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Life insurance can be a useful tool, but there may be times when you wish you could free up your investment to pursue other financial priorities. Some (although not all) insurance policies do give you that option. Whole life insurance, variable life insurance and universal life insurance typically have cash value components, which means that if you surrender your policy, you may get some money back. Term life insurance policies do not offer a cash value option. Before surrendering your policy, it is important to understand what the cash surrender value of life insurance is and how that value is determined.
What is the cash surrender value of life insurance?
Cash surrender value is the amount of money your life insurance provider would give you if you surrendered or canceled your policy.
Cash value is a component of a whole life policy and other types of permanent life insurance. With these types of policies, your insurance provider takes a portion of your premiums and puts it into a cash value account where the money can grow. Depending on which type of policy you have, that cash value component will move with market subaccounts, rely on internal company calculations or grow at the current standard interest rate.
If you decide to give up your life insurance policy, you get the cash value of the investments made within it after any surrender fees have been subtracted. As noted above, term life insurance policies do not offer this component and do not have a cash surrender value.
How is cash surrender value determined?
The cash surrender value can be determined in a couple of ways based on the different types of life insurance policies. For variable life policies, the value of the investment fluctuates with the sub-accounts that it is invested in. For a whole life policy, the value grows at a rate determined by the insurance company. With universal life policies, the value grows at the industry standard rate. The list below goes into greater detail about how cash surrender value is determined.
- Duration of account: The duration of your account plays the biggest role in cash value as it reflects both how long you have been paying into it as well as how long your investment has had to grow.
- Amount paid: A portion of your life insurance premiums makes up the investment capital in the cash value component of your policy. As such, the more you pay, the bigger your investment is.
- Market performance: If your investment is tied to the market, then market performance becomes a dominant factor. When the market does well, your investment may also do well.
Surrender fees and waiting period
Before taking your cash surrender value, you must first wait out the surrender period. The surrender period is a specified amount of time that must pass before you can surrender your policy and access its cash value. This waiting period is determined by the specific policy type and insurance company. It may be as short as a few years or as long as 15 years. Some companies will allow you to surrender a policy during this time, but typically for significantly higher fees and lower payout.
What happens when a policy is surrendered for its cash value
Most companies charge surrender fees when you claim the cash surrender value of your life insurance policy. In general, these fees are more expensive for newer policies and decrease over time. Surrender fees vary quite a bit between plans and depending on the age or duration of the policy in question. However, it is common to see surrender fees in the range of 10 percent to 35 percent.
For instance, imagine you have a twelve-year-old life insurance policy with a cash value of $7,000 in it. You decide to surrender your policy for the cash value. After your insurance company adjusts for their surrender fee of 20 percent, you receive $5,600, and the company takes $1,400 in fees. The amount you receive is the cash surrender value, while the initial amount is the base cash value.
Be advised that you might be taxed on a portion of the cash surrender value of life insurance. If you are unsure of the tax laws surrounding your life insurance policy and its cash surrender value, contact your insurance company, your agent or an accountant.
Is surrendering your policy worth it?
Depending on your situation, it may be worth it to surrender your policy. If you are planning on switching to a different life insurance policy, especially if it is with another company, then surrendering your policy might make a lot of sense.
Another potentially good time to surrender your policy is if you switch jobs and your new position offers free or subsidized life insurance. Of course, you might also surrender your policy if you are in vital need of immediate cash and have no other options. This final motivation, however, should be a last resort. In such a situation, taking out a personal loan may make more sense. You may even be able to borrow against your life insurance policy.
Surrendering your policy is not always going to be a wise choice. You will not likely recoup the full amount that you spent on premiums over the years. Cash surrender value is not a refund–it is only returning your investment while taking into account any gains or losses. If you want a policy that would allow you to get back what you spent on premiums, consider a return-of-premium life insurance policy instead.
Alternatives to surrendering your policy
Before you give up your life insurance policy and the financial protection it gives your loved ones, it may be wise to explore other options. Here are a few options you can consider before surrendering your life insurance policy.
Withdraw cash value
In many cases, you can make a direct withdrawal from your cash value. You may have to leave a specified amount of it in place but might be able to withdraw and use the rest. Keep in mind that the money you take out may be deducted from your death benefit, leaving your loved ones with less after you pass away.
Take out a policy loan
Another way of gaining quick money through your life insurance policy is a policy loan. These are loans that use your life insurance policy as collateral. If all or part of the loan is outstanding at the time of your death, your life insurance provider will subtract the owed amount from your death benefit.
Sell the policy
If you are determined to cancel your policy, then you might be able to sell it instead. This may net you more than the cash surrender value while still taking the plan off of your hands. This transaction is called a life settlement.
There are brokers for life insurance policies, but it is also possible to contact insurance companies directly. In some cases, your provider may be able to sell your policy for you in return for fees. Once you’ve located a buyer, the life settlement process is relatively straightforward. A price is agreed upon, and you fill out a specialized application. If that goes well, then you exchange the policy rights for the agreed-upon price.
This process may take a couple of months or longer. However, some life settlement companies will provide partial or full payments before the entire process is complete.
Frequently asked questions
Like most financial products, life insurance is very personalized, so there is no one best life insurance company for everyone. Instead, consider what it is you are looking for. Do you know what type of policy you want? Is customer service especially important to you? Which companies are known to offer policies that cater to your age and lifestyle? Make a list of what is important to you and then pick a few companies to get life insurance quotes from so you can compare policy offerings and see what is right for you.
Possibly. You may be able to contact an agent at your insurance company and inform them that you would like to make a life settlement on your life insurance policy, but this process is typically lengthy and should not be considered a guarantee fallback option when you buy a policy. You can contact a licensed agent from your life insurance provider for more details on your specific policy and whether it may be sold.
A portion of the cash surrender value may be taxable as income, depending on what it’s worth and how much you’ve paid. Specifically, this tax applies to any amount you receive in cash value that is in excess of what you have paid in premiums on the policy. The rest of the cash value is the amount you paid in and will not be taxed at this point because it will have previously been part of your taxable income. This taxable portion also includes interest gained on your policy’s cash value.
Cash value is the full value of the cash-generating portion of your policy. The cash surrender value is what you might expect as an actual payout if you surrender your policy and its benefits–typically the cash value minus any fees, penalties or other charges. Be mindful that surrender costs do not always apply; at some point, these values may be the equivalent. Consult your insurance company or policy documents for details about your specific policy.