What is Cash Surrender Value?
Cash Surrender Value of Life Insurance is essentially the amount of cash that you can withdraw if you surrender your policy to your insurance company and allow it to lapse. This amount can vary according to a variety of factors.
When you surrender your policy, you are forfeiting the death benefit protection afforded by the policy and will pay no further premiums into the policy. This alternative differs from borrowing from your policy, where you can take money out as a policy loan that charges interest but keeps the policy in force.
How Does Cash Surrender Value of Life Insurance Work?
People surrender their life insurance policies for numerous reasons. Often, they cancel because they no longer need the coverage.
If you’re the owner, surrendering your policy usually requires that you simply fill out a “surrender request” form and submit it to your insurer. Once you submit the form, you can expect to receive a check from the insurance company.
You can also request a partial surrender or cash withdrawal, or take out a loan against the cash value, instead of surrendering the entire policy. Talk to your insurer about how these might affect your policy.
Alternatives to Surrendering Your Policy
If you still need life insurance, it’s wise to continue coverage rather than cancel it. And there are ways you can access the cash value in your policy while keeping your coverage intact.
- Use the cash value to pay premiums: If you’re having difficulty paying premiums, your policy might have a provision to deduct premiums from your cash value when payments aren’t made. Alternatively, you may be able to select a “reduced paid-up” option, which exchanges your policy’s cash value for a smaller death benefit, but requires no additional payments from you.
- Make a withdrawal: You can withdraw from your life insurance policy’s cash value instead of cashing out the entire amount. If the amount you withdraw is less than the amount you’ve paid in premiums, you shouldn’t have to pay any income tax.
- Take out a loan against the cash value: If your policy is in its surrender period, consider taking out a loan against its cash value. You must repay the loan, with interest, or risk reducing your death benefit. But you won’t be assessed surrender fees.
- Exchange your policy: If you need long-term care insurance or would prefer to own an annuity, you can exchange your life insurance policy for either without having to pay taxes on any gains via a 1035 exchange.
- Make use of an accelerated death benefit (ADB) provision: If your policy includes an ADB provision, you may be able to access a portion of the death benefit “early” if you have a chronic or terminal illness or require long-term care.
- Sell your policy: If you’re over 65 or terminally ill, you might want to sell your policy in a life or a viatical settlement, and potentially receive more than the cash value. When you sell a policy, the settlement company becomes the owner and beneficiary, paying any subsequent premiums and receiving the benefit when you die.
Reasons to Surrender Your Policy
When you surrender your life insurance, you are telling the insurance company that you don’t want life insurance coverage. In exchange, the policyholder receives a portion of the cash value of the policy.
If you own a term or cash value life insurance policy that you no longer need, you may be wondering if it’s worth continuing to pay the premiums. If the answer is no, you have to decide what to do with the policy. You have several alternatives to choose from, but the simplest way is to surrender the policy altogether.
Here are the most common reasons why people surrender their life insurance policies.
1: The Coverage is no Longer Needed
If your policy’s beneficiary passes away before you, you may have no other person to name as their replacement.
Alternatively, if you named your spouse as your beneficiary and are now getting a divorce, you may want to get rid of the policy. Of course, your divorce decree may stipulate that you keep the policy in force with your ex as a beneficiary.
Another common scenario is naming your children as beneficiaries, but they no longer need the coverage as adults. This often happens when the adult beneficiaries are financially stable and have no need for financial assistance.
2: To Get the Cash Value
When a policy is surrendered, the policy owner will receive all of the remaining cash value in the policy, known as the cash surrender value. This amount will generally be slightly less than the total amount of cash value in the policy because of surrender charges assessed by the policy.
Surrendering a policy can be a valuable source of quick cash for someone who doesn’t have access to other liquid assets and needs the life insurance money now.
If you are surrendering your policy just to access the cash value, consider a life settlement instead.
Variable universal policies grow their cash values in mutual fund subaccounts that fluctuate in value depending on the performance of the stock, bond and real estate markets. It should be noted that any type of term life insurance policy does not have cash value and only provides pure death benefit protection.
The cash value in these policies grows over time as they continue to receive premium payments. The longer you have the policy, the more time your cash value has to grow and earn interest.
If you’ve had a policy for 30 years, your cash value will be much higher than it would be if you only had the same policy for 5 years.
How to Surrender Your Policy
Surrendering your life insurance policy is a relatively simple process. If you want to cancel your coverage:
- Stop paying the premiums
- Contact the insurance company and tell them that you want to cancel the policy.
- You will need to ask the insurance company to send you a surrender form or have them tell you where you can download one online.
- Also, ask them whether a letter of instruction will suffice to cancel the policy.
