Cash Surrender Value: Everything You Need to Know

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The cash surrender value of a life insurance policy is the remaining amount of cash value that you get after you surrender the policy and repay all outstanding fees and loans.

When you own a cash value life insurance policy, the cash value builds up over time as premiums are collected and deposited. If you want to cancel your policy, then you are at liberty to do so.

If you decide to do this, then you can simply stop making payments on the policy and notify the insurance carrier that you want to cancel. The insurance company will then cash in your policy and take all outstanding surrender charges and/or penalties out of your cash value and also any outstanding loan balances.

You will then get a check or deposit for the remainder. This amount of money is known as the cash surrender value. You will not get the death benefit from the policy, and you’ll have to take out a new policy if you later decide you want the coverage after all.

Only for cash value life insurance policies

All policyholders of cash value policies have the option to cash in their policies at any time. This goes for whole life insurance, universal life insurance, variable universal life insurance, and indexed universal life insurance. Those who own term life insurance policies do not have this option, as term insurance is pure death benefit protection and contains no cash value.

If you want to discontinue a term life policy, then you just need to quit paying the premium and it will cancel automatically at the end of the grace period (which is usually 30 or 31 days). But there is no cash surrender value.

What is cash value in a life insurance policy?

Cash value is the savings that build up inside a permanent life insurance policy. These policies credit the cash account with interest over time as premiums are paid into the policy. There are four different types of permanent life insurance.

  • In a whole life insurance policy, the rate of interest that is paid on the cash value is set at the time of purchase and does not change once the policy is issued.
  • In a universal life insurance policy, the rate of interest paid into the cash value will vary as prevailing interest rates move up and down.
  • In a variable universal life insurance policy, the interest that is credited into the cash value depends upon the performance of the mutual fund sub-accounts housed inside the policy. It is possible to lose money with this type of policy.
  • In an indexed universal life insurance policy, the amount of interest that is credited depends upon the performance of an underlying financial benchmark index such as the Standard & Poor’s 500 Index. When the index rises in value, a proportionate amount of interest is credited to the policy. When the index falls, no interest is credited, but the cash value does not decline in value either.There are several specific crediting methods that life insurance companies use when calculating the amount of interest that is payable. They may pay interest monthly, quarterly, semiannually, annually or biannually, and each method uses its own proprietary formula to calculate the amount of interest that is to be paid to each policyholder.

It is always the insurer that pays the interest into the cash value, and life insurance companies collectively have trillions of dollars of cash value stored up inside their cash value policies.

How cash value grows

In the early years of a cash value life insurance policy, most of the premium payments go towards paying for the death benefit (and accelerated benefit riders in many cases), so the cash value grows fairly slowly.

After about ten years, though, the majority of the premiums that are paid will be deposited into the policy’s cash value, where it will grow tax-deferred over time until it is either withdrawn or the policyholder dies.

If the latter happens, then the policy’s death benefit or face amount is paid to the beneficiary or beneficiaries. The cash value is retained by the insurance company, unless the insured purchased a rider that adds the cash value to the death benefit.

Is cash value taxable?

If you completely surrender your cash value life insurance policy, then you will have to pay ordinary income tax on any amount you receive that exceeds your total premium payments. This means that you’ll pay tax on that money at your top marginal tax rate.

Example

Bob takes out a $200,000 life insurance policy on himself and pays $300 per month in premiums. Five years later, he surrenders the policy and receives $22,000 after all surrender fees have been paid.

The first $18,000 is considered to be a tax-free return of principal, while the remaining $4,000 is classified as ordinary income. Since Bob is in the 24% income tax bracket, he will pay $960 of tax on his withdrawal.

There is no capital gains treatment allowed when you cash in a life insurance policy, regardless of how long the policy has been in force. Bob will also forfeit the policy’s face value of $200,000.

Are there cash surrender fees for policyholders?

If you surrender your cash-value life insurance policy within the first five years of taking it out, you will most likely have to pay some stiff surrender charges that could easily leave you with a cash surrender value that is less than the total premiums that you paid into the policy. These fees usually decline over time, so it may pay to wait for a few more years before cashing in your policy so that the surrender fees won’t be so high.

Happy seniors evaluating their cash surrender value and life settlement options.

For this reason, many financial advisors and insurance agents discourage their clients from canceling their life insurance coverage, especially during their early years. When you first decide to buy a specific life insurance policy, find out how long the surrender period lasts and think about whether you might need to cash your policy in before this period ends.

How do I determine my cash surrender value?

Your monthly statement for your policy will most likely show you what the current cash surrender value would be if you were to cash in your policy.

In most cases, you can also log on to your life insurance company’s website to get a payout quote. Just type in your login ID and then your policy number, and all vital statistics of your policy should appear on-screen.

If you can’t find your cash surrender value using either of these methods, you can just call your life insurance carrier and give them your policy number. They can give you an exact quote of your policy’s cash surrender value as of that day.

Cash value vs. death benefit

It should be noted that the cash value of a life insurance policy is the amount of savings that have accumulated over time. The death benefit (also known as the face value) of the policy is what is paid out to beneficiaries upon the death of the insured on the policy.

Whereas any amount of cash surrender value that you receive above your cost basis is taxable, the death benefit that is paid is always tax-free. This is true of all life insurance products. The death benefit will always be more (usually considerably more) than the cash value unless the policy matures. This may happen once you get into your nineties or reach age 100.

