered Socially Responsible Investing Counselor (CSRIC). She has been working in the financial planning industry for over 20 years and spends her days helping her clients gain clarity, confidence, and control over their financial lives.
A nonforfeiture clause is an insurance policy clause stipulating that an insured party can receive full or partial benefits or a partial refund of premiums after a lapse due to nonpayment.
Standard life insurance and long-term care insurance may have nonforfeiture clauses. The clause may involve returning some portion of the total premiums paid, the cash surrender value of the policy, or a reduced benefit based upon premiums paid before the policy lapses.
When the owner of a whole life insurance policy surrenders the policy, they have several nonforfeiture options. The insurance company guarantees a minimum cash value for the insurance policy after a specific period, typically three years from when the policy starts.
For traditional whole life policies, the owner decides which of four ways (see below) they would like to access the policy’s cash value. There are no guarantees for the minimum amount of life insurance available in variable and universal life policies, which allow for variable investing. Also, the amount of reduced paid-up or extended-term insurance may decrease if a policy’s sub-account performance is poor or credited interest rates are low.
Life insurance policyholders can select one of four nonforfeiture benefit options: cash surrender value, extended-term insurance, loan value, and paid-up insurance.
In permanent life insurance policies, if you fail to pay the premiums in the grace period, you won’t lose your life insurance. Instead, you can access your accumulated cash value with the following options:
If the policyholder does not make a selection, the terms of the policy will generally stipulate which option would go into effect if the policy lapses or is surrendered.
After surrendering a whole life insurance policy, the death benefit on that policy no longer exists. Before issuing payment to the policy owner, outstanding loan amounts are satisfied with the cash value.
Some companies offer an annuity option in the nonforfeiture clause. The remaining cash value may be used to purchase an annuity free of commissions or expenses. Annuities pay regular payments as outlined in the contract.
With the cash surrender value option, the policy owner terminates the policy and receives the remaining cash value within six months. Cash surrender value applies to the savings element of whole life insurance policies payable before death. However, during the early years of a whole life insurance policy, the savings portion brings little return compared to the premiums paid.
Cash surrender value is the accumulated portion of a permanent life insurance policy’s cash value that is available to the policyholder upon surrender of the policy.
Depending on the age of the policy, the cash surrender value could be less than the actual cash value. In the early years of a policy, life insurance companies can deduct fees upon cash surrender.
With the paid-up policy option, you can use your cash surrender value to buy a paid-up version of the same type of life insurance policy, so you would no longer have to make premium payments.
However, surrendering a portion of the cash value reduces the death benefit. The policy would retain a cash value component, but it would grow at a reduced rate.
Choosing the nonforfeiture extended-term option allows the policy owner to use the cash value to purchase a term insurance policy with a death benefit equal to that of the original whole life policy. The policy is calculated from the insured’s attained age. The term policy ends after a fixed number of years, as detailed in the policy’s nonforfeiture table. For some companies, this option may be automatic when surrendering a whole life insurance policy.
Extended-term insurance allows a policyholder to stop paying the premiums, but not forfeit the equity of their policy. The amount of cash value you will have built-in your policy will be reduced by the amount of any loans against your life insurance.
Extended-term insurance is often the default nonforfeiture option. With extended-term insurance, the face amount of the policy stays the same, but it is flipped to an extended-term insurance policy. Meanwhile, the equity you built is used to purchase a term policy that equals the number of years you paid premiums.
For example, if you purchased a policy when you were 20 years old and you paid until age 55, you would receive a term policy that is less than 35 years. Or if you were 35 when you purchased your policy and you paid until you were 45, you would receive a term policy less than 10 years.
Unlike conventional loans, policy loans don’t necessarily need to be paid back. However, any money you take out will be deducted from the death benefit that goes to your beneficiaries.
Just like with a conventional loan, you’ll be charged interest that could range from 5% to 9% on the loan. Unpaid interest will be added to your loan amount and will be subject to compounding.
Nonforfeiture clauses offer protection in the event that a policyholder stops paying their premium. Sometimes, a policy expires after a so-called grace period. If cash has accumulated in the policy, state law forbids companies from keeping it and canceling the policy.
With the extended-term option, you can choose to use the cash value in a whole life insurance policy to term insurance, allowing you to stop paying premiums. The death benefit would be equal to the benefit in the original whole life insurance policy.
Cash surrender value applies to the savings element of whole life insurance policies. This value is payable before death.
Overall, it’s the accumulated portion of a permanent life insurance policy’s cash value that is available to the policyholder upon surrender of the policy. Depending on the age of the policy, the cash surrender value could be less than the actual cash value.
Understanding your choices with a nonforfeiture clause can help you determine which option is best for your financial situation and goals, whether it’s an extended-term policy, cash surrender value, or another option. Consider consulting a financial advisor who can guide you on choosing an option that will best fit your circumstances.
Article SourcesA waterfall concept is a method of intergenerational wealth transfer that utilizes a rollover of a life insurance policy to a child or grandchild.
Guaranteed universal life insurance offers affordable permanent coverage, level premiums, a guaranteed death benefit, and may include a cash value component.
Group term life insurance is life insurance offered as an employee benefit. Often a base amount is covered at no charge, with the option to add more.
Adjustable life insurance allows policyholders the option to change key features like premiums and the death benefit.
Interest-sensitive whole life insurance carries more risks than traditional whole life insurance, yet it offers flexibility and the potential for faster growth.
Second-to-die insurance is a type of life insurance on two people providing benefits to the beneficiaries only after the last surviving person dies.
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