What Is the Cash Surrender Value of Life Insurance?
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Cash surrender value is the amount you get if you terminate certain life insurance policies.
Only permanent life insurance has cash surrender value.
You could owe taxes on part of the cash surrender value.
One advantage of buying permanent life insurance is that it offers both a death benefit and a savings component called cash value. If you no longer need life insurance — say, because your children are grown and financially independent — you can cash out the policy. The cash surrender value is the money you’ll receive after terminating a permanent life insurance policy.
How the cash surrender value works
Cash surrender value is the amount of money a policyholder receives when they terminate a permanent life insurance policy before it matures or before the insured dies.
When you buy permanent life insurance, part of the premium goes toward insuring your life. The remainder goes toward a cash value component that functions kind of like a savings account. Cash value is the amount of money in your policy. It grows slowly at first, but the value can accelerate over time thanks to the power of compound interest and earnings.
If you opt to terminate your policy, your loved ones won’t receive a death benefit. Instead, you’ll receive the policy’s cash surrender value, which is the cash value minus any surrender charges or fees, policy loans or prior withdrawals.
Because policies don’t have significant cash value in the first few years, you typically won’t get much money when surrendering your policy early on. Plus, most policies charge surrender fees for the first 10 to 15 years that the policy is in force.
Surrender fees start out at their highest in the first year of your policy’s life and go down slightly each year after that.
Most policies pay the cash surrender value in a lump sum, though some may make periodic payments. Check your policy contract to learn how the carrier pays out cash surrender value.
How the cash surrender value is calculated
The cash surrender value equals the policy’s cash value minus surrender fees. Any loans you’ve taken against the policy or unreimbursed withdrawals will also decrease the cash surrender value.
Due to surrender fees and the slow accumulation early on in the policy, the cash surrender value will usually be less than the premiums you’ve paid — or even zero — during the first few years. The longer the policy remains in force, the closer the cash value will be to the cash surrender value.
The cash value in a permanent life insurance policy grows on a tax-deferred basis. But if you cash out a policy, you’ll typically owe taxes if the cash surrender value is higher than what you paid in premiums.
For example, say you’ve paid $20,000 in premiums and the cash value of your policy is $25,000. Your policy has a 4% surrender charge to terminate it, resulting in a surrender charge of $1,000 and a cash surrender value of $24,000. Generally, the $4,000 gain would be considered taxable income.
Which policies have a cash surrender value?
Term life insurance policies don’t have a cash surrender value because they don’t accumulate cash value. Only permanent life insurance policies have a cash surrender value.
Whole life insurance: Cash value in a whole life policy accumulates at a rate guaranteed by your insurer. If your policy earns life insurance dividends, the cash value and cash surrender value can grow at an even higher rate than the insurer guarantees.
Universal life insurance: With universal life insurance, cash value and cash surrender value will increase or decrease based on current interest rates and cost of insurance and expense charges.
Variable life insurance: Both variable life insurance and variable universal life policies let you invest the cash value in mutual fund-like subaccounts. Your cash value and cash surrender value have more growth potential, but they could also drop significantly due to poor market performance or changes in the cost of insurance.
Indexed universal life insurance: The cash value of indexed universal life insurance policies are tied to an index, like the S&P 500. Your cash value will increase or decrease based on the performance of the indexes. These policies typically have minimum guaranteed returns and a cap on maximum returns.
When to consider surrendering your policy
Surrendering a life insurance policy is a big decision, given that your loved ones won’t receive a death benefit. However, there are some scenarios where terminating a policy for the cash surrender value makes sense:
You need a large sum of money. When you surrender your policy for its cash value, you can use the money however you want. That can be helpful if you’re facing major medical expenses or home repairs, you need to pay off debt, or you want to save more for retirement or an emergency.
You no longer need life insurance. Life insurance needs change over time. If your children are grown or you’ve paid off your mortgage, you may opt to surrender a policy for the cash value since your loved ones don’t need a death benefit.
Alternatives to surrendering your cash value policy
If you need cash from your life insurance policy, terminating the contract isn’t the only option. Consider these alternatives to surrendering a policy.
Borrow against the policy. You can take out a loan for up to 90% to 95% of the cash value of a policy. You’ll need to pay interest on the loan. You could pay back the loan in full to the carrier, or you could repay the interest and have the loan deducted from the death benefit. Borrowing against the policy’s cash value is a good option if you need money but don’t want to give up the policy.
Withdraw a portion of the cash value. If you want to keep the policy and don’t need the entire cash value, you could do what’s known as a partial cash surrender. You withdraw a portion of the cash value and the policy remains in force, though the death benefit is typically reduced by the amount withdrawn.
Use the cash value to pay premiums. If you need coverage but can’t afford the premiums, check the policy contract to see if it allows you to pay premiums or the cost of insurance using the cash value. Some policies also offer a reduced paid-up option, which allows you to use the cash value to pay in full for a whole life policy with a lower death benefit.
Sell your policy. Selling your life insurance policy to a third party for an amount that’s lower than your death benefit may be an option. This is known as a life settlement. A life settlement that occurs when a person with a chronic or terminal illness sells their policy is known as a viatical settlement.
Keep in mind that taking out a policy loan, withdrawal or using the cash value to pay premiums may impact your policy's future performance. It’s important to request a life insurance illustration every two years to monitor your policy’s projected performance.
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