Termination of life insurance: procedures and associated costs

Termination of life insurance: procedures and associated costs


Several reasons can lead an insured to decide to terminate his life insurance. This option, which is offered by permanent life insurance policies, allows customers to terminate the contract to cash in the cash value. However, this is an act with far-reaching consequences, and one that deserves to be thought about before initiating the process. What can terminate life insurance entail?

Why cancel your life insurance?

Termination of life insurance deprives beneficiaries of protection and has consequences, including tax consequences, for the insured. So you might think that canceling your life insurance is a bad idea. However, there are situations which can justify this choice.

This is particularly the case for retirees whose children are adults and who do not have retirement savings. The life insurance contract they signed is not the optimal solution given their situation. It is in their interest to pay the amount of their life insurance contract into an RRSP and top up with the amounts they dedicate to life insurance premiums. The RRSP is a retirement product with less financial and tax risks over the long term than life insurance.

The purchase of life insurance contracts is actually more for people who have maximized their RRSP and TFSA contributions.

How to cancel life insurance?

The process for terminating life insurance is fairly simple if the beneficiaries registered in the contract are revocable. In fact, the insured simply has to complete the insurer's form to request the termination of the contract since the agreement of the beneficiaries is not required.

If, on the other hand, the beneficiaries are named in the contract as irrevocable beneficiaries, the insurer will cancel the policy and pay the funds to the insured only with their authorization. Without their agreement, the insurance company will refuse to terminate the contract and pay its value to the insured.

The implications of termination

The termination of a life insurance contract has significant consequences. On the one hand, most insurers charge a surrender charge in the early years of the contract if the insured makes early withdrawals.

On the other hand, the amounts withdrawn, called the cash value of life insurance, are not exempt from tax. Depending on the increase in the value of the investments, they may be subject to federal and provincial taxes. The insured does not pay tax on the entire value but on the taxable part. It corresponds to the difference between the surrender value and the readjusted base price. So he does not pay on the part of the premiums allocated to protection, but only on the part intended for savings and which has produced a return. The insured adds this taxable amount to his other income on his tax return and is taxed en bloc on all of his income.

An alternative: the secured loan

Since the tax bill for terminating life insurance is high, in some situations it is better to opt for other alternatives and to keep your life insurance. For example, if the purpose of the termination is to obtain cash, it is better to apply for a bank loan using the life insurance contract as collateral. Thus, the borrowed sums escape tax and do not jeopardize state benefits or credits. In some cases, the interest paid may even qualify for a tax deduction.

Canceling life insurance is not something that happens on a whim. Even if the insured has good reasons to do so, it is in his best interest to inquire beforehand because there are other options with less onerous tax consequences than termination.