Surrendering a Life Insurance Policy

Last updated on July 2, 2021 by Chris Granwehr in Life Settlements, Retirement Planning

A happy couple wondering if they should surrender their life insurance policies.

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There may come a time when you no longer want or need your cash value life insurance policy.

Before you cash out your policy, consider your options and decide whether surrendering your policy is the best choice for you.

It is important to note that there are alternatives to a cash value surrender, including options that pay more.

This article details how a cash value surrender works and outlines other solutions that may be available to you.


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.

To Get the Cash Value

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.

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Less Expensive Coverage is Available

Has your health substantially improved since you took out your last policy (e.g., your weight changed dramatically or you quit smoking)? Then it may be wise to surrender your current policy and take out new coverage.

However, you may come out ahead by instead exchanging your current policy into the new one via a tax-free 1035 exchange.

Miscellaneous reasons might include:

  • Your current policy no longer meets your needs.
  • Better performing policies are now available.
  • Premiums have become too expensive.

Understanding Cash Surrender Value

If you are canceling something other than a term policy, you will probably have a small amount of money left after cancellation. The life insurance company will calculate this value, known as the cash surrender value or the non-forfeiture value.

The cash surrender value calculation is based on:

  1. The total amount of premium payments you made into the policy.
  2. The performance of the investments that the cash value is held in.
  3. Any applicable surrender fees.

The cash surrender value is, therefore, the amount of money you will receive after all surrender charges and administrative costs are subtracted from the policy’s cash value, and any outstanding loans are repaid.

The insurance company can only hold your cash surrender value for a set period that is determined by law before they have to give it to you.

Many life insurance companies offer policies that have surrender periods that last for 10 to 15 years. Surrender charges can be substantial during the first few years of the policy. Because of this, it is generally not advantageous to cancel a new policy.

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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.

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