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Because permanent life insurance policies build cash value, state law requires that certain guarantees connected to that cash value be built into the policy — guarantees the policyowner can never forfeit. These guarantees, known as nonforfeiture values, must be illustrated in a table covering a minimum of 20 years within the policy. If a cash-value policy lapses or is surrendered, the policyowner chooses one of three nonforfeiture options: cash surrender value, reduced paid-up insurance, or extended term insurance.
Nonforfeiture options are triggered when a policy is surrendered or lapses.
Under this option, the insurer applies the policy's existing cash value as a single premium to purchase a fully paid-up permanent policy — but with a smaller face amount than the original policy had. This new, reduced policy builds its own cash value going forward and stays in force until the insured's death or the policy's maturity, whichever comes first.
Under the extended-term option, the insurer instead uses the policy's cash value to buy term insurance for the same face amount as the original permanent policy — the coverage simply lasts only as long as that cash value is able to purchase term coverage for that amount. If a policyowner never elects one of the three nonforfeiture options, the insurer will automatically apply the extended-term option when the original policy terminates.
Extended term is the automatic default nonforfeiture option: it keeps the original face amount but shortens the length of coverage.
A policyowner may simply surrender the policy in exchange for its current cash value. If the cash value received is greater than the total premiums the policyowner has paid, that excess is taxed as ordinary income. Once cash surrender value has been taken, coverage on the insured ends, and — unlike a policy that has merely lapsed — a policy that has been surrendered for cash cannot later be reinstated.
| End of Policy Year | Cash or Loan Value | Reduced Paid-Up | Extended Term |
|---|---|---|---|
| 5 | $2,300 | $7,900 | 6 yrs, 40 days |
| 10 | $7,100 | $18,600 | 13 yrs, 210 days |
| 15 | $9,200 | $19,800 | 16 yrs, 40 days |
| 20 | $14,600 | $28,900 | 17 yrs, 300 days |
Example: $75,000 Whole Life — Nonforfeiture Values
Using the illustration above, a policyowner who surrenders this policy after 15 years could use the $9,200 cash value as a single premium to purchase $19,800 of fully paid-up whole life insurance under the reduced paid-up option, with no further premiums ever due. Choosing extended term instead would use that same $9,200 to purchase $75,000 of term coverage — the original face amount — for as long as that amount of protection can be funded, in this case 16 years and 40 days.