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BLOG 07/06/2022

Cash surrender value of life insurance

Permanent life insurance offers financial protection for a lifetime. Yet, you may not be aware of another compelling feature of permanent life insurance: you can withdraw cash from the policy while you’re alive. You can access funds from a permanent life insurance policy by making a withdrawal or taking out a loan. Or, if your financial circumstances have changed, you may decide to surrender the policy, thereby canceling coverage and removing the policy’s cash value.

While surrender may seem like a good option if your finances are tight, it’s best to use it only if you have another financial safety net for your loved ones, such as a term policy. Otherwise, loved ones may be without adequate financial protection if the unexpected happens.

What is cash surrender value?

Cash surrender entails canceling your coverage altogether while walking away with its cash value, minus applicable fees, in your pocket. When you surrender your life insurance policy for cash, you receive the cash value of premiums paid and dividends you’ve accumulated since opening the policy. But you’ll need to subtract any debts owed (like if you’d previously taken a loan against the policy) and the service charges and fees your insurer may deduct for terminating your contract.

Therefore, the surrender value equals the cash value minus any insurer charges and fees.

Which life insurance policies have a surrender value?

Permanent life insurance policies that accrue cash value have a surrender value. Term life insurance policies do not. eFinancial offers several types of permanent products to choose from:

  • Universal life insurance: This is one of the most flexible life insurance products since universal life coverage can be adjusted as your needs change. For example, if you suddenly lose your job and can no longer afford the monthly payment, you can work with your insurer to adjust the premiums and may be able to decrease the death benefit amount temporarily until you’re back on your feet. With universal life insurance, your cash value will grow based on a variable interest rate and can be used towards paying premiums or other day-to-day expenses in the future.
  • Whole life insurance: With whole life insurance, your premiums will remain level for the life of your policy. Whole life insurance allows you to build a tax-deferred cash value while also offering your beneficiaries a tax-free lump sum cash payment.

How is cash surrender value calculated?

Follow these steps to calculate the cash surrender value of your life insurance policy:

Calculating what you paid in premiums

With permanent life insurance, a portion of what you pay in premiums goes toward building cash value, while the rest goes toward funding your policy’s death benefit. To accurately assess surrender value, you’ll need to calculate how much you’ve paid into your cash-value account. This amount will depend on the length of time you’ve held the policy; the longer it’s been, the more you will have paid in premiums toward cash value. If you’re unsure how much you’ve paid toward cash value, it’s best to check with your insurer directly.

Determining if there are fees to surrender the policy

You may have to pay surrender fees depending on how long you’ve held your policy. The penalties your insurer might charge for terminating your policy will be higher in the first few years and generally decrease over time. Contact your insurer if you can’t locate information about fees by reviewing your contract or looking at your information online.

Subtract surrender fees from cash value

Once you know your surrender fees, subtract them from your cash value. For example, if you have an insurance policy with a cash value of $10,000 and a surrender fee of 20%, you will receive the policy’s cash surrender value of $8,000.

Factor in taxes

Some of the money you receive from cashing out your policy may be taxable. The taxable portion includes any investment gains or interest earned when you held the policy. You can calculate your taxable income by deducting what you paid in premiums from the cash surrender value you received. For instance, in the example above, if you paid $5,000 in premiums, you would be subject to taxation on the remaining $3,000.

When can you surrender a life insurance policy?

Life insurance policies with a cash value component are often subject to a surrender period which might last between 10 to 20 years. You could face financial penalties if you cash out during this time. The good news is surrender fees will decrease as you approach the end of the period. Insurers can provide a surrender fee schedule that shows the year-by-year breakdown of surrender fees. It can often save you money if you are able to wait until the surrender period has passed to cancel your policy.

Alternatives to surrendering your life insurance policy

Surrendering your life insurance policy may not always be the best option, especially if you have loved ones you want to take care of after you’re gone. For the sake of your beneficiaries and their safety net, it may be better to consider one of the options below.

Take out a loan or withdrawal

Instead of cashing out the entire policy amount, consider making a withdrawal that’s sufficient to meet your financial needs. You could also take out a loan against your policy’s cash value, saving you surrender fees. You’ll just want to be sure to repay any loans, or loved ones will need to sacrifice some of the policy’s death benefit to cover the remaining balance.

Use cash value to pay premiums

If you’ve had your policy for many years, you may be able to use the cash value to pay premiums. That means you could continue the policy at the same coverage level in a period of financial discomfort without actively making monthly payments. If using cash value to pay premiums is not an option, work with your insurer to see if you can reduce the death benefit or until you’re in a more stable financial situation.

Exchange or sell the policy

Some insurance companies allow you to exchange your life insurance policy for other products, such as an annuity or long-term care insurance, in a transaction called a 1035 exchange. This like-kind exchange transaction can be complex, so you may want to bring in a financial professional for assistance.

You might also be able to sell your policy to a third party. This arrangement could potentially get you more than the cash value, while the death benefit and the responsibility for paying the premiums transfer to the settlement company.

Consider a term life insurance policy

If you think it’s the right time to surrender your permanent life insurance policy, but you still want peace of mind, getting an affordable term life insurance policy could be a viable solution. Contact an agent at eFinancial to discuss the best options for your unique situation or get a free quote online.