Cash Surrender Value

Last updated on December 10, 2021 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.

Cash Surrender Value Process

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.

Reasons to Surrender Your Policy

When you surrender your life insurance, you are telling the insurance company that you don’t want life insurance coverage. In exchange, the policyholder receives a portion of the cash value of the policy.

If you own a term or cash value life insurance policy that you no longer need, you may be wondering if it’s worth continuing to pay the premiums. If the answer is no, you have to decide what to do with the policy. You have several alternatives to choose from, but the simplest way is to surrender the policy altogether.

Here are the most common reasons why people surrender their life insurance policies.

The Coverage is no Longer Needed

If your policy’s beneficiary passes away before you, you may have no other person to name as their replacement.

Alternatively, if you named your spouse as your beneficiary and are now getting a divorce, you may want to get rid of the policy. Of course, your divorce decree may stipulate that you keep the policy in force with your ex as a beneficiary.

Another common scenario is naming your children as beneficiaries, but they no longer need the coverage as adults. This often happens when the adult beneficiaries are financially stable and have no need for financial assistance.

How To Get the Cash Value out of a Policy

When a policy is surrendered, the policy owner will receive all of the remaining cash value in the policy, known as the cash surrender value. This amount will generally be slightly less than the total amount of cash value in the policy because of surrender charges assessed by the policy.

Surrendering a policy can be a valuable source of quick cash for someone who doesn’t have access to other liquid assets and needs the life insurance money now.

If you are surrendering your policy just to access the cash value, consider a life settlement instead.

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.

How to Surrender Your Policy

Surrendering your life insurance policy is a relatively simple process.

If you want to cancel your coverage:

  1. Stop paying the premiums
  2. Contact the insurance company and tell them that you want to cancel the policy.
  3. You will need to ask the insurance company to send you a surrender form or have them tell you where you can download one online.
  4. Also, ask them whether a letter of instruction will suffice to cancel the policy.
  5. Complete the form (or letter of instruction) and send it to the insurance company via certified or overnight mail for tracking purposes.
  6. Once the tracking system shows that it was received, call the company to confirm that they received your request. They will then cancel the policy, and you won’t owe them anything more.

This process is the same for both permanent life insurance (such as whole life and universal life) and term life insurance.

life insurance cash surrender value

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 lapse before the policy accumulates any cash value or no surrender charges are assessed.

Value of a Cash Surrender

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.


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Cash Surrender Value Taxes

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.

Any amount that you receive over the total amount of premiums you paid (known as the cost basis) is taxed as ordinary income. This means that you will pay tax on this amount at your top marginal tax rate.

For example, say that you are in the 25% tax bracket and you paid a total of $10,000 of premiums into your cash value (universal life insurance) policy.

Your cash value is now worth $13,000, and you decide to surrender your policy. You pay $1,000 in surrender charges and receive a check from the insurance company for $12,000. You will pay tax on $2,000 at a rate of 25%.

The other $10,000 is considered a tax-free return of principal.

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

Alternatives to Surrendering a Policy

There are several ways that you can access the cash value in your life insurance policy that don’t require you to surrender it. Here are some alternatives to choose from:

Direct Withdrawal

In a direct withdrawal, you take money out of your cash value but leave enough in the policy to keep it in force.

You have to continue paying premiums, but you can keep the death benefit protection this way. The death benefit is reduced by the amount you withdraw.

Policy Loan

The most common way to access the cash value in your life insurance policy is to take out a loan using the policy as collateral.

The interest on the loan is charged to the cash value in the policy but the interest rate is usually less than you would pay other traditional lenders.

This is great for those with poor credit histories because there are no underwriting requirements of any kind for this type of loan. You are essentially borrowing your own money out of the policy.

Life Settlement

The most profitable way to cancel your coverage is with a life settlement.

In a life settlement, a qualified buyer purchases your policy and assumes the responsibility of paying the premiums. The buyer will then receive the death benefit when you die, and you will walk away with a lump sum up front at the time of purchase.

The Tax Cuts and Jobs Act of 2017 made the tax rules for this type of transaction much simpler.

There are now basically three ways that the amount you receive is taxed:

  1. All money that you are paid up to the total amount of premiums that you paid is considered a tax-free return of principal.
  2. All money that is paid in excess of this amount is taxed as ordinary income at your top marginal tax rate.
  3. All money received over the policy’s cash value is taxed as a long-term capital gain.

Be aware that these alternatives are only available for cash value policies such as universal life policies. These options are not available for term life insurance policies.

This process is materially identical to the life settlement process, but you will generally receive a higher payout using this alternative. The tax rules are also the same.

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