What is the Cash Surrender Value on a Life Insurance Policy?
While term life insurance policies are simple, permanent life insurance policies are more complex.
One aspect found in permanent life insurance policies not found in term life insurance policies is a cash value component.
You can access the cash value during the policy to use for anything you’d like in many cases.
Some people want to end, or surrender, their policy.
When this happens, you probably want to know what your cash surrender value is on your life insurance policy.
Here’s what you need to know.
What is Cash Surrender Value?
The cash surrender value is a calculated number of the amount of money you’ll receive after surrendering a permanent life insurance policy.
Permanent life insurance is a broad category that includes many types of life insurance such as:
- Whole life insurance
- Universal life insurance
- Variable life insurance
- Variable-universal life insurance
Term life insurance does not have cash surrender value because these policies have no cash value.
How is Cash Surrender Value Determined?
The cash surrender value, sometimes simply called the surrender value, is calculated based on two categories of items.
When you make premium payments on a permanent life insurance policy, part of those payments go toward your cash value.
The cash value is a special account that you generally can access at any time for any purpose.
- In some policies, this is literally cash.
- In others, you may invest this part of your policy in an index fund or other investment.
If your cash value falls to zero or goes negative, your policy terminates.
You may also be able to take a loan out against your cash value.
This leaves the cash value intact but allows you to access funds you need for other purposes.
The cash value amount of your policy is the first number used when determining your cash surrender value.
Surrender fees and other charges
To get the cash surrender value, certain things must be subtracted from the cash value.
Loan balance and interest
First, any outstanding loans and interest due are subtracted from the cash value.
This makes sense because surrendering the policy means you no longer have the cash value to use as collateral for the loan.
Next, any surrender charges outlined in the policy are subtracted.
Surrender charges are amounts that are taken out of your cash value for terminating the policy in a certain period.
Surrender charges are highest at the beginning of the policy.
Permanent life insurance policies have surrender charges to discourage people from canceling their policy early in the policy’s life.
The period which you have to pay a surrender charge is called the surrender period.
The charges may be so high you get no cash value after the surrender charges in the first few years.
This is partially because these policies have high costs to the life insurance companies, including salespeople’s commissions for selling them.
The surrender fees usually decrease over time, eventually reaching zero. This may take a decade or more to happen, though.
Finally, any other applicable administrative or other fees the policy charges are subtracted.
These policies are often full of fees, so carefully read your insurance contract before deciding to surrender it.
This way, you’ll know the actual cash surrender value your insurance company will pay you before surrendering the policy.
How Cash Surrender Payments Are Taxed
Generally, surrendering a life insurance policy is tax-free.
That’s because the amount of money you receive usually is less than the amount of the premiums you paid.
Technically speaking, your life insurance cash surrender payout could be taxable, though.
To determine if your policy is taxable, you need to know two numbers:
- the payout you receive from the cash surrender value
- the total amount of the premiums you paid for the policy
As long as the premiums paid are greater than the payout, you don’t owe taxes.
Otherwise, you’ll need to report the excess on your tax return to determine if it is taxable or not.
Why Cash Surrender Value Matters
Cash surrender value matters because it’s the exact amount of money you get after surrendering your permanent life insurance policy.
Many people mistakenly believe they’ll simply get the cash value in their policy.
Unfortunately, the fees often result in a much lower payout.
Understanding this amount is essential because it can provide liquidity in a worst-case scenario.
If you need life insurance and the death benefit it provides your beneficiaries, surrendering your policy isn’t the best idea.
Instead, you may want to consider other alternatives.
Other Alternatives to Surrendering Your Policy
Surrendering your policy may seem like the best option to get the money you need. You may have other options, though.
Selling your life insurance policy
Selling your insurance policy to a third party is called a life settlement.
When you do this, you assign the policy to a third party. This party is responsible for making premium payments going forward.
You are still insured by the policy. However, the third party can change who the beneficiary is.
They will change the beneficiary to the company. Then, when you die, they’ll collect the death benefit payment.
If the payment from a third party is more than you’d receive from surrendering your policy, it may make more sense to sell it.
If you’re terminally ill or have a chronic illness, selling your policy for a sum of money up front would be called a viatical settlement.
You may want to do this to access the funds to pay bills or take a once in a lifetime trip before you pass away.
Remember that selling your policy means your beneficiaries won’t receive the death benefit payment.
If they still need the death benefit payment for financial support, selling your life insurance policy may not be a good idea.
Taking out a loan
If you prefer to keep your policy in place, you may want to take out a loan.
Most life insurance companies allow you to use your cash value as collateral for the loan.
This leaves the cash value intact. You can choose to repay the loan when you wish.
The loan charges an interest rate. Interest isn’t charged to you, though.
Instead, it gets added to the loan balance. This means it eats away at the cash value, though.
If the loan plus the interest owed ever exceeds the cash value, the policy will terminate.
That’s why you must carefully monitor the loan amount and your cash value to make sure there isn’t an accidental termination of your policy.
You can repay the loan as you wish. Doing so frees up part of your cash value.
If you completely pay off the loan and interest, your full cash value is restored and accessible again.
Using cash value to pay premiums
Sometimes you need money to make the premium payments on your policy.
After all, you don’t want your policy to expire because you missed payments.
Some policies allow you to use your cash value to pay the premiums.
This can help keep your policy active.
Even so, another option may exist. Some policies allow you to use your cash value to create a paid-up policy.
A paid-up policy means you never have to make premium payments again.
Unfortunately, the cash value isn’t usually enough to create a paid-up policy for your current death benefit in most cases.
Instead, the paid-up policy will result in a reduced death benefit value.
Still, you’d have a life insurance policy that will pay your beneficiaries when you die.
The best part is you never have to make the premium payments again.
Still Want to Surrender Your Policy?
If you want to surrender your policy but still need life insurance, consider purchasing a term life insurance policy.
Term life insurance policies have much cheaper premiums than taking out a new permanent life insurance policy.
They only stay in effect for a set period, called the term. You decide this when you take out the policy.
The term should give you time to save up or invest enough money to cover any needs after the policy expires.
Usually, you’re closer to retirement and have fewer dependents when the term expires, as well.
Consult an Expert
An expert can help you look at your situation to see if surrendering a life insurance policy makes sense.
Your life insurance agent isn’t the best person to talk to, though.
While they can explain how much money you’ll walk away with after surrender fees, they want you to keep your policy.
Your agent likely receives a small residual commission each year you keep your policy in effect.
For this reason, they’ll likely try to get you to keep your policy. Alternatively, they may try to sell you another policy.
Instead, consider consulting a fee-only fiduciary financial planner.
These experts do not accept commissions but do charge for their time.
They can give you an objective assessment of your situation and suggest the best path moving forward.