- Complete the form (or letter of instruction) and send it to the insurance company via certified or overnight mail for tracking purposes.
- Once the tracking system shows that it was received, call the company to confirm that they received your request. They will then cancel the policy, and you won’t owe them anything more.
This process is the same for both permanent life insurance (such as whole life and universal life) and term life insurance.
The cash surrender value is, therefore, the amount of money that you will get after all fees and charges have been assessed, and it will be less than the policy’s actual cash value during the surrender period. This form of income differs from what you get from a viatical settlement, life settlement or an accelerated benefit rider, because it is coming from the cash value and not the death benefit.
All types of permanent life insurance policies have a surrender period. This is an initial period of time that must elapse before the policy accumulates any cash value or no surrender charges are assessed.
How to access the Cash Surrender Value of Life Insurance
Premiums for cash value life insurance can be incredibly expensive, so it’s important to understand all the ways you can take money out of your life insurance policy. Whether you want to get rid of your coverage and cash out your life insurance or simply take out a loan, there’s a variety of ways to take advantage of your policy’s cash value.
Even if you no longer want coverage, make sure not to let your policy lapse at any point. When a policy lapses, you lose the death benefit as well as any cash value you could have been paid.
Pay your premiums with the cash value
Variable and universal life insurance policies are often favored because they allow you to use the policy’s cash value to pay premiums. This strategy will only work for a short period of time if you start while the cash value is too small or if interest rates are low. In addition, you have to carefully monitor the cash value to make sure it doesn’t drop too far, or you may lose your coverage. But if you have a fairly large cash value with consistent returns, you can keep coverage in place for years at little to no additional cost.
For example, say your annual premium is $5,000 and you have $100,000 in cash value. You would just need the policy’s cash value to return a net 2.5% interest annually to cut your premium payments in half while maintaining the full cash value.
Whole life insurance policies typically don’t let you pay premiums using the policy’s cash value except if you convert to a paid-up policy. Not all insurers offer this option but, with a paid-up life insurance policy, the cash value is large enough that you can stop paying premiums out of pocket. You use the cash value to pay premiums. The downside to paid-up whole life insurance policies is that each premium payment is deducted from the policy’s death benefit. In addition, less cash value is available for other purposes, such as a policy loan.
Put up cash value as collateral to borrow from your insurer
A life insurance policy loan is a loan from the insurer in which the cash value of your policy is used as collateral. It can be used for paying medical expenses, buying a car or anything else you might need cash for. Since the insurer holds the funds to cover the loan:
- There are no underwriting requirements
- You can keep the loan outstanding for as long as you want
- There’s no credit check, and the loan doesn’t appear on your credit report
However, if you pass away while the loan is outstanding, the value of the loan will be deducted from the death benefit your beneficiaries receive.
Borrowing against your policy’s cash value is simple and typically comes with quite low annual interest rates. But you need to either pay interest out of pocket annually or carefully monitor the size of the loan as compared to the policy’s cash value.
If you don’t make interest payments, the interest amount is added to the outstanding loan balance. If the total size of your loan ever exceeds your policy’s cash value, the life insurance policy will lapse, canceling your coverage. In addition, you will likely have to pay income tax on the loan.
Sell your policy for a life insurance settlement
If you want to give up your coverage and cash out your life insurance policy, you should first try to sell it in a life insurance cash settlement. You might want to do this if your premiums are high and you no longer have dependents, or they’re all financially secure. In a life insurance cash settlement, a company buys your life insurance policy for an amount that’s greater than the cash value but less than the death benefit. Some companies even buy term life insurance policies for cash, but only if you’re quite old or sick, so likely to pass away during the policy term.
You’ll have to pay income and capital gains taxes on the settlement. Be aware that any brokers that help pair you up with a settlement company will typically take a cut. But the net effect is that you will usually get more money than you would by surrendering your policy.
Once the policy is sold, the life insurance settlement company takes over premium payments and becomes the policy beneficiary. The downside is, you won’t always find a buyer and the process of being evaluated by a life insurance settlement company can take several weeks.
Surrender your life insurance policy for its net cash value
If you can’t get a settlement and want to cash out your life insurance, you can surrender your policy to the insurer. Simply let your insurer know and they will pay you the life insurance policy’s net cash value.
The net cash value is the “actual” surrender value of the policy. You will typically find it listed separately in your life insurance statements. The net cash value will generally be lower than your total accumulated cash value for the first several years of coverage as it’s reduced by fees and surrender charges. However, if you’ve had your policy in place between 10 to 15 years, the net cash value is likely to be close or equal to the total accumulated cash value.