At that point, the cash value in the policy will equal the death benefit. The life insurance company will pay you the cash value and then cancel the policy. The tax rules are the same as described previously.

Pros and cons of a cash surrender value of life insurance

If you decide to cash in your policy, then you won’t have to make any more premium payments (which may be the reason you decided to cash it in in the first place). But you will also lose the death benefit protection and must pay tax on any gain in your cash surrender value. For these reasons, most financial professionals recommend that their clients use an alternative method to draw cash out of their policies.

How to surrender your policy

If you decide to cash in your policy, the following steps tell you what to do:

  1. Discontinue making the premium payments.
  2. Contact the insurance company and inform them that you wish to cancel your coverage
  3. Have the insurance company send you the paperwork you need to fill out to surrender the policy or download the form online. You can also ask them if a simple letter of instruction is all that is needed to cancel the policy.
  4. Fill out the letter or other paperwork and send it to the insurance company via certified mail so that it doesn’t get lost.
  5. Call the company a day or two later to confirm that they received it and are processing it correctly.

Alternatives to policy surrender

There are five other ways that you can take your money out of a life insurance policy. These include policy loans, cash withdrawals, life and viatical settlements, and accelerated benefit riders.

Policy loans

This is a very simple way to get money out of your cash value life insurance policy. Simply contact your carrier and tell them that you want to take out a loan against the cash value in your policy.

Since you are essentially borrowing from yourself, you don’t have to qualify for this type of loan. The life insurance company will tell you how much you can borrow without causing your policy to lapse.

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You also have the option of borrowing from your cash value in the form of an annuity, where the life insurance company pays you a regular monthly or quarterly amount. This is superior to cancellation because this way the policy stays in force, and you retain the death benefit protection. If you die before repaying the loan, the death benefit will be reduced by the outstanding loan amount.

Cash withdrawals

This is another very simple way to access the cash in your cash value policy. You just contact your carrier and tell them that you want to withdraw a certain amount, and they will send you the money. Just be sure not to take so much that the policy lapses. Unlike a loan, this amount of money does not have to be repaid.

Life settlement

This method of getting money out of your life insurance policy is rapidly becoming the favorite alternative for many policyowners. You will most likely get much more money out of a life settlement than you’ll get from either of the other two alternatives.

In a life settlement transaction, you will sell your policy to a qualified life settlement company for a sum of money that is substantially less than the death benefit but considerably more than the cash surrender value. Just be sure to consult with a tax expert on how your settlement will be taxed.

In most cases, the amount of premium that you recoup is considered a tax-free return of principal, and any cash value in the policy that exceeds the amount of premium that you paid is taxed as ordinary income. Any payment amount in excess of the policy’s cash value is taxed as a long-term capital gain.

Example

Larry is a 60-year-old policy owner with an indexed universal life insurance policy with a face amount of $1 million. He has $150,000 of cash value in the policy but no longer needs the death benefit now that his kids are grown. He contacts a life settlement company to see what they can get him.

After they do their due diligence, the life settlement company comes back with an offer of $600,000 for his policy. Larry agrees to this and signs his policy over to the settlement company. He remains the insured on the policy, but the settlement company becomes the new owner and beneficiary.

The settlement company will continue to pay the premiums on the policy for the remainder of Larry’s life. When Larry dies, the settlement company collects the death benefit and recoups its costs plus a profit.

Life settlements are by far the most profitable way to cash in a life insurance policy, and the industry that services this segment of the population is exploding. Billions of dollars’ worth of these settlements will be transacted in the coming years.

Viatical settlement

A viatical settlement is a life settlement for someone who is terminally ill. A settlement company, called the viator, will buy the life insurance policy for someone with a life expectancy of less than two years.

In most cases, the insured will have to supply written evidence of their condition. Viatical settlements first appeared in the 1980s in the wake of the AIDS epidemic, as viators sought to profit off of terminally ill AIDS patients by giving them cash upfront to pay their medical bills for a period of time. This helped take the financial burden off of their loved ones as well.

Accelerated benefit riders

The last way to access the money in your cash value life insurance policy is with accelerated benefit riders. These riders will pay out some or all of the death benefit upfront if the insured becomes disabled or otherwise incapacitated.

This is perhaps the most efficient method of accessing the value in a life insurance policy, except that in most cases, the insured must be unable to perform at least 2 out of the 6 activities of daily living (ADLs).

These riders cannot be used for any other purpose. There are accelerated benefit riders for disability, long-term care, critical illness and chronic illness.

Accelerated benefit riders are changing the game in the life insurance industry as one vehicle can now provide several different forms of protection. And the total amount of money that comes from these riders is not considered to be taxable income.

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When it comes to personal finance, cashing in a life insurance policy can be a major step backwards. If you can use one of the alternatives listed above instead of cashing in your policy, in most cases you would be well-advised to do so.

Consult your financial advisor or life insurance agent for more information on how you can best access the money in your life insurance policy. Want to see how much you could sell your life insurance policy for? Find out in seconds with our free life settlement calculator.

Author:
Chris Granwehr is the Founder of Dawn Life Settlements and a former senior manager with Mason Finance, an industry-leading life settlement provider in California. He's a member of the Life Insurance Settlement Association, and he has a passion for empowering customers financially through a faster, easier life settlement system.