What is Cash Surrender Value in Life Insurance?

Last updated on October 21, 2019 by Mark Cussen in Life Settlements, Retirement Planning

Elderly couple on a hike at sunset discussing what is cash surrender value.

Canceling a life insurance policy can sound like an appealing solution for those looking to reduce retirement expenses.

If you’re thinking about canceling your life insurance policy, why not maximize the return on your investment?

Today, we’re going to walk through cash surrender value – an alternative to selling your life insurance policy that will allow you to trade in your life insurance policy for cash.

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We’ll start with a detailed overview of what cash surrender value is, followed by a walkthrough of how cash surrender values are calculated, and then talk about some alternatives to consider before surrendering your policy.


What is Cash Surrender Value?

The cash surrender value in your life insurance policy 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 Work?

When you pay the premiums on any type of cash value life insurance policy, such as a whole life policy, universal life policy or variable universal life policy:

  • Some of that money goes to pay for the death benefit protection that the policy provides
  • Some of it is used to pay the various fees and costs of the policy
  • The remainder is deposited into the cash value of the account.

The dividends paid by whole life policies can be used to increase the cash value, while universal life insurance policies pay an interest rate based on prevailing rates that is usually applied to the cash value.

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.

Couple discussing cash surrender value of 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.


Calculating Your Policy’s Cash Surrender Value

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.


Taxation of Cash Surrender Value

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.

cash surrender value taxation

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 in 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

The Term Alternative

If you need to liquidate your cash value policy, consider using some of the cash to purchase a term policy in order to replace the death benefit protection that you’re losing.

Term insurance costs much less than any type of cash value life insurance and can keep your beneficiaries covered while you get the remaining cash value.

Related: Term vs. Life Insurance: What’s the Difference?


MEC Withdrawals

Modified endowment contract withdrawals are taxed differently than the cash surrender value of a traditional life insurance policy. MECs are taxed on a last-in-first-out basis, which means that all of the growth in the contract will be paid out first, which is then counted as taxable income.

Surrender penalties may also apply. Any distribution from a MEC that is taken by someone under age 59 ½ will also be assessed a 10% early withdrawal penalty unless a qualified exception applies.


Conclusion

If you want to cash in your life insurance policy, it is always best if you can wait until the end of the surrender period in order to avoid extra fees and charges.

Taking out a policy loan is a better idea in many cases. Consult your financial advisor or life insurance agent for more information on cash surrender values.

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Mark Cussen
Mark Cussen
Mark Cussen is a financial counselor with more than 13 years of experience and has professional designations as a CFP®, CMFC and AFC. Mark has worked in all segments of the financial industry from investment management to mortgage loan origination, life insurance and annuities, financial planning and income tax preparation. He currently works with the U.S. military, helping service members transition financially into civilian life and in other capacities. Mark also sells life insurance and annuities on the side. He graduated from the University of Kansas with a Bachelor’s degree in English.

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