Make a partial withdrawal of the cash value
If you don’t want to get rid of your life insurance coverage entirely but have fewer financial obligations, you can also withdraw a portion of the cash value. This provides you cash while reducing the life insurance policy’s death benefit. For example, if your children have done well in their careers, you may be less concerned about passing on an inheritance but still want some coverage for your spouse.
How a partial withdrawal works can vary based upon the life insurance policy:
- Variable and universal life insurance policies – A partial withdrawal is similar to receiving a portion of the death benefit early, as the payout to beneficiaries is reduced by the amount you withdraw. So long as you don’t withdraw more money than you’ve paid in premiums, there are no taxes on the partial withdrawal. If you withdraw more than you’ve paid, it will be taxed as income.
- Whole life insurance policies – We typically don’t recommend a partial withdrawal if you have a whole life insurance policy, as the insurer will often reduce your death benefit by a greater amount than you withdraw. You might want to consider a life insurance settlement or simply surrender the policy if it’s too large.
Increase your death benefit with paid-up additions
If you have a sizable cash value but don’t have a use for it, you may be able to increase the amount of money left to your beneficiaries. This option isn’t always available, so you’ll need to check with your insurer, but it’s a simple way to make sure your family doesn’t just lose the cash value you’ve built up over time.
Similarly, if you have a participating whole life insurance policy from a mutual insurer, you can use any dividends you receive to purchase paid-up additions. Buying paid-up additions is similar to buying a small single-premium life insurance policy as you increase the policy’s cash value and death benefit but don’t have ongoing payments.
Finally, there are no medical exams or underwriting requirements involved in buying paid-up additions, so you can increase your coverage even if your health has gotten worse.
How To Calculate Cash Surrender Value of Life Insurance
There are several factors that go into calculating the cash surrender value in your policy. The key factors include:
- How long the policy has been in force and the total amount of premium that you have paid into the policy
- The amount of interest, dividends or capital gains that have been earned by the cash value in the policy
- The amount of cash surrender fees and charges that the insurance company will assess in order to liquidate the policy. These charges can remain in effect for as long as 10 or 15 years after purchase in some cases. Once this period of time has elapsed, the policy cash value will equal the cash surrender value.
If your policy is relatively new, then you’ll probably get little or no cash value if you cancel your coverage, because your cash value hasn’t had much time to accumulate, and the life insurance company will most likely assess a surrender charge on any amount that you receive.
The amount of cash value that you receive will always be substantially less than the policy’s face value.
Cash Surrender Value Taxes
In most cases, the cash surrender value that you receive will be considered a tax-free return of principal up to the amount of premiums that you have paid.
For example, if you have been paying $250 a month into a $100,000 whole life policy for 30 months, then you could expect the first $7,500 of cash value to be tax-free because you have paid that much in premiums.
However, any dividends, interest or capital gains that were paid to the cash value will be counted as taxable income. Therefore, if you earned $800 in dividends from your whole life policy while it was in force, then you would have to pay taxes on that income. Your financial advisor or life insurance agent should be able to tell you what the tax ramifications will be if you cash in your policy.
Any amount that you receive over the total amount of premiums you paid (known as the cost basis) is taxed as ordinary income. This means that you will pay tax on this amount at your top marginal tax rate.
For example, say that you are in the 25% tax bracket and you paid a total of $10,000 of premiums into your cash value (universal life insurance) policy.
Your cash value is now worth $13,000, and you decide to surrender your policy. You pay $1,000 in surrender charges and receive a check from the insurance company for $12,000. You will pay tax on $2,000 at a rate of 25%.
The other $10,000 is considered a tax-free return of principal.
If you need to access the cash surrender value in your policy but want to keep the policy in force, then you can take a loan out from the policy using your accumulated cash value as collateral.
This may be a much better alternative than cashing in your policy because your beneficiaries will be able to receive the death benefit protection of the policy. The loan will charge interest to the remaining cash value in the policy, which will reduce the rate of growth of the cash value, but the policy will still remain in force.
However, any outstanding loan amount that remains when the policy is paid out will be subtracted from the death benefit.
For example, if you borrow $5,000 from your policy’s cash value and before passing away, then the amount your beneficiaries will receive will be reduced by that amount. Nevertheless, this is still usually considered a superior alternative to cashing in the policy by most financial and life insurance professionals.
How is Cash Surrender Value of Life Insurance Taxed?
- The total amount of premiums you have paid will be tax-free
- Dividends, interest, and capital gains from your policy will be taxed
If you are looking for ways to access cash without taking out debt, you might think that surrendering your life insurance policy is the best way to do so. However, surrendering your policy will mean that you no longer have a death benefit that can be extremely helpful for your beneficiaries. Additionally, surrendering your policy will mean giving up part of your cash value to fees and taxes. Therefore, you might want to consider the alternatives to help you access your cash and keep your policy in place.