What is a Non-forfeiture Clause?
In permanent life insurance, a non-forfeiture clause stipulates that if the policy lapses due to non-payment or the policy owner decides to cancel coverage, they won’t forfeit the policy’s accumulated cash value.
When non-forfeiture applies
In most cases, the non-forfeiture clause only applies when the policy owner has consistently made on-time premium payments for a specified amount of time. Many non-forfeiture clauses go into effect once the policy has been in place for three years, for example.
At that point, two distinct situations can activate this clause. First, non-forfeiture can apply when the policy owner has missed a premium payment and the grace period has expired. The policy lapse means losing the death benefit, but the non-forfeiture clause protects the policy’s accumulated cash value for the policy owner.
Non-forfeiture clauses can also apply when a policy owner voluntarily cancels the policy. Again, they lose the death benefit but not the policy’s associated cash value. The non-forfeiture clause may stipulate how the policy’s cash value gets distributed to them.
Generally, policy owners have options about how they’ll receive the cash value this clause protects against forfeiture. Some of the most common options include:
Using the accumulated cash value to fund a term life insurance policy, with the term lasting as long as the cash value will sufficiently cover.
A lump-sum payment of the cash value to the policy owner, minus any outstanding loans against the cash value and applicable fees.
A refund of a portion or all of the paid premiums.
Using the cash value to purchase a paid-up permanent life insurance policy with a death benefit reduced to the level proportional to what the cash value will cover. To clarify, the policy owner would owe no future premiums on this reduced policy.
An automatic premium loan, which means the insurance company will use the cash value to pay the missed premium.
Generally, the non-forfeiture clause will lay out the policy owner’s specific options and a deadline by which they need to choose one. If they don’t, the insurance company selects the default option.