When a permanent life insurance policy lapses due to non-payment, or when the policyholder chooses to surrender the coverage, the nonforfeiture clause helps protect the accumulated cash value. Nonforfeiture clauses stipulate how a policyholder can receive their policy’s cash value, allowing them to receive a lump-sum payment or apply the funds to continuing coverage.

Nonforfeiture Clause Definition and Example

A nonforfeiture clause determines how an insurance policyholder can receive their policy’s accumulated cash value in the event of a lapse due to non-payment, or when the policyholder chooses to surrender the coverage. The terms and conditions of a life insurance policy require you to make premium payments.

In addition to a death benefit, permanent life insurance policies also build a cash value over time. A nonforfeiture clause, which stipulates that a policyholder will not forfeit their accumulated cash value if they stop paying premiums, is part of many permanent life insurance policies.1

Let’s say you have a $120,000 whole life policy that has accumulated a cash value of $30,000. Six months ago, you lost your job and now can’t afford the premium payments. If your policy lapses due to non-payment, you are still entitled to the accumulated cash value if your policy contains a nonforfeiture clause.

Understanding Nonforfeiture Clauses

After a policyholder has paid premium payments for a sufficient period, the policy’s nonforfeiture clause may apply if the policy lapses due to non-payment. The nonforfeiture clause may also kick in if the policyholder surrenders the policy. The amount of money an insurer will return to the policyholder depends on the policy’s surrender value.2 This is the amount the policyholder can borrow or withdraw from the accumulated cash value.

Nonforfeiture Payout Options

When a policyholder chooses to surrender their life insurance policy or if it lapses due to non-payment, they may have several payout options.

Automatic premium loan: When a policy lapses due to non-payment, some insurance companies allow the policyholder to borrow the amount of lapsed payments from their policy’s accumulated cash value. This option is only available when the lapsed premiums amount is less than or equal to a policy’s cash value.

Cash surrender value: With this option, the insurance company cancels the policy and pays its cash surrender value in one lump-sum payment. Most state insurance codes enable insurers to take up to six months to make the payment.4 And once the carrier cancels the policy, it cannot reinstate the coverage.

Extended term: The extended-term option enables the policyholder to use the cash value from the original policy to purchase term life insurance coverage. The length of the term will depend on the amount of cash value accumulated in the original permanent life policy. Nonforfeiture clauses stipulate a default payout, which is often the extended term option. 

Reduced paid-up: This option allows the policyholder to use the cash surrender value to purchase another permanent life policy of the same type with a single lump-sum payment. The new policy will have a reduced face value but will accumulate a cash value without paying further premiums.5

Single-premium annuity: Some carriers enable a policyholder to use the cash surrender value to purchase an annuity. The amount of the lump sum payment will depend on the amount of the original policy’s accumulated cash value and will pay the policyholder for the remainder of their life.

Pros and Cons of a Nonforfeiture Clause

Pros Explained

Retains accumulated cash value: A nonforfeiture clause safeguards a policy’s investment by allowing the policyholder to cash out the accumulated cash value.

Option to continue life insurance coverage: The cash value of a policy protected by a nonforfeiture clause may also be used to purchase another policy or annuity.

Cons Explained

Reduced death benefit: When the policyholder chooses the extended term or reduced paid-up options, they can retain life insurance coverage, but with a reduced death benefit.

Loss of coverage: Choosing the cash surrender value option enables the policyholder to keep their accumulated cash value, but it also cancels the life insurance coverage. 

The Bottom Line

A nonforfeiture clause ensures that a permanent life insurance policy owner will not lose their accumulated cash value. While it’s an important financial safeguard, it requires the policyholder to make wise choices when selecting a payout option.

Sometimes, a policyholder may no longer need the life insurance coverage. In such cases, receiving a lump-sum payout can prove beneficial. But when a policy lapses due to non-payment and the policyholder still needs life insurance coverage, nonforfeiture options, which often reduce coverage, can leave them with insufficient protection.